The latest dispute over PJM’s bidding rules has raised the level of uncertainty in organized electricity markets. Efforts at reform have created a market structure so jumbled that it can’t produce...
IOUs Under Pressure
Policy and technology changes are re-shaping the utility business model.
introduction than upside benefit. Industry history, therefore, is one of careful and slow change.
At the same time, by many measures, the pace of technological change and importantly, the rate of adoption of change is accelerating ( see Figure 3 ). The meaning is clear: Technology is more rapidly assimilated today than in the past and will be more rapidly assimilated in the future than today. Industrial and energy-related technologies are not immune from these forces. Advances in distributed generation technologies such as photovoltaic arrays, fuel cells, wind power, batteries, and other more exotic supply sources continue to show dramatic improvements in cost and efficiency. The same is true for grid-related technologies, such as advanced sensors, distributed computing, high-speed two-way communications and smart meters. In some ways, the message is as frightening as it is impressive. What happens to companies when technology development and deployment outpace an existing industry’s ability to keep up?
The demise of electric utilities isn’t at hand. The service provided is too critical and the existing infrastructure too expansive for any technology development to quickly overturn the status quo . But change in the telecommunications industry serves as a reasonable proxy. It has been over 25 years since the landmark decision to unbundle AT&T, the original telecommunications utility, into seven regional operating companies (plus a long-distance company) that were essentially providing local and regional landline services. Now, the landline business is dying, the cell phone industry has exploded and may yet be supplanted by voice over internet protocol (VOIP) technology, and most of the regional operating companies have been acquired, merged or sold. The telecommunications landscape is vastly different from what it was 10 years ago, let alone 25 years ago.
Arguably there’s no single disruptive technology on the horizon in the electric utility industry, akin to cellular service, that will serve as the catalyst for dramatic change. But that’s not required. The industry is characterized by the simultaneous emergence of several technologies (and regulatory and legislative initiatives), each of which can create incremental change that collectively can cause an industry disruption. And with the government prepared to invest billions of dollars in renewable and distributed generation (DG) technologies over the coming years, and regulatory, tax, and environmental policies poised to dramatically impact the industry, it would be surprising only if such changes didn’t materialize.
Recent history on under-performing utility stocks provides some guidance as to investor perception of future utility value. A recent article 8 reviewed trends in utility share prices. The article noted that investors penalized utilities that had cash-flow and liquidity constraints, un-competitive market positions and contentious regulatory relationships. While these negatives might be self-evident to utility executives, this is exactly the environment to which the utility business could be headed, regardless of business-cycle considerations. The overall industry trends point to a combination of all three factors. Even the most conservative regulated utilities may not escape pressure on enterprise value.
Rate base rate-of-return regulation will not disappear, but the current usage-based model that rewards increased energy sales almost certainly will. In the short-term,