Booz & Co.
Never has the old adage—the only certainty is uncertainty—been more apropos. Two years ago, after the election of President Barack Obama, the outlook for the power industry seemed fairly clear: carbon cap and trade, a federal renewal portfolio standard (RPS) and aggressive investment in and subsidization of alternative renewable technologies, as well as energy efficiency expansion.
Since the inauguration, however, the political and economic realities have shifted. Near-term carbon pricing schemes are dead, EPA rule making is likely to be bogged down in court, a federal RPS is unlikely or will be set at minimal thresholds and budget concerns will steadily, if not sharply, reduce renewable subsidies (notwithstanding the 2011 renewal of available grants and credits).
This Booz & Co. report does not suggest that alternative generation and energy efficiency investments will disappear; indeed, there are notable pockets of resilient green thinking, particularly in California and the Northeast. However, the authors believe that economic orthodoxy has returned, reflecting an increasingly skeptical national mood regarding the economics of energy mandates. These doubts about the continuing wisdom of highly subsidized investment suggest that a more judicious approach to capital deployment is warranted. Even where selective market opportunities appear to exist, power and gas companies will need to understand how these choices affect business risk and decision-making complexity. For those companies with poorly defined strategies and those hoping for more market clarity before committing to significant action, the window for definitive decision-making is closing, leaving many uncomfortable choices to be made—and soon.
The industry generally has outperformed the S&P 500 in recent years, although 2010 was not a year characterized by robust relative performance. Future value, however, will be bolstered by the avoidance of higher dividend taxation rates at least through 2012, as a consequence of the extension of the Bush tax rates. Despite the historically attractive industry performance, few avenues for meaningful, strategic and sustainable growth exist. Most power and gas companies either are stuck in the middle strategically, making small, one-off investments, or have resorted to a mix of acquisition and regulatory strategies. While these moves might be beneficial, neither approach is typically sufficient to achieve and sustain long-term strategic or financial growth.
In this muddled environment, defining and meeting shareholder expectations will be difficult. Each company will have to reevaluate strategy and priorities from its own perspective, whether its focal point is strategic, operational or financial. But to develop a clear, coherent growth strategy, every company will need to address three intertwined issues: scale, portfolio balance and capability alignment. A portfolio-based model that is focused on financial strength and flexibility, is balanced and hedged to an acceptable risk tolerance threshold, and has the right set of market-oriented capabilities will provide a powerful strategic foundation.
Given these strategic imperatives and the associated uncertainties, the authors believe that five trends merit attention during 2011.