The North Korean Threat to Utilities
In times of market uncertainty, some investors will flock to “safeguarded” currencies such as the Swiss franc or Japanese yen. Others may choose diversifiers like gold, farmland or other hard assets. And then there are those who flock to alternative investments like bitcoin or fine wine. Yet one investment that has historically been considered a safe bet, low-risk option for investors when frothy markets appear ripe for a correction, or when market bubbles look to burst, is the utility sector. But the recent nuclear threats from North Korea could change that belief.
If North Korea launched a HEMP (high-altitude electromagnetic pulse) attack on the U.S., it could knock out the electricity grid. The industry would suffer severely, eliminating another flight-to-safety investment.
On Sept. 3, North Korea announced that it had developed a hydrogen bomb that could be used for a “super-powerful” HEMP attack. This news provided an additional jolt to the utilities industry already shaken by threats from the country’s regime this year, including missile tests over Japan and talk of targeting Guam.
Although the probability of North Korea setting off a nuclear bomb is low, according to geopolitical experts, the potential ramifications of such an event are colossal. To date, regulators have not mandated utility safety measures; however, the sector has become more vigilant in light of the level of preparedness in such an event.
U.S. utilities are in year two of a three-year program to comprehend the potential impact of a HEMP attack on the generation and transmission of electricity and to protect the network. The program was funded by about 60 electricity companies in a sector that, since 1962, has been concerned about a nuclear threat. In that year, the U.S. detonated a nuclear weapon high above the Pacific Ocean. Designated Starfish Prime, the operation was part of a series of high-altitude nuclear bomb tests named Project Fishbowl at the height of the Cold War. The effects were devastating and far larger than expected. The strength of the electromagnetic pulse was so massive that it affected the flow of electricity as far as Hawaii.
At a Senate hearing in May, concern was raised over the reluctance on the part of the nation’s armed forces to share intelligence with utilities. The nonprofit Electric Power Research Institute is leading industry efforts to get a better understanding of how to keep the grid running. The group has been researching geomagnetic disturbances and electromagnetic pulse events for many years.
Many argue that an attack on the U.S. power grid could lead to a months-long catastrophic blackout. An EPRI study in February calculated that E3 (the longest-lasting of three EMP components) from multiple detonations would have marginal effect on bulk-power transformers. The results, the study emphasizes, should not be interpreted as indicating that HEMP would not affect bulk-power system reliability, adding that more research is needed to assess the true impact of HEMP on the grid and to develop cost-effective mitigation options.
In another study, The Foundation for Resilient Societies, a New Hampshire-based nonprofit that advocates for EMP protection of critical infrastructure, estimates that a deterrent against such an attack could be established for a cost of about $5 per American. This money, they suggest, could go toward protecting critical transformers, with an inexpensive protective device called the “neutral ground blocker.” The application of the device alone would add to North Korea's uncertainty as to whether or not an EMP attack would succeed.
If anything, this fast and practical step can buy the U.S. time for more comprehensive protection of the electric grid. While neutral ground blockers were successfully tested by the U.S. government and are commercially available, they have yet to be installed in large numbers and cost approximately $500,000 to $600,000.
Looking at a chart of the S&P 500 forward P/E ratios of utilities, we see that they have been steadily rising since 2009, after crashing along with the market at large during the financial crisis. The P/E ratio of the Dow Jones Utility Average as of Sept. 18 was 37.82. This compares with the Dow Jones Industrial Average P/E of 20.43. One year earlier, the P/E of the DJUA was 27.64.
So while the North Korean leader, Kim Jong Un, may just be saber-rattling, there is concern about the unpreparedness of U.S. utilities and the grid they support in the event of a nuclear war. And the retaliation from even a limited attack on North Korea by the U.S. could be much greater than a tit-for-tat response.
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