Data Centres and Beyond: WEC Energy powering regional US growth

The information contained in this podcast is for general information purposes and does not constitute investment advice. You should seek investment advice tailored to your circumstances before making an investment decision. This is In the No, a monthly investment podcast brought to you by Mellen Asset Management. Not all data centers are alike, but what we're seeing now is an explosion of data center construction to support the expanded consumer applications for AI. To give you an example, one data inquiry that you might make through your PC using AI requires so much more computational capacity and ability that basically to support that one inquiry using AI requires 10 times more electricity than just going on Google today and looking up 'Where's Milwaukee, Wisconsin?' For example, that's Gale Klappa, the chairman of America's WEC Energy Group, one of the country's most important utilities, spelling out the extraordinary opportunity in electricity demand emerging in the US. Welcome to Mellen In the No. In this episode, Gale Klappa is in discussion with Mellen portfolio manager Joel Lorz and Jim P, the vice president of Milwaukee 7, a regional economic development entity in the state of Wisconsin. Together they explore the anticipated transformation of the power utility sector and its critical role for industry giants like Microsoft and other hyperscale companies empowering their operations. It's an enlightening conversation about the future of power generation and the opportunity it presents for investors. But first, here's a warm welcome from Joel.

Welcome to our podcast Mellen In the No. I'm Joel Lorz, one of the portfolio managers in the infrastructure team here at Mellen, and I'm joined by Gale Klappa, who makes his second appearance on our podcast. Gale is Chairman of WEC Energy, one of the largest investor-owned utilities in the US, serving gas and electric customers across Wisconsin, Illinois, Michigan, and Minnesota. Welcome back, Gale, and thanks for making the time.

Yeah, it does. Thanks, Gale. And so maybe switching over to Jim... Jim, you've been one of the architects for the development of this particular area. What did you envision? What was your mandate under M7?

Sure. So any number of different things that we look at, but at the end of the day, what we're really interested in doing, Joel, is finding locations for companies that make sense. We look at the core assets all around the region, and as Gale mentioned, the I-94 corridor essentially connects us to Chicago. So you've got all the assets that Gale mentioned, but the other really important one is workforce. If you put together the concentration of talent you have, especially for manufacturing talent — for us, on the white-collar side, a lot of engineering talent, technical talent, and given the manufacturing pedigree we've had in this region for a century that still is very strong today, we're also looking at technical talent on a production floor. Especially for companies looking for scale in labor, that's an area where not only can you draw workforce from the Milwaukee area in that corridor, but you can also draw labor up from northeastern Illinois. So we sort of thought about that corridor strategically back in the late 2000s — essentially it's a play that draws us closer to Chicago. Southeastern Wisconsin is a place of scale — we have about two million people who reside here. But then you look at Chicago, a big global mega city just to our south (we often joke they're our favorite southern suburb), with about nine million people. So when you put the two together, you're talking about a mega region, and that corridor is where we have seen a lot of that start to play out.

Fantastic. Now, maybe if we get into the drivers of growth in electricity, WEC seems to be the beneficiary of all those drivers that I've mentioned. Maybe we start off with the main one, and that being data centers. Data centers are expected to drive about 50% of the long-term growth for US electricity demand. We have heard a lot about them, but some of our listeners may not actually know what these facilities look like. Can you describe it for us? Give us a sense of the size of the facilities.

Jim, when you spoke with Microsoft in attracting them to the area, what were the key ingredients or elements they needed for a data center? What are the developers looking for?

There's any number of different factors, and there's probably no site in the country that can check every box, but we're trying to check as many boxes as possible, whether it's a data center, an advanced manufacturer, or a financial services company. Certainly the power is something that there's timing risk if we don't have the power available, or if we don't have a pathway to deliver that power. So that's an important component that Microsoft looked at. Another factor that's really important is the scale of the site. Gale gave you a hint of how large this will be. Microsoft owns about 1,350 acres today in Mount Pleasant, a suburb of Milwaukee. The site matters — it's not something where we can go to a company and say 'if I can line up four different owners and get this guy to sell who hasn't shown interest,' companies see risk when they hear that. So to secure a mega project like this — a hyperscale data center of the scale Microsoft is planning — we have to have the ability to deliver the land site. Another factor: Microsoft's President Brad Smith was here with President Biden last month to announce the scale of some of the things they were talking about, and one of the things Brad mentioned was that this will employ 2,000 people. Recruiting 2,000 people is not easy, and that's true of any operation. So they have to be convinced that we can find the labor, either by drawing people from outside our region or, more likely, by training up our workforce so they are qualified. The last thing I'll say that was pretty important to Microsoft is the general business climate. Wisconsin recently enacted a sales tax exemption for equipment that goes in data centers, which will be important not just to Microsoft but to any of the hyperscalers. So all those things together — and some other things too — were the primary factors that drove that location decision.

I've seen it myself personally, and I think 'huge' is an understatement even to that extent. Now, bringing in the likes of Microsoft or any of these large developers into an area is a massive challenge, but one might argue that actually servicing the data center is just as big of a challenge. So, Gale, when you think about the requirements of the data center, both from an electricity standpoint and an infrastructure standpoint, how does WEC approach this challenge? What are the actual challenges?

What's been interesting — and correct me if I'm wrong — the likes of Microsoft and developers of these large data centers have come out and said 'we want these data centers to be fueled by renewable sources,' and now we've seen a transition to that statement, or an adjustment, to 'low emissions.' So that would suggest that gas, given the needs of these data centers, has to be a factor. Is that fair to say, Gale, in terms of ensuring that reliability?

And presumably would that be something that you'd entertain or at least explore within your service territory, given the demands we're looking at?

Now, with data centers, it's not just the generation aspect that involves the utility. There are other parts to the infrastructure. Can you tell us a little more about what's involved from a utility point of view in terms of being able to deliver that amount of power?

Now, one last thing before we move on. When Microsoft announced their initial investment of over a billion dollars into establishing the first phase of their data center buildout, I initially thought that was a huge challenge for you to meet in terms of delivering that amount of power. More recently, they announced they will be investing an additional $2 billion, taking their total investment to $3.3 billion in the area. How much harder is that challenge for you in terms of delivering even more power to that particular facility in the second or third phase?

There are other aspects to all this. I'm thinking about the other stakeholders for the utility, specifically the residential customers. Obviously, when you bring in a large new customer, the first question among your residential customers is 'What does this mean for my bill?' How does that come into play? Is that a risk for you as a utility, and I suspect there are conversations to be had with the regulators around that?

And now, more importantly and perhaps more pertinent to our listeners, what does this mean for WEC shareholders? When we think about the growth and the returns, I'm interested to understand whether there's duration in that growth or if it's just a flash in the pan. Is this a short-term growth spurt or is it longer than that? And second, what are the risks for WEC and other utilities in the same situation when it comes to data centers? What do we need to think about?

Thanks, Gale. That's fascinating. Clearly, given the pace of construction there, it surely does look like they are playing catch-up to some degree. Now, maybe we move on to the other aspects of what some are calling the super cycle of growth. I wanted to talk about onshoring or reshoring, as some might say, and the return of manufacturing and production back to the US. As I mentioned, data centers are only driving half of the projected long-term demand growth. The other large driver is manufacturing growth. Supply chains and manufacturing are coming back to North America. Jim, bringing you back into the conversation, how is this playing out for the I-94 corridor?

We started to see that the supply chain issue is of concern to companies here in southeastern Wisconsin that are making products. We saw it pre-COVID, so we started to see this in 2018 and 2019 that companies were concerned about these global supply chains and the bottlenecks. Then COVID came along and really accelerated it. That's when it rose up in public consciousness — the issues we had as a country in terms of what our manufacturers were trying to do and how to service customers here in the US when you've got supply chains that widespread. We had already seen some de-risking, and we now think we're positioned well to take advantage of that. If you look at the pedigree we have here in southeastern Wisconsin, we're a good landing spot. We have the workforce available, and a lot of our education institutions are really centered on generating manufacturing talent and creating training for that same talent. That trend line — and I don't think we're headed back to what it looked like in the 1940s where half of our workforce was directly involved in manufacturing — there have been productivity advancements, automation is here to stay, and we think that will continue to accelerate. But we also think that reshoring will create a lot of opportunities for us. The other thing we love is that these jobs coming back tend to be high-value employment jobs. These are not jobs where you put part A into slot B 10,000 times a day; this tends to be work that is much higher value, and as a result, compensation is higher. That's how we build regional prosperity — through high-value employment.

When we spoke the other month, there was something interesting you said about why Wisconsin looks attractive: the low probability of natural disasters.

Yeah, absolutely. We have this slide. I remember I would show this slide back in the late 2000s, and it was a map of the United States that had different zones where natural disasters were likely to occur. You had earthquakes in California, hurricanes coming in through the Gulf. I used to show that slide, and almost invariably people laughed — they'd say, 'What's next, Jim? Are you going to show me where the plague is coming and where locusts start coming?' Nobody laughs anymore when we show that slide. There's almost always something going on in our country in which people and businesses are being affected by natural disasters. So this is a really important component of our value proposition: we can pretty much promise that we're going to be able to deliver a lack of disruption for a long period of time. Occasionally I get people who tell me, 'Well, it snows there in the wintertime.' It's like, well, yeah, we plow the snow, we go to work, our kids go to school. We call it Tuesday. So that part of the risk proposition for us has really become an interesting discussion, and we think we've got a competitive advantage there.

Absolutely. Earthquakes are not good for data centers.

How much more growth can you expect out of this trend, particularly in that area? How long can this last?

We see it as a virtuous cycle. What I mean by that is there are two factors that work well together. The first one, which is really foundational, is creating economic opportunity: we want to have a lot of opportunity for our current residents. As we stack those opportunities one after another, we then have the ability to draw more talent from outside. Economic development, when you put aside the corporate attraction side and the businesses, is really a people game. It's about whether you can have the talent that can continue to meet the labor needs your companies have. They really sort of layer and build on one another. We don't look at this and say our job is to attract engineers from Texas or software developers from San Jose. We love those people here, and when they want to come to southeastern Wisconsin, we absolutely want to have them. But that's not the goal. The goal is to be a talent destination within the Midwest. Can we draw people up from Illinois? Our net migration numbers from Chicagoland and the state of Illinois are off the charts, and we're drawing people from Indiana, Ohio, and Michigan. These are people who have Midwestern sensibilities; they're used to cold weather in the winter, so I don't have to explain that part to them. We like this idea of becoming that in the Midwest, and it's a long game. We thought about this probably 15 or 20 years ago, and we're going to stay on this pathway because ultimately that's what's going to drive prosperity.

Thanks, Gale. Now, maybe moving on to the other growth driver I mentioned: electrification. Most people would relate that to electric vehicles. Electrification is the other key driver for total growth of US electricity demand. We've seen a number of articles recently about EV penetration slowing. Is that the case for Wisconsin and other US regions from what you see, Gale?

That's something I never looked at that way. I've seen that statistic before, so I guess you can see why EVs are a big driver of overall demand growth. Over the next 10 years, where do you see EVs, particularly in your service territory as well as the rest of the country, Gale?

Exactly. Well, I think that wraps it up for our conversation. I'd like to thank you again, Gale, for coming on our podcast, and Jim, for sharing some of your valuable insights. Are there any last comments you wanted to make?

Thanks, gentlemen. Thanks for your time today.

Thank you, Joel. Take care. That was Mellen portfolio manager Joel Lorz in conversation with the chairman of America's WEC Energy Group and Jim P, the executive director of the Milwaukee 7 regional development agency. We trust you've enjoyed this episode. For more information on previous episodes, visit mellengroup.com.au/podcast, where you can also sign up to receive our regular investment insights program. Thanks for listening.