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A Utility Executives' Guide to 2007: A Cloudy Forecast

Experts predict the top issues that utilities will have to weather this year, and beyond.

Fortnightly Magazine - January 2007

At the dawn of a new year, what will 2007 bring the utilities industry? To paraphrase Charles Dickens, will it be the best of times, or the worst of times? The age of wisdom or the age of foolishness? The season of light or the season of darkness?

Some utility experts are coming to the sobering conclusion that the industry’s darkest hour may be just ahead.

After several years of extraordinary stock performance, improved balance sheets, and restored credibility—not to mention the passage of an Energy Policy Act in 2005 (EPACT) that many utility executives hoped would bring needed consolidation and more infrastructure investment—a number of disturbing trends took shape last year.

First and foremost, the political backlash in Maryland and Illinois against large but necessary rate increases changed the financial calculus utilities were using to manage higher costs and plan for new infrastructure investment.

Moreover, the failed FPL-Constellation and Exelon-PSEG mergers showed the prominent role that state regulatory commissions could play in derailing a merger when rate concessions become too onerous.

FERC Chairman Joseph T. Kelliher, in early December, told Reuters he was “not really” surprised by the failure of these mergers, noting that state blockage of mergers was not a new phenomenon. “Most utilities mergers that have failed in the last 10 years were due to state actions,” he said.

But the merger failures raise the prospect that utilities may not be able to pursue consolidation strategies to achieve greater economies of scale as a way to contain escalating costs.

Furthermore, in late October, the North American Electric Reliability Council (NERC) issued a grim report warning that demand for electricity in the United States is increasing three times as fast as resources can be added, and is threatening to make electric service unreliable in the coming decade.

NERC, which won official certification this past summer as the nation’s Electric Reliability Organization (ERO)—said U.S. demand would increase by about 20 percent from 2006 to 2015, outstripping investment in new power supplies.

“The operation and planning for a reliable and adequate electricity system is becoming increasingly difficult,” said Rick Sergel, CEO of NERC, offering a reason why reserve margins are threatening to fall below required levels.

Of course, the multi-billion-dollar challenges have not been lost on utility executives. In a survey conducted by Cambridge Energy Research Associates (CERA), utilities executives said they expected their companies to face major risks and changes in the coming years from fuel and capital costs, environmental mandates, and potential mergers and acquisitions, as well as long-term investment and technology challenges, to name just a few big issues.

As far as building power plants, CERA respondents predicted possible supply shortfalls in regional markets in the coming years—a shocking revelation. But what may be even more shocking is that utilities do not regard this as their greatest business risk. The top three

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