Marc Foster: Greetings, my friends. This is Marc Foster, and welcome to my second podcast. It is November 17th. It's just shy of noon, and I hope this podcast process becomes a little more seamless. As you know, the last one took a bit of time to get through the regulatory process and get in your hands, and I'm hoping you get this by Friday of this week.
I'm currently sitting in the Newport Beach office. I've left Montana for the month, and it is a beautiful post-rainy day here, blue sky, gigantic clouds cruising by, so it's pretty nice here, pretty nice here. Although not only is it a little cooler for the market, it's a little cooler here in California. It is typically, for the market, it's a warmer month. Usually November is one of the best months of the year, if not the best month of the year, but not so much this year. We've had a couple modest pullbacks in that 3, 4%, maybe 5% range. We're in our second pullback here. It's easing down a little more today. So investors seem pretty skittish.
This coming Wednesday, on the 19th, our country's largest chip manufacturer, at least largest based on market cap, is going to announce earnings. And that announcement may support the AI narrative, or it might question the AI narrative. It might do both, probably initially endorses it and then people will question it. But either way, in all likelihood, it's going to create some additional volatility. The volatility du jour seems to be caused by concerns about an AI bubble or data center investment bubble. And then in December, we get to stress over what the Supreme Court does with the Trump tariffs. That'll be pretty interesting itself.
Bubble or not. One of the concerns about this current large CapEx cycle is will electrical power be the limiting factor to AI expansion and AI success? Recognizing this power need and the problem that we have in our electrical grid, for our investors we've made several investments in companies that are involved in our electrical infrastructure and the data center electrical functionality. So the topic today is actually of real significance to all of us and all of our portfolios.
Today I'm joined by two incredible resources, to me. These are two really nice guys. These guys are always available. They're incredibly insightful, and without question, they've impacted where you and I are placing our money these days. We have with us Nathaniel Gabriel. He is a UBS wealth management industrial Analyst who covers the companies directly engaged in building out our grid as well as the data centers that require so much power and so much cooling.
Along with Nate, we have James Dobson. Jay is the UBS wealth management utility and natural gas company analyst who covers the regulated as well as the non-regulated power generation companies.
Both of these guys, with a group of others, publish a, well, UBS has an investment perspective they refer to as the TRIO, and that TRIO stands for Transformational Innovative Opportunities, Power and Resources. And these two guys are part of the publishing team that puts that report out, and in that report they touch on a lot of the companies that you and I know.
So gentlemen, as you guys know, I really appreciate your continuous support and all of those who are listening in appreciate all of your efforts on all of our behalf. So thank you very much and let's get into the discussion starting with Jay.
Jay, these tech companies have plans to spend just hundreds of billions of dollars on data centers and AI, maybe a trillion dollars. Do we actually, as a nation, have the ability to supply the power that they require? And then as a follow-up question to that, what can the government do to help facilitate this process?
James Dobson: Well, Marc, first, thank you so much for having Nathaniel and I on. As you said, it's fair to say we live, eat, breathe this topic, so thrilled to be on to talk to you and your clients about this.
I would offer in summary a qualified yes to that question, but I would also want to say it needs to be unpacked a little bit. So just to put a quantum around it, if we talk about a single NVIDIA chip, depending upon which one we choose and how much we run it, at about an 80% utilization factor, it uses about as much electricity annually as a US household does in a similar period a year. If you look at a data center, what we'd call a gigawatt scale data center, you'd have 500,000 or a billion, somewhere between there, of those chips. So you're saying in the upside, or let's call the mid-scale, 750,000 homes are essentially the electricity demand equivalent of a gigawatt data center. So that's a lot of demand, for sure.
Now I would say looking back over the last decades, the electric industry has always risen to the challenge. But I think you also have to step back, and maybe I've been doing this too long, but I still do marvel at the electric system here in the United States. I always tell people, if you're interested, go over to the room you're sitting in and turn the light on or off, whichever is the opposite of what it is right now. And when you've done that, so long as the lights go on or go off, you've made a power plant somewhere very close to you do something. It's either spun up or spun down in response to your demand or change. And the reality is electricity has to be balanced, supply and demand needs to be balanced basically every 50 or 70 milliseconds.
It's an unbelievable undertaking. I think electricity is one of those things, like many things in our society today we take for granted. But I would say we need a lot of investment to service load. I think that supply is going to develop. The question really is, and I hope we'll get an opportunity to talk about this, exactly how big is the demand? And probably the reality is looking out five or seven years, my crystal ball is pretty cloudy, so I'm not sure what that demand figure is, but I think we can do it. The question really is going to be in the interim are we going to give up a little reliability, is affordability going to remain where we are, and then what is the pace of these supply additions?
You asked about the government's role. I think the government has a really, really important role to play here to both incentivize the different kinds of generation you want to add, but also to help manage risks. Think about adding nuclear, which I hope we'll talk about a little later. These are very, very large investments that take a decade to put in place. Large investments that take a long time often come with a lot of risks.
So yes, I think we can do this, but it's going to take a decent amount of time.
Marc Foster: Well, let me ask a couple stupid questions here. Listening to what you just said, you said that each data center has something like 500,000 to a million chips. Okay, so a million chips, and you said each chip basically burns at the same rate as the average household and-
James Dobson: Yeah, uses electricity about the same rate. You've got to make some assumptions about utilization factor, but yes.
Marc Foster: Okay, so if you figure we've got 350 million people in the country and you got, let's say, three and a half people on every single house, how many data centers are we powering if you had to wild-ass guess?
James Dobson: Well, it's interesting. So the data centers we have in place that weren't just added in the last year or two, were much lower electricity demand. It's the deployment of AI that makes these data centers we're developing now, because that's where the NVIDIA chips are coming into.
The cloud data centers, if you look at where the data centers are concentrated in the United States, it's really in Virginia because when you have a lot of power, data centers tend to want to go where you can reduce latency or how fast the internet replies to you. And Virginia is the place that the internet lands in the United States, at least on the East Coast, and so there's a lot of concentration at data centers in Virginia, particularly Loudoun County. And so you source them there when you're focused on latency. Now you're seeing that spread out across the United States because you want access to power, and you want access to power because you're adding these much, much more electricity intensive chips.
But yeah, I would say of these all data centers, there's hundreds of them. And I would bet given the scale, you may not be adding a doubling of that, but you'll be adding significantly larger data centers, and you'll be probably quadrupling or quintupling the electricity demand associated with just data centers here in the United States.
Marc Foster: But if you had 20 data centers, that's like adding 20 million people to the population. I mean, that's-
James Dobson: Exactly.
Marc Foster: That's insane. And you mentioned cost and reliability. I mean, frankly, if people's air conditioning systems turn off because of a power center, they're going to lose their mind. I mean, there could be a huge societal pushback. So Nate, I mean thinking about this huge task, where do you see the bottlenecks to this process and how are those likely to change over time?
Nathaniel Gabriel: Yeah, thank you very much for having me on as well. Delighted to be here to talk about this topic. It's really fascinating. And I think the bottleneck question is really a great one because there are clearly a number of existing constraints, but there are also a lot of future constraints, which you certainly alluded to. It's layered a bit like an onion in that we could see some very visible bottlenecks on the surface, and over time those are likely to get addressed and then the next gating factor will come to light. And because there's just no shortage of demand out there and the backbone of physical electrical infrastructure is that overarching constraint, we would essentially expect there to be a rotating cast of bottlenecks that really elongate the duration and smooth out the path of the investment cycle here.
I always like to flag that these constraints might be a source of frustration for the tech giants that are elbowing each other to pursue those expansive AI ambitions, but they are not at all a bad thing for the companies that are causing them. It gives these companies, many of which I follow closely, it gives them visibility into future revenue, not just record backlogs, but much stronger partnerships with those tech customers who open up their capital spending plans years into the future.
It gives them pricing power in some cases in industries that haven't had any real pricing power in decades. And those higher prices go to the end of the backlogs, meaning that profitability can continue to improve with fairly high confidence. It allows them to plan production efficiently, pick the customers that'll be most supportive. And all of this is no secret to those companies themselves who are largely doing their best to protect those conditions as long as possible basically without angering their customers or causing them to give up.
So I mentioned that because the companies that are the bottlenecks are very aware that they are the bottlenecks. And so over the last year or two I would say the limitations have mostly stemmed from the electrical equipment space. There really hadn't been much investment in production capacity here for many years. This was a skill that was left to stagnate for some time.
And then we went right into this surge of demand. And here I'm thinking about companies that are manufacturing things like transformers, high-voltage equipment, gas turbines, all the way down to little circuit breakers. And right now if you want a complex transformer, which is one of the first things you need at a construction site if you're building a data center to link to the power grid, you're going to the end of a two-year wait list. And if you want a gas turbine for power generation, you're either waiting three-plus years for a production slot or you're paying through the nose for some kind of stopgap solution.
Marc Foster: You and I chatted, I don't know, three weeks ago or so, maybe a month ago. And you had talked about how these companies that you cover, being industrials, are typically cyclical companies, and because of that, lower valuations and nobody believes that these things can be longer term growth companies, so they don't get the investment respect that you might expect. But also, from their own perspective, I mean should they really ramp up their production capabilities because if the AI thing just doesn't quite work out, they could be flying right off the edge of a cliff?
Nathaniel Gabriel: Yeah, it's a terrific point. And just to your first item that you pointed out, these have been historically cyclical companies that fed into construction markets. So back in the past, they were primarily driven by manufacturing plants and commercial construction, residential construction, and there would be these small cycles, but it was very difficult to have pricing power on a circuit breaker or a switch, an electrical switch, and the country was growing at a rate that wasn't conducive to needing to expand capacity to any meaningful degree.
So this truly is something different for the companies that are participating in this value chain. And they are very hesitant to fully underwrite the magnitude of investment that many of the hyperscalers have put out for their AI plans, especially because it overlaps with other drivers of demand, whether it's the energy transition, electric vehicles, and the government investment and grid resiliency. The list goes on and on, and most of those rely on the same equipment from the same small group of companies.
So I would say that we've reached the point where many of them are expanding production, but our impression is that they're purposely undershooting demand because again, their goal isn't necessarily to ensure that every tech company meets every aspiration that they've told their investors, but to make this cycle as long and profitable as possible.
And to the point you made, investors have been super sensitive to how they thread that needle. If orders are incredibly strong, then they should believe in the opportunity and invest. And on the other hand, if you tip the scales too far in the other direction, you add so much capacity that you start to lose the pricing power.
Marc Foster: I had a conversation with you, Jay, sometime in the last couple of weeks, and you, I think it was you, but you made the comment that the growth that we'll likely see is going to be somewhat similar to the growth that we saw back in the 1950s and '60s. I think that was you that made that comment, and that comment really got my attention in terms of building out infrastructure.
Over the weekend I saw some comment from our energy secretary that Trump wants to create low-cost loans for the expansion of nuclear power where the White House would endorse loans of something like three-to-one or four-to-one compared to the equity that any company's putting up to build out these power plants. So I don't know if that's going to come to pass, but Jay, what do you think about the prospects for nuclear power going forward?
James Dobson: Well, to address your earlier point, I think this period has a lot of echoes of the 1950s and 1960s, and it's really to what Nathaniel was saying. This is a secular growth driver that will likely, we can't obviously tell the future with specificity, but it sure feels to me that this is a secular growth in AI power demand in addition to reshoring industrial demand and electrification, all of which goes forward for, let's call it in round terms, the next seven to 10 years, so it makes you want to add new supply.
When you start unpacking what new supply we'll be adding, I think the first thing you have to do is say, well, it takes me, let's call it, 18 to 24, maybe 30 months to build a data center, okay? So let's call that somewhere between two and two and a half years. Now, that's the demand.
When I look at supply, we can add solar with batteries or wind in about the same time, let's call it 18 to 24 months. If we have access, as Nathaniel was saying, to an industrial-scale gas turbine, we can put that on a concrete pad and run it really inefficiently, or we can build a combined cycle gas turbine, which is what utilities tend to do. That would take us about four years. If we want to build nuclear, that's going to take us seven to 10 years. So you can see right there that the demand and supply response have different timeframes to them.
Specifically your question on nuclear, yeah, I think we're going to build more nuclear. I just think natural gas and renewables are going to be, by definition, the required response in the near term because they're much faster to market, to commercial operation than nuclear is.
But I would also say, and I think this is where the government has to look a little harder, I don't think it's an absence of capital that is preventing nuclear from being built. It's folks that are worried about the risk of building a new nuclear plant. And what I mean by that is the risk of cost overruns.
A company in Georgia just built a nuclear plant. They started building it in 2016. They completed it in 2023, and it was two times over budget. Now, part of that wasn't the company's fault. Part of that was the fact that we haven't built nuclear plants here in the United States in quite a long time, and so you have atrophied those muscles that you used to have, and we need to rebuild that. But you probably need the government to stand in and backstop that risk of cost overruns and then commit to making sure we build five or 10 of these back to back such that the 10th one gets the benefit of the first or second one where cost overruns across the portfolio you have more attractive costs.
Marc Foster: What-
James Dobson: But yeah, I think you're going to build a lot of renewables and a lot of natural gas in the near to intermediate term.
Marc Foster: Well, for those of us who remember Diablo Canyon, a 2X overspend seems like nothing. That doesn't seem like a big deal.
James Dobson: Yeah, I agree with that. The only thing I would say comparatively there is that was the environment changing within Diablo Canyon. When you think of the time that was being commercialized, that was about the time we had the Three Mile Island accident, so Diablo Canyon wasn't even the worst of them. Comanche Peak in Texas was actually almost complete when the Three Mile Island accident happened, and the plant had to be almost completely torn down and rebuilt, so it was 10X the cost it was originally. So some of those things are incomparable, but I do appreciate what you're saying. This is expensive technology.
Marc Foster: Okay. Where I was really going to go with it, and other than trying not to build these things on the San Andreas Fault, but what these SMRs? I thought they were pretty small and pretty cheap and like plug and play-ish. Is that not something that would work?
James Dobson: That is the hope. These SMRs are small modular reactors, and I am reasonably confident we're going to see these develop. The question is when are they developed? Lots of companies are pursuing these. There's no company that has one available for sale today. All of them are working their way through the regulatory process. We do believe ultimately in the 2030s we'll see the commercialization of this technology.
You might immediately say what gives you the confidence in that, Jay? And I would say, well, there's probably 103 or 105 SMRs floating around the world on US military vessels that are powered by nuclear. Those are essentially small modular reactors. You need to commercialize this, make it safer operation on land, all the different things that have to occur. But yeah, the challenge is they're not ready today. A CEO of one of these companies recently told me, Jay, if you wanted to give me an order, I couldn't take your order today because I don't know what I'm going to charge you.
So I have high hopes for that. I'm a fan, as you can tell by some of my comments on nuclear, but the small modular reactors aren't quite ready yet to respond to this demand.
Marc Foster: Hey, Nate, one concern is I keep hearing this idea that maybe there's going to be some new technologies that come out that all of a sudden makes these chips way more energy efficient or just a lot cooler and don't need the technology in these data centers to keep them going. What's the likelihood of something like that in the next say three to five years, which I guess would be my investment timing on this sector?
Nathaniel Gabriel: It's a good question. And I think there's a very high likelihood that something is perceived to change the game, but very challenging to tell if something will actually impact the trajectory of energy demand. And I think we all probably remember the, I suppose we'll call it a scare early in 2025 when the markets learned of China's DeepSeek AI model, and we all started assessing if we really needed to be spending so much money and, of course, energy to keep pushing the leading edge of AI further. But since then, of course, the tech companies have remained fully committed to pushing the envelope with those compute-intensive models.
So I would say, in all likelihood, the path is still toward greater energy intensity in the data center rather than less, for a couple reasons. One is that the chips we're using for high-performance compute are getting more and more powerful, and we have a decent sense of the trajectory of chip development because of what NVIDIA and others have laid out.
And so hearkening back to what Jay was mentioning earlier, an average server rack back before generative AI used to use 10 to 15 kilowatts of electricity. Now we're around NVIDIA's Blackwell version of its chip uses about 120 kilowatts per rack. We're moving toward Blackwell Ultra, which is higher. But the next generation architecture, which is called Rubin and Feynman, that's trending toward 1,000 kilowatts per rack. So it's not exactly apples to apples, but we're now talking about two orders of magnitude higher power consumption, which will need higher voltage infrastructure. It'll also require a lot more cooling. And then, of course, those cooling systems hoover up a lot of power on their own. So you can see why we're now talking about gigawatt plus scale data center campuses.
And then the other facet of this is that if it gets cheaper and more efficient to train AI models, then presumably it becomes easier to use them in the real world, and that should accelerate adoption in general. So it may well be the case that we actually in that situation need more data centers over time, not fewer, but just geared more toward inferencing, which is how we, as users, would interact with AI, and that will still need a lot of electrical content.
So definitely not saying some new technology can't come out of left field and change this trajectory, and we do have these periodic scares here and there, DeepSeek, liquid cooling and others. But I wouldn't say we're seeing anything glaring at the moment that might make the way we're currently thinking about the AI infrastructure build out irrelevant, but certainly fast moving. It keeps us on our toes, so keeping an eye on the technology development is super important.
Marc Foster: A lot of the volatility that we're seeing in the market right at the moment is the battle lines of is AI going to potentially be a bust or is AI going to really change how we live with huge productivity gains? Things usually don't go to one extreme or the other. Things typically end up somewhere in the middle. So if that's the case, if the growth is not as logarithmic, if it's just a slower ascension, what happens to these bets on investing in the electrification of the United States? And I assume you each have an opinion, so have at it. What do you think?
James Dobson: Maybe I'll begin, and I'll hand it to Nathaniel. I think there's a silver lining here. I mean, my first assessment would be there's no technology or commodity cycle that, to me, is a linear function straight up and to the right. So we have to recognize that there's going to be, as Nathaniel was referencing, the DeepSeek scare and all of these things. You have the difference between expectations and perceptions, and those two lines move around.
But I'd also say, and I think it's a cautionary tone, is look, I've not found the commodity market where high prices don't solve high prices and low prices don't solve low prices, and I do think that's fair here. When we're talking about energy or electric power, the number of new entrants we're seeing here convinced me that at some point we are likely to overbuild. I expect this cycle will take us five to seven years, so I still think this is an outstanding investment opportunity, but it does tell me, hey, I need to look out on that horizon.
What makes me comfortable about that though, and we're seeing this in the affordability side of things, is some of the hyperscalers, these large developers, the MAG 7 companies, are stepping in and saying, hey, we're going to support nuclear. We're going to support geothermal. We're going to support renewables, and they're stepping in to protect customers. That helps on affordability, but it also says over time if we get to a point where supply is actually "adequate" or maybe slightly higher than adequate, then we can, in fact, start shutting down some of the coal, start shutting down some of these older power plants that right now we're leaving running. We're actually encouraging people to continue to run because we need the supply.
So I think ultimately though it will definitely not be a linear function or a straight line. The next 10 to 20 years leads us towards a more reliable and cleaner grid. And there may be some indigestion as we go through that process, but I do believe, and I wouldn't want to categorize myself as the eternal optimist, as Nathaniel knows, and I think you do too, Marc, but I really do believe this will come out the other side with a better grid. But certainly I do anticipate, looking at all the new entrants today, that we're likely to overbuild, and that's a silver lining, but there will be some challenges throughout as a matter of that.
I don't know. Nathaniel, I'll throw it to you.
Nathaniel Gabriel: You make a great point there. I think for my space I would disaggregate a little bit valuation and the fundamentals. And what I mean by that is that most of the companies we're tracking have more than enough demand to meet their needs On the industrial side. They're remaining remarkably disciplined, and they're adding capacity pretty tentatively and in stages so it doesn't become a competitive race to the bottom so quickly.
So they're taking their customers spending plans and haircutting them pretty sharply before making their own plans, either purely for conservatism or because they're applying very stringent criteria about what constitutes a real order. You have to have power secured. You have to have firm contract in hand, maybe a big down payment that de-risks the outlook and splitting that from what's more aspirational. So I would say the fundamentals for the industrial companies participating in the value chain are pretty solid, even if the end, the true trajectory of data center spending ends up being lower than all of the announcements that have been placed out into the ether.
But I'll say the other side of that coin is that the valuations very much reflect the leading edge of news flow. And back to something you cited earlier, Marc, the reason these stocks responded so significantly to the DeepSeek event is because their production capacity is constrained. The companies can only generate so much revenue in a given period because of their production capacity, and therefore the stock performance in the short term tends to be driven by valuation expansion or contraction. So if that leading edge of AI headline starts to sour a little bit, sentiment starts to sour, it could impact some of the stock prices in the short term, but the fundamentals are pretty resilient, we think, over that time period that Jay outlined.
Marc Foster: I almost hate to say this because anytime somebody says it, they end up looking foolish. But things this time do feel kind of different. And I think back about Y2K and everyone concerned about the computers shutting off when we hit the year 2000 or thinking that Pets.com was going to be something of significance when back then, I mean our computers were pretty much nothing but things that sat in the kitchen holding recipes.
But now on Friday, Brian and our group took me for a ride in his self-driving Tesla, and I'm telling you, when you get in a car that drives itself and you think about the technology required to make that happen, I mean, it's just unbelievable. Or let's say, hypothetically, to catch a rocket ship coming down from space with a pair of chopsticks so you can use that thing again, you think that requires a little technology?
Or if you go on YouTube and you look at the optimist robots that they're testing in houses, you'll look at, I mean, it's just nuts what's out there. Things feel different. And anybody who uses ChatGPT every time they come out with a new iteration, I mean, it seems to me that there will be a change in terms of our overall productivity. And ultimately, it does feel like we're in the early innings, and I think both of you guys are in areas that probably end up being, will transition from being more boring stocks to really interesting growth stocks. And just like Jay said, it'll feel like the 1950s and '60s and that industrialization.
So do you guys, either of you have a final thought that you'd like to pass on to our investors?
James Dobson: I guess the only one I'd say is just around energy efficiency. I mean, I think what's really interesting here is this demand is growing. And I agree with you, Marc. I think this is a very, very secular trend. And you talked about energy efficiency, is there going to be something that makes chip more efficient or need less cooling? Any of those things that occur, to your point you were just making, probably actually increases adoption because it makes the deployment of this technology cheaper, so we actually end up using more of it.
I think it's going to be a really, really interesting time. I'm confident, and Nathaniel and I joke about this a lot, particularly being professionals sitting at these seats and looking at these stocks on a daily or weekly basis, you're going to have to make sure your seatbelt's on. But I think this is a durable secular opportunity. And as I said earlier, I really do think we come out the other side of it with a better, more resilient, likely cleaner, and dare I say, at least on a real basis, so inflation adjusted, more affordable grid, potentially.
All of those things may prove somewhat slightly aspirational or optimistic, but I think if you start with that and hope that the hyperscalers and data center developers are going to work in that direction, this is a huge opportunity over the next two decades.
Marc Foster: I hope you're right about cost and reliability. I mean, that could be a real problem if people push back. But anyway, Nate, what were you going to say, my friend?
Nathaniel Gabriel: I'll agree with your point. When I first started covering industrials 15 years ago, I was worried that I was stuck in a dying, old-world industry. And now to see it so fundamentally linked to something as exciting as AI is quite a change.
And to that point, I just think this cycle is different in some ways, as much as it pains a cyclical investor to say that, and that the visibility that we have to future revenue is quite unique. These companies have almost never, I mean, certainly not in the time I've covered them, had the visibility to their customers spending plans for three to five years out and still trying to find the ceiling on pricing power. So I think that's a really exciting aspect that makes us feel much more comfortable about the forward trajectory.
And then the other aspect that I just think isn't as so often discussed is that the content in the data center has a relatively short life, and technology will keep progressing at a rapid pace, so we're not just building a data center and then letting it run for decades like a manufacturing plant. We'll have to tear this stuff out and add higher voltage and better cooling and newer chips, and therefore we can think of it a little bit more like a recurring opportunity that cycles on every couple of years or so, I think. So something else to keep in mind that keeps my enthusiasm pretty high about this trajectory.
Marc Foster: Well, that's awesome. You guys, I really appreciate you. I appreciate all your efforts on our behalf, like I said before, your accessibility, your insights. I mean, you guys are awesome, and I really appreciate you taking the time today to connect directly with our investors. And I'm sure they'll listen to this and know that we've got an incredible team behind us giving us some incredible ideas. So guys, I really appreciate you. Thanks for being with us today.
James Dobson: Thanks, Marc.
Nathaniel Gabriel: Always a pleasure. Thank you.
Marc Foster: Okay. Until next month, it is Marc signing it off. Thanks a lot, everybody. Bye-bye now.
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