Convergence breeds market savvy

Cameron Hsu

Energy Industry Analyst

This year`s Energy Expo served as a forum for energy traders, commodity brokers and vendors to get together and exchange war stories. Nothing seemed out of the ordinary. Seemingly.

Upon closer review, there were some notable absences by some of the key industry players.

Some of these missing players were Texaco, Amoco, UP Fuels, LG&E Energy, CNG, and Equitable Resources.

Organizers report that total exhibitors were down 16 percent from last year. However, the total space occupied by the exhibitors went up by 1,500 square feet.

This is a reflection of the industry`s aggressive mergers & acquisitions (M&A) activities as the convergence between power and gas takes shape. To illustrate this further, major electric utilities are actively acquiring gas assets (including pipelines) to ensure their fuel supplies and to offer additional retail energy products as a way to secure customers.

On the wholesale marketing side, marketers are actively acquiring generation assets throughout the country to create “asset-based trading companies.” In addition, with the physical assets, companies are able to market risk management services to other industry participants.

The following examples illustrate these trends:

– Dominion Resources, the parent company of Virginia Power, has set its sights on Consolidated Natural Gas (CNG), one of the largest natural gas producers, transporters, and distributors, serving retail customers in the Midwest, Northeast, and Mid-Atlantic. The new company will be the fourth largest electric and gas utility in the U.S. with about $8.8 billion in revenues, $23.9 billion in assets, and 17,000 employees.

– CMS Energy acquires Panhandle Eastern Pipeline and Trunkline Gas from Duke Energy for $2.2 billion. CMS plans to build gas-fired merchant plants along the newly acquired interstate pipeline in order to provide base-power to the Midwest.

– Sempra Energy, parent company of Southern California Gas Co., San Diego Gas & Electric and Sempra Energy Trading, acquires KN Energy, primarily for its gas pipeline and storage system. Much like CMS Energy and CNG/Dominion, Sempra also plans to construct gas-fired merchant plants along its new pipeline system.

– Other similar deals include AEP Resources` acquisition of Equitable Resources` midstream gas assets; Duke Energy`s acquisition of UP Fuels` midstream assets; ONEOK`s acquisition of Koch Midstream`s gas assets.

– El Paso Energy, taking a slightly different approach, bolstered its cross-country pipeline network by acquiring Sonat Inc. for $5.9 billion. The newly created pipeline giant will own 40,000 miles of natural gas pipeline, transporting nearly one quarter of the natural gas in the United States each day. As the energy industry, particularly the electricity generators shift toward a more “natural gas-centric” environment, El Paso`s acquisition of Sonat should prove to be a smart investment for the future.

Along with pipeline acquisitions, “Asset-based trading” is another developing trend in power marketing:

– ConEd Energy, ConEd`s unregulated subsidiary recently acquired 290 MW of generation assets in New England to support its attempt to not only support its wholesale energy trading operations, but to also market its risk management and energy reservation services.

– Dynegy acquired 951 MW of generation assets from San Diego Gas & Electric. According to Chairman/CEO Chuck Watson, Dynegy plans to integrate supply assets with its marketing and trading operations to minimize supply risks.

– Taking a similar approach, Allegheny Energy recently merged its unregu-lated generation subsidiary Allegheny Energy Supply with its power trading and marketing unit, AYP Energy, to fully complement its integrated supply chain.

Ken Rice, chairman and CEO of Enron Capital & Trade, supports this strategy. While speaking at Arthur Andersen`s Annual Energy Symposium, he cited ownership of generation assets as the key to a successful trading business. Rice also predicted increased levels of convergence and integration between not only gas and electricity, but also with coal and weather derivatives.

Charles Oglesby, CEO of Reliant Energy Wholesale Group (formerly Houston Industries), also agreed with this strategy. Oglesby listed three key ingredients to successfully compete in the wholesale energy market:

1. Significant domestic generation ownership.

2. Top 15 power and gas marketing presence.

3. Total market capitalization in excess of $10 billion.

Both Rice and Oglesby predicted that when the M&A dust settles, there would only be between five and 10 national wholesale players remaining.

On the local level, co-ops are coping with similar challenges facing the larger investor owned utilities. As a result, mergers and acquisitions activities are expected to take place at the co-op level as well. For example, in April 1998, Western Michigan Electric Co-op, Great Lakes Energy and Top O`Michigan Rural Electric Co. joined forces to form Great Lakes Energy Cooperative, serving more than 100,000 customers. These types of mergers are taking place for two primary reasons:

1. Establish critical mass to compete with larger marketers that might be entering the market territory.

2. Economies of scale. By joining forces, co-ops are able to reduce operating costs and provide better services.

So what can we expect from the energy providers of tomorrow?

As more states resolve the sticky issue of stranded cost and pass deregulation bills to open the retail energy market, mergers and acquisitions will continue.

Energy companies must position themselves to become total solution providers. Such solution providers will not only have the critical mass and variety of offerings to serve the general public, they must also have the ability to customize its services to cater to even to the smallest of end users.

Two other critical factors for success: effective branding and cutting edge information technology. Many have argued over the value, or better yet, the ability to brand energy. After all, electricity is electricity, and gas is gas.

But the local water retailer may disagree. They have managed to successfully brand water, earth`s most abundant resource. Lab tests have shown that fancily packaged bottle water may sometimes be inferior in quality when compared to water straight from the kitchen faucet.

The second key to success in the deregulated world is leading edge information technology. The most crucial application is a customer-focused architecture.

To acquire, and more importantly, retain customers, it will be essential to create an interactive environment between the energy services provider and the consumers. Whether it is a savings statement, bundled services (gas, water, and long distance, etc.), online billing, or historical energy usage, leading edge IT solutions provide a statement of monthly tangible value to the consumers.

From the energy providers` perspective, leading edge IT solutions will provide a scalable infrastructure for growth as well as the ability to reduce the cost of customer acquisition.

In the end, only time and a progressive regulatory environment will determine the impact of deregulation in this industry in transition. However, those with an aggressive strategy to reposition via mergers and acquisitions, comprehensive branding campaign, and leading IT infrastructure will clearly have a distinct advantage over others.

Cameron Hsu focuses on market analysis and strategy for the electricity industry. He can be reached at chsu@pdg.net

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