TXU strives for best-in-class

Michael T Burr

Editor

Editor`s note: This is the first installment in EL&P`s new special feature, “Utility of the Month.” Each month this feature will profile a company that demonstrates exemplary performance in a variety of business practices, including finance, investor relations, operating efficiency and reliability, and most notably, market competitiveness. At the end of the year, these utilities will be considered to receive EL&P`s coveted Utility of the Year award.

EL&P`s first Utility of the Month is TXU of Dallas, Texas. TXU`s CEO, Erle Nye, spoke with EL&P in January.-MTB

EL&P: Congratulations on being selected Utility of the Month. TXU was picked for this recognition because it is pursuing an aggressive strategy for growing and competing in deregulating markets. How would you describe this strategy?

Nye: The industry has a great opportunity in connection with this movement from regulation to competition. With our strategy, we will be excellent at what we do, wherever we operate. The really fine companies will be first-rate operators whatever their strategy.

We want to be involved in a selected number of regions, domestically and interna- tionally. Where we operate we want to have significant scale, and we want to be in both gas and electricity if that is possible, with a business model that integrates across the full value chain. That is to say we will pursue a model that allows us to have upstream positions, in both gas and electricity, whether that is actual gas and electric generating capacity, or creative arrangements to have access to these resources. Then we will aggregate downstream, either at retail or wholesale, and manage the two ends of the value chain with our portfolio management and trading operation.

Akin to that would be the regulated wires and pipes, but the unregulated value chain is where we are placing a lot of our emphasis. In our annual report, I said: “we will achieve excellent operations of significant scale in selected regions, which integrate and leverage synergies and capabilities across multiple products and services.”

EL&P: Many companies are focusing on either retail or wholesale. Fewer are doing both. Why are you pursuing the whole value chain?

We think this gives us an opportunity to maximize our gains over time, and to do so in a fashion that minimizes our risk-that is to say the ability to balance your upstream positions with some obligations downstream. You don`t always have to be in balance, but you need to be in a position where you can balance if the market requires it. The capability and knowledge that goes into that model gives us a very strong position. As I look at some of our peers in the premier category, they are all pursuing that same basic principle when you get behind the strategy.

EL&P: What key turning points have led to TXU`s present position?

Nye: Four years ago, we were strictly an electric utility in north Texas, with $20 billion in assets. Now we have $40 billion in assets, and our electric and gas revenues have almost tripled. Now we`re an electric and gas utility on three continents, and we have adopted a policy of moving aggressively to competition. Our properties in the U.K. are well along in that proposition-eight or 10 years into the transition-and we worked hard in this last year to get a bill which will move us to retail competition here in Texas.

The elements that allowed us to do that are the acquisitions that we made. First we acquired the largest natural gas distributor and pipeline in Texas, which overlaps our electric properties in the state. That convergence has been very beneficial to us and will provide benefits going forward.

Second, we made acquisitions in Australia and the U.K. because of the attractiveness of the markets. Now about half of our property is outside the electric business in Texas.

There has been a fair amount of integration in Australia-we built the model there. We have upstream positions in gas and electricity, we`ve got downstream distribution properties in both gas and electricity, and we have the best middle-market, portfolio management operation in Australia.

In the U.K., the same model has been fully applied, and several aspects of our business have been judged by others to be the best in class. We think we can bring that same best-in-class approach to a newly integrated, competitive model here in Texas and hopefully to other U.S. regions.

At the same time, we`ve sold some properties that don`t fit the new model and the strategy. The re-deployment of that cash has been a part of these decisions. The selloffs have been typically properties that are not core. For instance, for some years we had a passive share of a digital wireless company in Texas. We`ve sold that at a significant gain, although we`re still aggressive and active in the telecom business, through our acquisition of Lufkin-Conroe Communications, a full-service telecom operation.

We think telecom is a good business, although it`s somewhat a niche business. It offers tremendous growth potential, and gives us the added value of being able to provide gas, electricity, steam, plant operations and telecommunications to large customers. That is a nice opportunity to bundle. I don`t mean to suggest we`ll try to bundle at the retail level for all customers, but it is a nice dividend from what is, in its own right, a very attractive business.

We`re also selling our gathering and processing business. Most pipeline companies have determined that it`s better to let someone else do the gathering and processing, someone who does that as their primary business.

Finally, we`ve sold off some power plants that were outside the regions where we want to focus-mostly some minor properties in South America, which were small and isolated. It all goes to the strategy of carefully selecting where we want to operate, and being a significant player in those areas.

It`s entirely possible we may develop or acquire power plants in connection with an integrated strategy, but I don`t think you would put us in the category of simply going around developing IPPs.

EL&P: Are you developing new generation in Australia and the U.K.?

Nye: Yes, and we have bought and participated in developing properties on the European continent. Those markets are liberalizing, and the European Union has taken a strong position on competition. We have significant interest in the Nordpool in Scandinavia. We have some developing interest in Spain. We are in regular pursuit of opportunities in central Europe; we`ve had discussions with major players in both France and Germany.

Our portfolio management and trading operations in the U.K. are perhaps the best in Europe. We acquired the Energy Group, now TXU Europe. They`ve made a prestigious reputation by moving into the liberalized market in the U.K., acquiring upstream positions in gas and electricity, and trading around those positions.

EL&P: Tell me about your partnership with EdF in the U.K.

Nye: We have one of the largest regional electric companies in the U.K. We recently initiated a joint venture with Electricite de France, which operates London Electricity. We`ve entered a joint venture in which we will combine our management and work force around the two regional electric companies. We have proven capabilities in driving down costs while improving efficiency, reliability and safety, and we will bring the same kind of cost savings to London Electricity. The combined operations themselves will produce savings, which we`ll share.

We`ll continue to own our property, and they`ll continue to own theirs. But we`ll bring best-of-class practices to those combined properties. They`ll be operated together even though they`ll be owned separately.

This is the sort of creativity that will be required going forward in this competitive environment. We think it offers some real possibilities, and the model could be extended to some other parts of our business.

EL&P: Are you actually integrating operations in terms of billing systems, grid management, etc.?

Nye: Right now, this is purely related to the wires and pipes. We`re talking about construction, operation and maintenance of distribution facilities. The supply business will do the billing and read meters, so forth. But I can imagine a time when you would combine billing systems and call center operations, within the limits of the requirements of competition.

Everybody can`t come together, but as long as there is significant competition for customers and the customer has multiple choices, the opportunity for two or more suppliers to get together and lower the cost of delivering their competitive service is very appropriate and possible. I don`t know of anyone who is doing it, but if we`re thinking about it, others are thinking about it.

EL&P: What are your goals for earnings and growth?

Nye: We have a matrix of financial expectations that are applied to two or three categories of investment. It`s a different set of financial parameters depending on the type of property you`re operating, acquiring or building.

We want to produce, in each of our enterprises, high single-digit earnings gains each year. That includes traditional properties and new properties. If you have traditionally middle single-digit utility properties, you need to produce double-digit returns on other properties to achieve high-single-digit overall.

We try to develop a portfolio going forward that produces an overall result for the corporation of positive cash flow and high-single-digit gains in earnings per share in the near term.

In the U.K., where we acquired a fully competitive enterprise of significant size, that operation has contributed about 30 percent to earnings. It was significantly accretive in the first year on the order of 20 to 25 cents. That`s pretty significant on our earnings [editor`s note: 1998: $2.79/share; 1999: $3.19/share].

We`re in a position in Texas, given the statute we`ve got, that we can hold a significant share of market sufficient to grow earnings in the United States as we make the transition to competition. Granted, electricity is still being deregulated, but we`re encouraged about the prospects.

EL&P: What do you think is the biggest impediment to competition moving forward?

Nye: We`re doing this on a state-by-state basis, and to some degree that is an impediment. If we get federal legislation-and I presume we ultimately will-it should recognize the rights of the states to have differences in the way they provide retail choice, with some assurance of interstate transmission facilities being fully open access.

We need to have the North American Electric Reliability Council (NERC) designated as the arbiter of transmission lines, so everyone has transparent access to the use of that system to move competitive power. Letting NERC do that with an independent board, backed up by a federal agency-probably the FERC-is the key issue to ensuring you have full and fair competition in the states that adopt retail competition. That will take legislation.

There are a series of issues around the broad comprehensive bill for federal legislation. But as long as there is uncertainty about competition, it will be an issue. I`d be remiss if I didn`t say we desperately must move to eliminate the vestiges of the Public Utility Holding Company Act (PUHCA), which has served out its usefulness. Also PURPA was enacted at a time when circumstances were different, and a lot of the provisions of PURPA are inconsistent with competition.

There is some need for federal legislation. Whether we can reach it in the near term is open to question.

EL&P: To what degree is TXU looking to the unregulated side of the business for its future growth and profitability?

Nye: We are in transition. We`ve got about $10 billion in revenue in the U.S., $6 billion in the U.K., and $600-700 million in Australia. In the U.S., we`ve got gas, electric and telecommunications, with most of the revenue from gas and electricity. The U.K. is essentially completely competitive, except for the wires business, which is about 25 percent of our total business there. So we have about $4.5 billion in competitive revenues in the U.K. We`re approaching half of our revenues competitive in Australia. So in total, $5 billion out of $17 billion is competitive.

We`re moving rapidly in Texas, and we`ll move $6 to $7 billion of revenue into competition in the next two years. We`ll move from roughly one-third of our revenues in competitive markets to two-thirds being competitive in the next couple of years.

That`s something we`re pushing pretty hard. We decided a while back that competition was the way to go. It was beneficial for our customers and shareholders, and we wanted to be in the forefront of making it happen. That way we could take advantage of the situation-better optimize our earnings, better take care of our shareholders, by being out front and making it happen in the right way.

We take a lot of benefit from what we`ve learned in the U.K. and Australia, so we may have some degree of comfort that others might not have. We`re very excited about the prospects.

EL&P: Has this changed the dividend picture for TXU stock?

Nye: We`re continuing with the dividend policy we`ve had for several years [editor`s note: TXU returned 65 percent of earnings to shareholders in 1998]. The natural question is how long will we exhibit the characteristics of a traditional utility, and at what point in the transition will we begin to exhibit the characteristics of a growth enterprise, which would be associated with the competitive model I`ve described. Our stock is trading someplace in between.

We wouldn`t change our dividend policy until after the transition was clearly recognized and after the growth was demonstrated.

EL&P: What are your goals for the future?

Nye: I`m very proud of this company so I don`t hold any modest goals. My vision is to be one of the best performing companies in the industry-that is, the broader, international energy services business. I`d be pleased to say we`re in the top five, in every measure of performance. We have size but that`s not the final arbiter. It`s the quality of the operations. I`d like us to have best-in-class across the board. The elements are in place, and we have the opportunity to get there.

In terms of our position, access to continental Europe offers a remarkable growth opportunity. We have a somewhat similar, though smaller, situation in Australia.

In Texas, given the new statute, when we once and for all make the transition to competition, and given the significant cash flows we will continue to have, we have a wonderful basis for extending our capabilities outside Texas into select regions where we can have access to a receptive and liberalizing market.

The stars are in alignment. We`ve got the opportunity to make significant gains and distinguish this company. We are not unmindful that competition is tough, but frankly, we`re anxious to get to it. Given our size and our positioning, we think the best is yet to come.

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TXU is pursuing an integrated strategy for growth on a global basis. Its retail businesses provide a firm load for the power plants and gas properties it operates.

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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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