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That Giant Sucking Sound? Rural Distribution Territories and Utility Earnings

Fortnightly Magazine - November 15 2001

belonging to the cooperative run down on one side of the road, while investor-owned utility lines run down the other side. This occurs even as substations belonging to separate organizations are within sight of each other. This poor use of hard assets leads to a second problem: all of these facilities must be maintained. Each utility manages its own team of linemen to maintain its plant. Even if the linemen stay busy all the time and under-employment is not a problem, most workers must spend time crossing through the other firm's territory to get to the next job. This increased ratio of travel time to work time raises employment costs.

Few utilities have systematically looked at the impact of service territory characteristics-density, load mix, growth, geography, climate, etc.-on the profitability of that territory. The difference can be dramatic.

The Solution? Let the Cooperatives and Skilled IOUs Take Over

Who wants this low-growth territory, with low return on assets? Potentially two groups: 1) investor-owned utilities who develop the specialized skills and approach to serving rural territory; and 2) cooperatives to whom the incorporation of interstitial investor-owned utility territory into the cooperative service area adds density, load mix, and size.

Our analysis focused on acquisition of this territory by cooperatives. They are much more ubiquitous than rural investor-owned utilities and the significant overlap in service territory creates the greatest financial incentive to consolidate the territory. Transferring these rural investor-owned utility service territories to cooperatives will be beneficial to both companies.

These transactions will decrease costs and increase returns for both organizations. For the investor-owned utilities, the advantages come from divestment of poor performing assets, and a refocusing on more profitable, densely populated urban areas. A jump in the utilities' return on assets is inevitable. In the utilities modeled by Management Consulting Services, the cost to serve urban customers on a per MWh and per customer basis was, on average, only 55 percent of the cost to serve rural customers-it costs nearly twice as much to serve rural areas. At the same time, net utility plant per customer falls steadily as population density rises. Divestment of rural areas will lead to larger margins on smaller asset bases.

Rural cooperatives are ideally suited to serve customers in these high cost regions. Acquiring these customers will increase a cooperative's customer density and allow it to rationalize the combined asset base (closing unneeded substations and abandoning duplicative stretches of distribution line). Additionally, given the not-for-profit, tax-free status of rural cooperatives, they are much better suited to financially succeed in the asset-intensive rural distribution business. Management Consulting Services built a series of models to recreate investor-owned utility operations in rural areas and compare operating results between service territories. Using only publicly available information, 1 we built statistical models to predict how much net utility plant was likely to exist within a given service territory and the cost required to serve customers within that area.

Each model was built using a database of FERC Form-1 and RUS Form-7 reports from over 650 electric cooperatives and utilities. Each model was built