generation investment: are power generation companies overlooking the cheapest source of capital?

Jon Reeves, REL

Prior to deregulation, investor-owned utility companies were guaranteed some rate of return on distribution and generation systems upgrade investments because the costs could, largely, be passed to the end user. However, today’s deregulated markets typically don’t allow for such direct cost recovery. This major factor-along with the competitive landscape, pending legislative and regulatory issues, consolidation and considerably more wary Wall Street investors-forces utilities to look at other avenues of cash to fund new plants and upgrades, and compete with independent power producers and distributors that continually undercut retail prices. This has led to investor-owned utilities under-investing in generation capacity, evidenced by the decline in capacity margins to 15 percent in 2001.

With scarce amounts of extra capacity to handle peak demand days, the system will continue to manifest rolling brownouts and possibly even blackouts. Coupled with recent spikes in the price of a hydrocarbon, oil and natural gas, and you quickly see the challenge that power utilities face in attracting investment dollars on the open market. With oil and its equivalents currently trading above $50 a barrel, utilities face the challenge of passing this cost burden onto the customer while still finding cash to invest in their businesses. The result is exactly what the industry has seen over the last few years-continued under-investment in generation and relatively flat distribution capacity.


Investment in infrastructure is extremely capital-intensive. With experts predicting a 22 percent jump in electricity consumption by the end of the decade, the amount of additional dollars needed to fund the increase is expected to balloon to $56 billion by 2010. Projections show only $35 billion has been allocated to date.

Boatloads of cash are sitting on the sidelines waiting to be invested. However, with the uncertainty of regulatory and legislative issues, many on Wall Street would rather invest in safer havens that offer better returns. One analyst recently said he would rather invest in a gas pipeline project at 12 percent than an electric utility at potentially 18 percent. And, when taken in context with the latest data from the Energy Information Administration, which shows that 428 GW of new generating capacity will be needed by 2025 to meet the growing demand for electricity-equivalent to 1,427 new power plants (300 MW each)-it’s easy to see that utilities have to secure new sources of low-cost capital to invest in capacity.

Unless utilities provide a special risk assessment to their investments, investors will likely steer clear until Congress passes a comprehensive energy bill and each state progresses along the deregulation path. Meanwhile, infrastructure and investment must keep pace with the growing demand.

finding cash in unlikely places

Despite these grim realities, there is light at the end of the tunnel. Excess working capital, often trapped in the balance sheet by inefficient payable, inventory and receivable processes, is a company’s cheapest source of capital that is often overlooked. By implementing a program that eliminates bottlenecks in these cycles, a utility can quickly liberate millions, if not billions, with relatively little investment.

According to REL Consultancy Group, the 60 U.S. electric utilities, in 2003, achieved total accounts receivable of $44 billion, inventories of $19 billion and accounts payable of $30 billion, while cost of goods sold (COGS) reached $150 billion. In REL’s estimate, addressing working capital could reduce accounts receivable by 20 percent, cut inventories by five percent, enhance accounts payable by ten percent and decrease COGS by one percent-translating into a cash opportunity of $12.7 billion and cost opportunity of $1.5 billion. It could also cut total net debt by five percent ($12.7 billion/$270 billion), improve net profit (based on both cash and cost, with a standard tax rate of 35 percent) by four percent (one-third coming from cash and two-thirds from operating cost) and enhance pre-tax return on capital employed (ROCE) from 14.9 percent to 15.6 percent.

The results are staggering. One Fortune 500 company unlocked $5 billion in working capital in two years by restructuring its worldwide collections and billing processes and rewarding the sales force when payment disputes were averted, while another improved cash flow by $200 million in just four months by implementing best practice business processes for both revenue and expenditure management. And a large European utility recently improved working capital by $1.2 billion through a focused approach on improving receivables, procurement and payables.

By releasing these dollars, utility companies could increase cash flows and reinvest in building the very infrastructures that the current deregulated environment has forced many to under-invest in.

strategy for success

Improving working capital is more than just a numbers game or a balance sheet exercise owned by the CFO. At its core, improvements are operational rather than financial. For example, when customers refuse to pay their bills in a timely manner due to economic pressures or, as a matter of practice, or when customers turn on their suppliers because goods are not being delivered on time this is an operations issue that needs to be addressed. The best case scenario is to initiate a program that looks at improving processes in all three, interrelated areas comprising working capital management-receivables, payables and supply chain.

The goal is to drive efficiency within the processes that control the amount of dollars tied up from the time a dollar is invested to the time a dollar is deposited in the bank. This focus within purchase-to-pay (P2P), customer-to-cash (C2C) and forecast-to-fulfill (F2F) processes can not only improve cash flow, reduce costs and improve customer service, but also drive balance sheet strength (an essential element in determining a credit rating). C2C and F2F are extremely relevant in the utilities sector as many companies have sold energy but have not yet billed the customer.

A corporate mandate to release the billions of dollars tied up in working capital within investor- owned utilities will go along way toward providing significant amounts of cash that can be reinvested in new generation capacity. And, since these monies are already “in the system” and require little investment to garner, it behooves the industry to seize this opportunity post haste.

Reeves is a principal with REL Consultancy Group, a total working capital management consultancy firm based in Purchase, New York. He can be contacted at or 914-539-4245.


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