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Building a Better Utility

Many of the obstacles and strategic issues that utilities face today are all too familiar. This time they must be solved with a different business model.

Fortnightly Magazine - June 2005

In the 1970s, the industry struggled under the burden of a huge capital expenditure program to improve reliability that came on top of spending needed just to keep up with customer demand. Inflation reared its ugly head. Interest rates began to rise. Fuel prices doubled, then doubled again. And the icing on the cake: new environmental laws that mandated costly new equipment. Sound familiar?

All those costs for environmental spending, coupled with higher reliability and increased demand, led to higher customer rates. No longer did new investment mean lower prices and happy stakeholders.

At first, it didn't matter. Regulators were supportive. They understood. They wanted adequate supply and higher reliability and cleaner air. They knew costs were out of control.

So they approved the price increases and supported the plans for new capacity-and the capital expenditure programs necessary to fund them. They supported environmental spending and new plant to meet greater customer demand, understanding that geopolitical factors caused rising fuel prices-even as they happily passed along those increases, too.

But finally it all began to take its toll. The price increases began to pinch, consumers complained, and politicians listened. Gubernatorial races turned on promises to stop rising utility rates and "restructure" those utility commissions that simply rubber-stamped outrageous requests.

Unfortunately, that's just when those price increases were needed most- to cover higher interest costs on debt and dividends necessary to convince investors to risk their hard-earned money on companies with such dire prospects.

History Repeating?

We all know history never repeats itself. But sometimes it comes uncomfortably close.

The future I see looks frighteningly like an old rerun. The same prospects are on the horizon. And the first stirrings of unrest are already apparent.

Analysts are focusing on capital expenditures. The first revisions of cost projections have been announced. Free cash flow after dividends is turning negative. And when that happens, investors get grumpy-then demand higher returns.

Ironically, they'll need higher returns just when regulators will be searching for creative ways to justify reneging on their promises to support the capital budgets. Remember the last time that happened? Remember the fun of prudence reviews? That won't happen this time, but something equally unpleasant will—because one of the easiest ways to cut back rate requests is to lower returns on equity.

You'd Think We'd Learn

We overbuild, run short, then overbuild again. You'd think we'd learn, because when the forecasts aren't accurate, when overcapacity plagues the industry, companies fail.

Can we get the forecasts right? Probably not. But we can plan for forecasts that will be wrong. They always are. And they will be until the system is redesigned to let prices clear the market.

That has nothing to do with deregulation. It is simply getting accurate price signals to your customers and then letting them choose how much and when they

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