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Competition, Convergence...and Cashflow?

Fortnightly Magazine - April 1 1996

remaining thermal units will either be shut down as uneconomic even at nominal book value, or grudgingly operated after large one-time write-offs.

The economics of the remaining generating plants (geothermal, wind, biomass, solar, QF hydro, rate-based large hydro, and nuclear) will be so influenced by political considerations that speculation over their future is futile. An additional imponderable is whether the operating licenses of several perfectly serviceable nuclear and hydro assets will be renewed or fall victim to environmental special interests. Environmental pressure may shut down older nuclear and hydro units, but market reality might also shut down several hundred megawatts of renewable assets. The issue of who pays what to whom during this transition is unresolved and will finally be decided by the courts. The current inclination to leave everything up to the pocketbooks of consumers seems untenable.



The more interesting questions of risk and reward concern new entrants. One can expect three waves.

The first wave will comprise three sets of entrepreneurs, with varying degrees of capitalization. Undercapitalized entrepreneurs will most likely fail unless they 'flip' their business concepts or development ideas to substantial corporations. Adequately capitalized entrepreneurs will emerge with the professional discipline and financial acumen to sell or refinance their projects or young businesses at the earliest opportune moment (A few of these may indeed make the proverbial

100-to-1 venture capital return on their $1 to $5 million in seed capital). Resourceful energy companies or financial houses with the foresight to lead the industry in capturing value before their peers will either see the opportunities or rouse themselves to act. (These can expect a return on equity of around 2 to 2.5 times the corporate long-bond rate (em i.e., an enterprise capital return.)

In the second wave will come the imitative companies and financial houses that will seek to buy, develop, or otherwise fund assets similar to those owned or controlled by the first wave. Their returns on equity may cluster around 3 to 5 percent above the corporate long-bond rate (em i.e., somewhere between enterprise and utility capital return.

The third wave will find energy companies or active money managers seeking to accumulate established assets with a demonstrated record of performance (without quite realizing that these assets are available only because the sellers, often first-wave entrants, see margin compression coming) in the hope of making a return on equity in the mid-teens. Unfortunately, actual returns may not exceed the corporate long-bond rate, which suggests that the value added from management may be entirely consumed by the costs of management.

Very few companies will earn first-wave returns. The companies (including financial houses and sophisticated hedge funds) or wealthy entrepreneurs most likely to succeed as first-wave investors are already using two business techniques to position themselves: 1) Opportunities and Concepts Contour Mapping, and 2) Strategic Choke Point Analysis.

Different electricity industry functions in different geographic areas and regulatory regimes are subject to differing paces and magnitudes of change. Contour Mapping aids in understanding, at a fine level of disaggregation, how existing asset values and operating margins