Companies continue to embrace the back-to-basics strategy, and investors seem to think that it is paying off.
Regulated Utilities: Reinventing the Classic Business Strategy
Opportunities and limitations of five top strategies.
negative actions are the regulator’s invention of “royalty” charges to the unregulated operations for the use of the utility’s “goodwill.”
Public service commission staff or consumer advocates file rate-case testimony against the interests of the shareholders in diversified utility companies. Additionally, however, competitors to the utility’s unregulated business also use the regulatory process to try to handicap the utility. The competitive opposition even can orchestrate a legislative prohibition against utility investment in a particular line of business. Wisconsin, for example, passed statutory restrictions in the mid-1980s on the diversification selections of utility holding companies.
There always will be exceptions to every rule. Some unrelated diversification might emulate GE’s apparent success. However, the decision for the CEO and board of directors of any non-regulated company to diversify into unrelated business lines comes back to increased risk. Does the potential for a home run outweigh the risk of striking out? When it comes to creating value through diversification, the regulated utility company faces the additional risk of regulation. The regulator can tilt the playing field against the shareholder without any commensurate opportunity to see increased value achieved.
Vertical Integration: From Mine Mouth to Meter?
The value creation option of “vertical integration” is the movement to invest in either upstream or downstream assets, but such a move introduces new regulatory regimes, alternative outsourcing issues, and the response from existing regulation.
Going upstream or downstream could lead to investment in a business subject to additional regulation by another regulatory agency. The repeal of the Public Utility Holding Company Act by the Energy Policy Act of 2005 allows more options when it comes to utilities in one sector and geography investing upstream or downstream in regulated utilities in another sector or geography.
Natural-gas distribution companies considering a move upstream could invest in a natural-gas pipeline. In that case, the state-regulated local gas distribution companies would own an investment in a business fully regulated by the Federal Energy Regulatory Commission (FERC).
This is the position that Wisconsin electric utilities face in their ownership of the American Transmission Co. (ATC). However, in this case ATC was created by the spinoff of transmission assets from the utility rate base. The state-regulated electric utilities now own a share of an electric utility subject to regulation by FERC as well.
The same situation faces a federally regulated natural-gas pipeline investing in electric or gas distribution assets or wholesale power generators investing in electric distribution facilities. Both Enron (initially a gas pipeline company) and AES (a wholesale generator), for example, bought state-regulated electric utilities.
Similarly, pipeline companies or electric and gas distribution systems investing in wholesale power generation will find that FERC has regulatory authority over the new investment.
Investments further upstream into natural-gas production, coal mining, or transportation systems also are possible and have been made by a few utilities. The acquiring board’s decision, when reviewing the possible move upstream, is whether the efficiencies gained by upstream integration are greater than those available from outsourcing these activities.
One possible downstream integration move is to invest in companies that provide services on the