With regulators reluctant to OK rate hikes, utilities can better justify an increase – if it compares well with the utility’s peer group.
Navigating in the Age of Uncertainty
Business models are evolving to suit a shifting industry landscape.
The next 10 to 15 years will be among the most disruptive the U.S. utility industry has witnessed in more than 50 years. While utilities have faced change in the last three decades, including deregulation, re-regulation, the rise and fall of the merchant model, and new Clean Air Act regulations for SO2 and NOx, the structure of the industry has remained fundamentally unchanged. In addition, all of these changes have been mostly sequential, allowing utilities to focus on the one issue at hand.
Today, the reality is different. There are many forces at play simultaneously—for example, mergers and acquisitions, smart grid development, customer activism, environmental regulations and new technologies—and the industry is being forced to confront these trends, while at the same time facing unprecedented political and regulatory uncertainty.
Utilities will need to undergo significant change in order to respond to this challenge, but many will be hampered by a lack of long-term planning, a disbelief among C-Suite executives that the future will truly be different (namely “we’ve heard this all before!”), an economic recovery fraught with uncertainty, and a regulatory and legislative framework that’s ill-suited to driving the required level of change.
The Age of Uncertainty
The age of uncertainty is characterized by four main forces: Unprecedented consolidation of the industry; a shift in the demand-supply balance; a tipping point in the take-up of smart grid technologies; and increasing downward pressure on returns on capital.
The first force, consolidation, is characterized by the increased pace of M&A activity. The utility industry has seen more acquisitions in the last 24 months than in the previous six years. The number of shareholder-owned electric utility companies has dropped approximately 41 percent in the past 15 years from 98 to 58. 1 We expect this trend to accelerate over the next decade and the number of public utilities to halve over the next 10 years. This trend isn’t only a response to escalating cost pressures and the need for stronger balance sheets to accommodate growth in capital expenditures (cap-ex), it’s also a result of a lack of organic growth options for utilities, making M&A one of the few attractive EPS growth options in the short term. The market has priced-in this trend with potential targets commanding a P/E ratio that, on average, is one point higher than the ratios of potential acquirers; this P/E differential seems unlikely to slow down M&A activity.
The effectiveness of these M&A deals at driving value is significantly constrained by regulation, labor rules