Underground Construction - January 2019 - 14

Daniel Shumate|Director, FMI Capital Advisors Inc.

2019 Outlook and Utility & Communications
Construction Update

The utility transmission, and distribution and communication industry
had a strong 2018, but with more mixed results than anticipated this
time last year. Investor-owned utilities remain in a multiyear investment
cycle driven by the need to repair, replace and upgrade the transmission
and distribution infrastructure across the United States.
The aging investor-owned utility construction and repair workforce
has increased the revenue of utility contractors, which are now the primary service providers. However, the construction of fiber networks
to meet the growing demand for broadband service has lagged in some
parts of the country, as engineering limited construction expectations.
Additionally, the infrastructure investment expected from Congress did
not materialize. We enter 2019 with both high expectations and new
challenges to similar growth.
Outsourced utility-related construction is anticipated to nationally be
an opportunity of approximately $60 billion in 2019. It is anticipated to
grow at a combined compound annual growth rate of 3.6 percent into
2021, reaching nearly $66.2 billion. Of the total opportunity, approximately 60 percent of the market is composed of maintenance and repair
related work, which is expected to grow at a lower rate of 3.3 percent
CAGR. New construction related opportunity, while smaller, is expected
to have more greater growth, at 4.0 percent CAGR.
One of the significant drivers of opportunity in the utility construction market is a shift towards greater outsourcing of services to
third-party contractors. Utility providers are doing this to a greater extent because their internal staffing resources have declined in the last decade and have not been replaced. This has occurred primarily in electric
utilities.
As the underground construction industry has continued to grow,
limitations and risk factors are present that could impact sector performance. The most significant is the demand for labor to complete the
work opportunities that exist. Multiple initiatives are ongoing across the
industry to recruit and develop the workforce, and individual companies
have expanded their own internal training plans.
However, training and development of people takes time and could
impact industry growth. Rising interest rates at the Federal Reserve will
affect the volume of construction. Investor-owned utilities and LDC's
have been able to borrow money at very low rates to implement their
investment plans. As borrowing costs rise, however, we anticipate the
burden on the rate payer will increase.

Power distribution
Aggressive power distribution contractors fared well in 2018 with the
rise of distribution spending. They should have similar results in 2019.
Overhead to underground initiatives have been a great opportunity for
contractors in the Southeast and the recent fires in California, related to
down power lines, may create change in California and other parts of the
country. The assets and technology that represent the backbone of our
electric infrastructure were put in place in the 1950s and are near the

JANUARY 2019 | UConOnline.com

end of their life cycle. An estimated 45 percent of electric distribution
assets either currently or will soon need replacement due to reliability
concerns.
Along with required power line infrastructure, significant investment
will be made in complementary infrastructure. For example, utility scale
power storage is expected to grow rapidly as distributed generation becomes more common. In addition, aggregated distributed generation
groups are working with utility commissions to sell excess power back
into the broader network. Electric vehicle charging infrastructure also
has the potential to receive rate base approval in select states.

Natural gas transmission and distribution
The outlook for the natural gas transmission and distribution contractors is very strong. Demand for natural gas has increased in electric power generation, industrial use, exports and residential heating. New power
generation will primarily come from natural gas or renewable sources
such as wind or solar. The price of natural gas will largely determine the
generation direction over the next 20 years.
Natural gas-fired power plants are the primary source of new utility-scale generating capacity today. To accommodate this growth, companies have had to repurpose or reverse existing pipelines and laterals to
gas-fired generators, build new pipelines and increase storage infrastructure. Compared to 2017, over 10 percent more capacity has been put in
place in 2018, and there are strong expectations for 2019 at current price
levels. We expect similar transmission pipeline mileage in 2019 with the
current backlog of expected projects.
For the distribution contractor, North American gas local distribution
companies continue efforts to remove cast-iron and bare steel in 20- to
30-year replacement programs addressing aging infrastructure. PHMSA oversees almost 2.2 million natural gas main and service miles. of
which almost 30 percent are "leak-prone." Unlike other utility products,
the combustible nature of gas does not allow for poor maintenance and
inspection practices. This was felt profoundly in Lawrence, Mass., when
over 40 homes experienced explosions and over 80 homes were damaged
in fires as a result.
Approximately 60 percent of the U.S. gas distribution network was
built prior to 1970. The most leak-prone distribution pipeline material is
cast iron, which still represents approximately 3 percent of gas mains in
the U.S. Bare steel is the second most leak-prone material and represents
4-to-5 percent of gas mains in the U.S. Using estimates from the American Gas Association and PHMSA data, the cost to replace leak-prone pipe
in the United States is still greater than $300 billion.

Communications infrastructure
The communication construction segment (up 5 percent year-over-year)
is experiencing similar tailwinds. The emergence of 5G wireless technologies marks the next great shift in telecom infrastructure (i.e., from
wireline to fiber). Without the far-reaching densification of deep fiber,
carriers will be unable to support the projected increase in mobile traffic

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Underground Construction - January 2019

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