Utilities’ Business Model

by Philippe David and Chris Miller, Capgemini

Confronted with the economic downturn, leading U.S. utilities faced a 5.2 percent drop in overall electricity demand, according to a Capgemini financial study of the top 56 U.S. utilities, “US Power and Gas Utilities Resilient Business Model.”

The study concludes U.S. power and gas utilities were surprised in mid-2008 following a boom characterized by increasing commodity prices and cheap equity. The economic slowdown and fall in commodity prices created a difficult environment for contenders too exposed in the unregulated market or heavily relying on debt. The following summary contains excerpts from the study.

A Financial Study of Top 56 U.S. Utilities

Significant slowdown in capital investment was a direct consequence of turmoil in the financial markets. Funds emanating from the American Recovery and Reinvestment Act somewhat preserved the renewable segment and most demand reduction and energy efficiency initiatives, but lack of clarity in future energy policies hinders investment strategies.

In the aftermath, 2009 heralded a new era of slow demand growth—characterized by a progressive recovery of the economy and ongoing results of demand-reduction initiatives—combined with a forecasted abundance of cheap gas from shale reserves and increased scrutiny from federal and state regulators on investments, allowed earnings and rates.

A resilient business model is emerging centered around three strategic capabilities:

  1. Lean operations and tight management of return on equity (ROE),
  2. Portfolio management, and
  3. Achievement of critical size.

Lean operations and tight ROE management focus on a company’s capability to concentrate solely on those activities that create value for customers while maximizing economic returns subject to mandated restrictions (for the regulated activities) or based on accepted risk levels (unregulated activities).


Technology innovations such as smart metering and smart grid will help make operations and processes leaner.

Portfolio management is the capability to focus on areas of the value chain or within the geography that will match a company’s core capabilities best. For example, investing today in electricity transmission and serving regulated power and gas customers in well-chosen markets might be the safest way to ensure consistent growth and a respectable allowed ROE.

Achieving critical size is necessary for companies to face investment challenges around generation and new builds (e.g., nuclear).

Capgemini’s top North American energy and utility industry professionals analyzed financial reports, annual reports, media coverage and other public information for each of the top 56 U.S. utility companies.

The team also reviewed recent surveys and studies, including the Platts/Capgemini Utilities Executive Study 2009-2010 and the NARUC/CAMPUT Smart Grid and Renewable Survey 2009: Key Findings and Analysis.

The Resilient Business Model in Action

We selected the 56 largest companies operating mainly in the U.S. power and gas markets, most of which are investor-owned and listed on the U.S. stock exchange.

A full list of companies surveyed is provided in the appendix, available online.

Our overall assessment of business model resilience focuses on overall ROE secured and growth in turnover.

A combined consideration of these two key indicators is fundamental to understanding a utility’s potential for value creation.

Overall ROE. For the regulated part of this industry, the allowed ROE is around 10.5 percent, which we will use as the industry average. Considering that a significant portion of the business is not regulated, higher ROEs are achievable through strategic portfolio management. The 10.5 percent ROE average for 2009 varied slightly by activity: Gas distribution was set at an average 10.25 percent, electric distribution averaged slightly below 10.5 percent, and power transmission above 12 percent on average, where the associate premium stems from the added complexity of new construction.

ROE allowances for similar activities also can vary among states. Utilities can have many avenues to increase their ROE in the short and medium terms, including cost discipline, investment activity (increasing the rate base), portfolio restructuring (including more or less regulated activities in the mix), etc.

Growth in turnover. Utilities secure additional sources of return by growing turnover. This growth depends mostly upon the energy intensity of the gross domestic product, the growth of the overall economy, temperature and the prevailing price level, mostly driven by regulatory activity. An interesting challenge to the underlying business model emanates from the general expectation that utilities should actively contribute to reductions in demand. Four quadrants make up the value creation grid (see Figure 1):

  1. High Value Creation: Companies that were able to grow turnover while outperforming the overall industry average ROE.
  2. Preservation of Value Creation: Companies that experienced a decrease in turnover but managed to maintain an above-industry-average ROE.
  3. Value Destruction: Companies that managed to grow turnover without reaching industry-average ROE.
  4. Significant Value Destruction: Companies that decreased turnover and saw ROE slipping below the industry average.

For our 2009 panel of companies, the overall result is shown in Figure 2. Based on the criteria described, only three companies fall within the High Value Creation quadrant (Figure 2):

  • NRG Energy Inc., a wholesale-focused utility, was boosted by its hedging gains ($118 million), resulting in a 30 percent 2009 revenue growth.
  • ITC Holdings Corp., an independent electricity transmission company that owns and operates 2,800 miles of power transmission lines in southeastern Michigan, maintained a high operating margin in 2009 despite reductions in volume by optimizing revenues collections. Also, 2009 saw ITC’s smallest ratemaking true up in aggregate in its history.
  • Allegheny Energy Inc. managed extremely well through the economic downturn mostly because of its diversified portfolio. Regulated operations generated the best results, reflecting improved cost recovery in Virginia and additional income capabilities. Also, Allegheny Energy Inc. and FirstEnergy Corp.—strong companies with adjacent service territories and similar cultures—announced their merger Feb. 11, 2010.

Six companies exceeded 5 percent revenue growth:

  • NRG Energy Inc (see above).
  • Unitil Corp. managed a 27 percent increase because of the successful integration of Northern Utilities Inc. and Granite State Gas Transmission Inc. pipelines. This acquisition increased the customer base by 50 percent.
  • Black Hills Corp.’s full integration of gas utilities acquired from Aquila and other electric utilities allowed for a 26 percent revenue growth. Exposure to nonregulated activities was reduced via the divestiture of seven independent power producer plants in 2008.
  • Great Plains Energy Inc. incorporated an additional 18 percent revenue by fully acquiring other Aquila assets.
  • Idacorp Inc. grew organically by 9 percent, aided by favorable water conditions leading to increased power generation.
  • Progress Energy achieved 8 percent organic growth primarily through retail activity in Florida.

Business model resilience can be considered in further detail based on positioning within the value chain. The primary aspects are:

  • Independent power producer,
  • Integrated company (segmented further based on generation types represented within its portfolio), and
  • Pure energy deliverer.

Independent power producer. Independent power production (see Figure 3) represents the most versatile group in value-creation trends because contenders are mainly merchant players with significant exposure to commodity prices. The sharp drop-off in wholesale electricity and gas prices in 2009 led to significant contraction, negatively impacting the bottom line.


One company retained its position within the value creation quadrant: NRG Energy Inc. (23,000 MW of U.S. diversified generation, including nuclear). NRG Energy Inc. increased its ROE from 2008 to 2009 while decreasing turnover slightly, thereby demonstrating dedication to preserving returns. Its impending acquisition of several Dynergy plants from The Blackstone Group (3,884 MW of assets in California and Maine) for $1.36 billion ($351 per kilowatt) will cement further expansion.

Calpine (29,000 MW of combined-cycle natural gas-fired and geothermal power generation) also increased its ROE while decreasing turnover. After completing its Chapter 11 restructuring and emerging from bankruptcy Jan. 31, 2008, Calpine improved its financial performance within the umbrella of Project Phoenix, a combination of conservative risk management and sound operational, commercial and financial execution throughout 2009.

Mirant Corp. (10,000 MW of coal and gas capacity) decreased turnover and ROE. Nevertheless, 2009 was a very good year for Mirant Corp. The company maintained operating levels for its plants (89 percent of commercial availability) and executed on a hedging strategy that protected it from further losses during the downturn. Mirant Corp. and RRI Energy Inc.’s (also an independent power producer with 14,000 MW) agreement to join in a merger of equals to create GenOn Energy Inc. is estimated to generate $150 million a year of synergies.

Dynergy (12,200 MW of coal and gas capacity) saw losses from most of its generation business throughout 2009. The company’s near-term debt maturities in 2011 and 2012 represent a further potential challenge. Despite an aggressive cost-savings initiative with anticipated total savings estimated at $400 million to $450 million over four years beginning in 2010, Dynergy announced Aug. 13, 2010, that it entered into a definitive merger agreement in which it will be acquired by an affiliate of The Blackstone Group LP in a transaction valued at some $4.7 billion (including the assumption of existing debt).

Integrated companies with more than 70 percent coal in generation portfolios. Most companies on this segment faced strong decline on turnover (see Figure 4). All companies but Energy Future Holdings and NiSource faced difficulties in preserving ROE in 2009. ROEs on this segment are close and tend to converge between 5 and 10 percent (other than Allegheny Energy Inc.).

Two companies from this group are especially worth detailing. Allegheny Energy Inc. showed the most resilience in turnover and ROE. Allegheny Energy Inc. was the only company of this segment that maintained its position in the Value Creation quadrant.

NiSource operated a 100 percent regulated portfolio of gas distribution, gas transmission and storage and electricity generation (3,322 MW) and distribution. NiSource improved ROE, although facing strong reduction in gross revenues because of the fall of gas commodities prices and the decrease in volume because of mild weather. The net revenue progressed during 2009. Overall, NiSource through the nature of its portfolio (100 percent regulated) weathered the economic downturn very well.

Integrated companies with less than 70 percent coal in generation portfolios and with nuclear. Companies in this segment (see Figure 5) faced strong reductions in turnover—only Westar Energy and Xcel Energy managed increases. Nevertheless, more than half maintained their ROE levels above 10 percent. Utilities with nuclear assets can operate at ROEs higher than the industry average. In 2009, not a single company remained in the Value Creation quadrant.

In ROE, three clusters emerge:

  1. Companies that improved their ROEs: Constellation Energy Group Inc. (resulting from the sale of some asset to Electricite de France), NV Energy Inc., Duke Energy Corp., Progress Energy, FirstEnergy Corp., Edison International and Public Service Enterprise Group Inc.
  2. Companies that maintained their ROEs: PPL Corp. and Xcel Energy.
  3. Companies that saw their ROEs decrease: Duke Energy Corp., Pinnacle West Capital Corp., CMS Energy Corp., Dominion, Scana Corp., Entergy Corp. and NextEra Energy Resources LLC.

Integrated companies with less than 70 percent coal in their generation portfolios and without nuclear. Most companies in this segment saw strong reductions in turnover and faced significant challenges in maintaining their ROEs at or above 10 percent (see Figure 6). Exceptions include OGE Energy Corp., Avista, Idacorp Inc. and Teco Energy. OGE Energy Corp. is a fully regulated electricity and gas company with 6,600 MW of coal, gas and wind capacity and is an operator of a gas pipeline. As in the previous case, not one company remains in the Value Creation quadrant.


Pure energy delivery companies. Pure pipe and wire companies are fully regulated and can attract higher ROEs. Some augment and balance their regulated business with unregulated activities. Most companies in this group maintained or increased their ROEs.

CenterPoint Energy operated in the regulated and unregulated segments (competitive energy market in Texas) and faced significant revenue losses attributable to its exposure to competitive gas markets and fluctuations in commodity prices. Amid these pressures, revenues naturally decreased. Nevertheless, CenterPoint Energy increased its ROE by (1) combining midstream gas pipelines and electric transmission lines, which attract higher ROE, and (2) committing to continued investment in the assets. Consolidated Edison Inc., UIL Holdings Corp. and Unitil Corp. maintained their ROEs. All three operate in the Northeast—New York, Connecticut and New Hampshire, respectively—where retail prices are the highest in the country and regulatory pressures to avoid further rate increases are significant.

Successful Strategies

Three strategies drove resiliency during the economic downturn. These same strategies can be implemented to provide utilities with the necessary flexibility to face new market evolution, especially in consideration of a likely slow demand growth future:

  1. Lean operation and tight ROE management,
  2. Portfolio optimization, and
  3. Achievement of critical size.

Lean operation and tight ROE management. Maximizing value based on a prescribed maximum return for regulated activities or a return more directly based on market dynamics for nonregulated activities is the foremost critical goal for any utility. Additional emphasis was placed on delivery of target ROE during the downturn as demand decreased and the price of commodities fell. The measures taken by utilities in light of these market forces ranged from pure cost containment (reduced expenditures, etc.) to process improvements, capex optimization, FTE reductions and changes in organizational structure. Many companies initiated cost-reduction measures. Process improvement came second in priority only to managing ROE through cost containment.


Process improvement took a backseat to capex optimization and FTE reduction for companies managing to maintain their ROEs while FTE reduction remained a priority for those faced with declining returns. Capex optimization focused mainly on deferrals of investments that while beneficial in the short term can negatively affect asset renewal and sustainably meeting growing demand. FTE reduction is not a prevalent way of driving costs of the utilities sector even in light of recent economic events. Nevertheless, for nearly 30 percent of utilities, not growing ROE translated to the need for adjusting head count as part of their initiatives to maintain economic efficiency. Finally, organizational restructuring (centralization, decentralization, spans and layers, outsourcing, etc.) only factored into the picture for companies deviating positively or negatively from stable performance and did not constitute a primary means of obtaining higher efficiency levels.

Despite notable increases, inoperational efficiency brought about in response to economic realities, the utilities industry still lags the best-in-class processes associated with industries such as manufacturing (industrial) and the services sector (customer focus), leaving opportunity for improvement.

Portfolio adjustment. Achieving a balanced portfolio, maintaining a balanced portfolio or both is key to weathering the recession and ensuring continued success despite weakening demand for electricity and gas.

The key components in a balanced portfolio are:

  • On the generation side, nuclear assets provide long-term price stability. Gas plants enable flexibility in short-term hedging strategies and allow for long-term carbon dioxide-abatement options against coal. Renewable energy sources greatly contribute to a CO2-free portfolio, providing financial subsidies while federal and state support remains.
  • On the infrastructure side, a focus on power transmission brings higher limits on allowable ROE and provides growth opportunities, considering that large renewable capacities require new and additional transmission infrastructures.
  • On the geographic side, a good mix of regional and state presence allows a utility to take advantage of healthier energy margins, even if associated markets are deregulated. In addition, some regulatory authorities provide more incentives for utility growth than others.
  • Finally, when demand and customer base are concerned, a large share of regulated activity de-risks the business mix while a large share of residential customers ensures demand stability.

A surefire way for utilities to actively manage, balance (or re-balance) and optimize their portfolios is through organic growth. Investments made by companies often center on improving their share of gas within their generation portfolios or investing in the electricity-transmission business to bolster long-term stability. Asset transactions are another alternative for adjusting the asset mix. Finally, the divestiture of noncore assets is a reliable means for companies to reposition their business and focus on higher returns and lower risks. A few choice examples follow:

  • After the divestiture of its generation business to Calpine and the wind-down of its retail energy supply business, Pepco Holdings Inc. will become a utility focused solely on regulated transmission and distribution. This will enable the company to (1) focus its investments solely on its distribution and transmission assets, (2) minimize regulatory lag, and (3) optimize overall financial returns.
  • Iberdrola USA Inc. sold three gas companies to UIL Holdings Corp. in a move to ease its cash position and focus more of its investment on electric transmission in the Northeast.
  • Dominion Resources Inc. will focus most of its investment ($10.9 billion through 2012) on regulated operation (83 percent) and environmental and nuclear (17 percent) operation. Dominion also is considering the construction of a nuclear plant. In addition to aggressive cost containments aimed at financing this ambitious growth plan, Dominion announced the sale of its shale gas reserves to Consol Energy Inc. for $3.4 billion.

Achievement of critical size. Large transactions typically are aimed at drastically changing a company’s competitive position in the market. The following transactions illustrate the steady, albeit slow, consolidation of the U.S. utilities sector:

  • Sale of E.ON U.S. to PPL Corp. for $7.6 billion,
  • Acquisition of Allegheny Energy Inc. by FirstEnergy Corp., $4.7 billion in stock,
  • Sale of Conectiv Energy to Calpine for $1.6 billion,
  • Merger between Mirant Corp. and RRI Energy Inc., $1.6 billion stock swap, and
  • Sale of three gas distribution companies from Iberdrola USA to UIL Holdings Corp. for $1.3 billion.

Also worth mentioning are Exelon Corp.’s unsuccessful move to acquire NRG Energy for $13 billion in 2008 and preliminary discussions around FPL Group Inc. and Constellation Energy Group Inc., proving the need to reach a critical size within the utility industry to be able to tackle significant investments. This is especially true for new nuclear builds to maximize efficiencies, reduce costs and better manage risks. A recovery of the credit markets and the rebound of equity markets have increased mergers and acquisitions activities. While 2009 marked a sharp decline in utility sector mergers and acquisitions activity with even private equity and infrastructure funds staying away, power and gas utilities remain cautiously optimistic. Nevertheless, regulatory approval remains a critical consideration in any transaction and with it the realization that any associated scrutiny from regulators could result in additional significant costs. It is in this respect that the proceedings for the FirstEnergy Corp. and Allegheny Energy Inc. merger are extremely informative and might foreshadow the fate of future utility sector mergers and acquisitions activity.

Philippe David is vice president of energy and utilities at Capgemini Consulting. Reach him at philippe.david@capgemini.com.
Chris Miller is principal of energy and utilities at Capgemini Consulting.

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The Clarion Energy Content Team is made up of editors from various publications, including POWERGRID International, Power Engineering, Renewable Energy World, Hydro Review, Smart Energy International, and Power Engineering International. Contact the content lead for this publication at Jennifer.Runyon@ClarionEvents.com.

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