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That Giant Sucking Sound? Rural Distribution Territories and Utility Earnings

Fortnightly Magazine - November 15 2001

In Illinois, where extremely dense Chicago is surrounded by fairly unpopulated farmland and small towns, the non-urban distribution system is operating only at the breakeven point. In the Carolinas, where the differences in population density are muted, the rural system is showing an ROA of nearly 6 percent. However, that is still far below the ROA for the remainder of the utility. With divestment, every utility stands to increase its ROA by 1 percent to 2 percent.

This ROA increase is the result of a number of factors. First, less utility plant is employed per customer in more densely populated regions. Thus, greater revenues are generated per unit of net plant in an urban area versus a rural area. The slight drop experienced in net plant per customer after divestment is enough to slightly boost ROA. The impact is multiplied when distribution operation and maintenance cost per MWh sold also falls after divestment. Distribution O&M costs are closely correlated to the amount of utility plant. When the amount of net plant employed on a per MWh or per customer basis drops, so does the O&M expenses. This drop () leads to increased margins. Additionally, line loss in rural areas is going to cut into margins. As electricity is forced to flow longer distances through distribution lines, less of the generated electricity will reach the end customer. The power costs are absorbed by the utility. Divesting rural territory will lower average power costs and raise margins. Increased margins on a smaller asset base lead to greater profitability.

The results discussed above are, in the opinion of Management Consulting Services, conservative. It is quite likely that utilities will actually realize greater savings than those resulting simply from the divestment of underutilized assets. Additional factors that could have cost implications include overhead expenses, environmental conditions, and management focus.

The models as presented assume very little impact on a utility's administrative and general expenses. These expenses on a per customer and per MWh basis actually rise in our scenarios for the base utility. However, if a utility could take advantage of these streamlining transactions to reduce non-allocated overhead expenses, savings could grow.

Additionally, environmental factors could adversely affect a utilities current cost structure. While environmental conditions did not appear to be significant in the models we used in this analysis, we have found that they are important when comparing cost structures between electric cooperatives. Important considerations include vegetation cover and precipitation. Urban and sub-urban service territories are not likely as rural areas to be affected by the problems posed by vegetation growth and collapse. Additionally, rural areas are likely to have inadequate or non-existent drainage systems. Saturated ground and standing water could complicate efforts to repair storm damage in these rural areas.

Finally, a rural divestment program could help focus a utility's management team on its core business. Not only would divestment reduce crew-dispatching complexity, but also it would allow management the ability to reduce the intensity of relationships with many of the communities currently served. Utilities must now spend time maintaining contacts with the variable