Restructuring a Challenged Business Model–How Will Electric Utilities Survive?

by Tanya Bodell, Energyzt

The electric utility business model has served us well. The cost-of-service rate structure prompted private investors, municipalities and electric cooperatives to fund electrification of the country. A capital-intensive industry, economies of scale quickly brought the cost of power down to affordable levels spurred, in part, by a business model designed to reward continued growth in demand; however, stagnant load growth, policies focused on energy efficiency and demand response, new regulatory requirements tied to portfolio mix and emissions, and competitive threats at nearly all parts of the value chain now challenge the traditional business model. Which utilities will survive and thrive?

Beyond Back to Basics

Some utilities initially responded to deregulation in the late 1990s by establishing competitive affiliates and trading arms. Price volatility and an industrywide credit crisis after Enron’s bankruptcy caused many of those firms to go back to basics and focus firmly on their regulated businesses. When liquidity reappeared, some began expanding back into competitive businesses, searching for growth in markets outside their own regulated franchise. Both successful and unsuccessful examples exist: case studies of utilities’ expanding beyond their regulated monopoly service offerings into renewable energy, commercial transmission and alternative retail price offerings. In competitive generation, however, low energy prices and tight spreads have forced many investor-owned utilities to sell their competitive generation portfolios and focus again on their regulated return businesses. Although this hunkering down has worked in the past, it might not be as effective this time. Utilities that have a platform and the financial strength to diversify into a combination of competitive and regulated activities will have more flexibility to expand into growth areas as new opportunities present themselves.

Recapturing Captured Customers

One of the biggest threats to the regulated utility business model is new technology that threatens to take customers off the grid. Many a regulated monopoly in other industries has scoffed at the threat of losing their captured customers until it was too late. Although the process might be slow and gradual, disruptive technology can create a death spiral that becomes inexorable once economic parity is reached. As lucrative customers move off the network, more costly customers are left behind, requiring the utility to raise prices to cover costs, forcing more customers to adopt increasingly commercialized technology. Just as enterprise computing companies lost customers to personal computers, traditional telephone companies found their landlines abandoned for cell phones, and record labels and books are being displaced by Internet downloads, utilities might find their physical connections displaced by distributed generation and community-based energy storage solutions. Most utilities have attempted to protect themselves against excessive net metering arrangements that create an economic incentive for end users to install generation behind the meter–defensive measures that will be difficult to maintain as grid parity crosses the Maginot Line. Utilities that can embrace new technologies and tie them into their service offerings are more likely to thrive than those that struggle to maintain position against a strengthening current of technological advancement.

Acquiring Synergies

As markets mature, investor demand for growth often comes via acquisition. This works well for utilities that are geographically near potential acquisition targets because synergies from the combined firm are easier to argue to regulators who need to approve the transaction. Such synergies, although well-argued and supported in advance, might be difficult to realize, especially coming out of a belt-tightening recession. Instead of cost savings, focus on finding combined revenue growth opportunities. Those utilities that can top line synergies beyond what already exist in the two firms via a merger are more likely to thrive than those focused solely on cost reductions.

The Next Evolution

Some industry organizations have emphasized the need for new business models to respond to challenging utility trends. Proposals generally focus on the role utilities can play in energy’s evolving markets and how utilities can be rewarded for that role. This philosophy attempts to maintain the traditional risk-reward structure by modifying the levers in a regulated business model, an approach regulators might be reluctant to take in the face of innovative technologies. Successful utilities should identify where their customers have unmet energy needs and think through how best to meet those needs. Those who can use the keys of technology to unlock new value will be rewarded.

Tanya Bodell is executive director of Energyzt, a collaboration of energy experts intent on understanding the impacts of energy integration. Reach her at 617-416-0651 or tanya.bodell@energyzt.com.

“It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change.”  -Charles Darwin

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