U.S. utilities find

a wealth of opportunity

down under.Australia.

It drew more than $7 billion in investment from U.S. electric utility subsidiaries at the end of 1995. Ongoing privatization will likely draw billions more.

Five electric distribution companies and a generating company have been sold in Australia's southeastern State of Victoria, and four more generating companies are expected to go on the block. Unregulated subsidiaries of U.S. utilities already own or have interest in Victoria's five distribution companies, or "distcos."

And then there are several smaller investments: Northern States Power's NRG Energy, Inc.'s share of the $100-million recommissioning of a Queensland power station; Southern California Edison Corp.'s purchase, via Mission Energy Co., of a 51-percent stake in a Victoria power station for $1.1 billion; TransAlta Energy Corp.'s $39-million joint venture to build a western Australian power plant.

Other Australian states, such as Queensland, also are privatizing. Five of the country's six states are expected to move toward a National Electricity Market grid, although four aren't now connected. Sometime after 1997, however, power will be traded in a pool or through a series of regional interconnections.

What's the attraction for American utilities?

"It is perhaps the most attractive regulatory climate for the kind of transition that the electric energy industry is making that I see anywhere," says Frederick W. Buckman, president and CEO of PacifiCorp.

H. Jarrell Gibbs, president of Texas Utilities Electric, whose company, like PacifiCorp, also invested in an Australian distco, says slow U.S. growth and Australian privatization are fortuitous: "Otherwise, you would have electric utilities in the United States looking for ways to grow without any ways to grow."

The march to Australia matches a trend in overseas utility investment in general, notes Barry M. Abramson, a Prudential Securities analyst. In countries with little political risk, companies will readily invest. "Many of these markets are restructured and deregulated, similar to how the United States might look in a few years: generation separated from transmission, which is separated from distribution," he says. "They want to learn. They want to diversify risks."

According to Prudential Securities, recent Australian acquisitions have garnered $1.5 to $2 billion each, 10 times the typical foreign investment for the period 1992-94.

Another attraction, according to Prudential, is that Australia is slowly allowing residential customers to choose electric suppliers. In addition, Australia has a price-cap system; therefore, operators have incentives to cut costs and increase efficiencies (em unlike in the United States, where rate-of-return regulation still reigns.

What do the Aussies think about the American "invasion"?

For one, they say, privatization and competition already have meant lower prices (em up to 20 percent in some cases. But they have brought closer scrutiny of distco reliability.

"Routine outages are suddenly news," says Keith Orchison of the Electricity Supply Association of Australia, Ltd. (ESA), a trade group. "Whereas two or three years ago, you were lucky if you found a paragraph at the back pages of the morning newspaper, now it's more likely to be on the front pages. And on some occasions, it's actually the front page lead."

Jim Gallaugher, technical director of national markets for the Victoria Power Exchange, says it may be too early to judge the Americans' record.

"As the new owners of these businesses, they are initially concentrating on internal cost controls, organizational structure, and service delivery to customers," he says. "The way in which these companies operate in the market may become more apparent as the retail franchise limit drops to 750 megawatt-hours on July 1, 1996." At regular intervals after that, distcos will have to compete for even smaller customers.

Whatever supplier customers choose, distcos can always count on being the deliverer of power, whether generators, power marketers, or another distco sells the electricity. "We always get paid the delivery charge," says Larry Folks, Entergy Power Group's vice president, responsible for Australian activities. "And we make 90 percent of our profits from the delivery charge."

"We're having some success in selling to customers outside our territory," says Buckman. "It really comes down to being able to

create a portfolio of price and duration that's consistent with the customer's needs. That's something we've had quite a bit of experience doing in the United States with wholesale customers."

Like the other distcos, Texas Utilities' Eastern Energy has been soliciting large industrial customers outside its service territory in Victoria. "I don't know that anybody has been more successful than anybody else," Gibbs says. "I think our experience in Eastern Energy has been we gained three customers and we lost three."

But Daniel L. Spalding, PacifiCorp senior vice president and Powercor chairman, voices another opinion.

"We've had more success than any of the other four Victoria distribution businesses in attracting customers from outside our service territory," says Spalding. "I want to say 28 [industrial] customers. And I would say the key for us was just to do your homework and learn about the market, learn about the customers you're shooting for."

Generally, Spalding says, the deals came down to price: "Very few of the players in the market to date have put a high premium on anything but price."

Powercor, located in the western part of Victoria, has grown its load the fastest (em 3.1 percent each year (em since 1986. That's 1 percent above the rest of the state.

Orchison, the ESAA official, says that opening the market to competition among distcos and power suppliers, and to progressively smaller customers through 2000, brought U.S. utilities to Australia in the first place, and will keep them there. From Victoria, competition will spread to the remaining Australian states.

However, utilities shouldn't expect to take their Victoria experience and put it, cookie-cutter style, into markets outside Australia.

"We are not England and Wales," Orchison says. "The United States is not Australia. Our situations are all different. And each of these jurisdictions has to sit down and look at its own needs and design a system that fits."

Gibbs says that learning how to operate in a new regulatory and competitive field has its merits, but knowledge isn't the sole attraction: "You don't go make a huge investment in a foreign country just to learn something if you can't make any money doing it."

"We would like to have three or four ... five good investments in Australia," says Folks. "We see it as an excellent country to do business in."

What utilities shouldn't forget is the larger picture, says Buckman. Customers are becoming increasingly global: "To be a company that can hope to provide customer service comparable to the service of American Express or Federal Express, we cannot hope to do that with a presence only in the Pacific Northwest."

But in their quest to become more in tune with customers, utilities are pausing along the way.

"The thing that they're learning is a great many of these customers don't understand their own load profile," Orchison says. "And, therefore, they have great difficulty negotiating satisfactory deals. It's all very well bringing in a market, but a market only functions well when you have a well-educated bunch of customers."

H. Dan Farell, managing director of Texas Utilities Australia, Pty., Ltd., believes that some providers will make mistakes in their zeal to capture new customers.

"They're going to be tempted by market share, as opposed to profitability. We're paying a lot of attention to trying to understand the real profitability of our various customers and this gets into understanding their load profile."

Then, load profiles can be modified to reduce power costs, Farell adds.

What the American expatriated companies also have to watch, he says, are impediments that remain within the once government-owned distcos. A bureaucratic mentality must be changed to a bottom-line mentality. Distributors mustn't see themselves as commodity providers; they must provide service. Marketing, too, has to be emphasized. The public needs to be educated on energy technologies and the "plain, old-fashioned efficient use of electricity."

The real test of the American-Australian utility experience will be the bottom line. Can strategic alliances be made, industrial customers be won and lost, while costs for consumers are kept low through improved economies of scale? Can more layoffs be avoided and energy quality maintained?

"I think this is the real test that these privatized companies face," Orchison says. "In order to run the leanest organization they can, they will continue to downsize their staff. It is a very ticklish business in terms of maintaining quality and supply if you are cutting into muscle instead of fat. And there are dangers there. These companies are going to have to tread very carefully."

From 1988 to early 1995, Australia's electricity workforce has been reduced from 82,000 to 46,000.

"So a hell of a lot of this has already happened, and the lights haven't gone out," Orchison says. "The unions haven't gone on permanent strike. It's actually being managed reasonably well. The element that has changed in Victoria is that we now have a bunch of companies, and what's more they are foreign companies who are in this 'to make a buck.' And that means that the public views it all through a somewhat different lens."

Powercor has been part of the asset rationalization, reducing its headcount from 1,500 to 1,200 in pursuit of best practices. "And my sense is we can do better than that," Spalding adds. Employees have been told as the distco gets better every day, the logical outcome is fewer human resources. "On the other hand, there are opportunities for us to expand our business presence," the executive says. "You can bid out your own workforce to build lines or connections for a customer in somebody else's service territory."

Farell insists that reliability and service in Victoria will increase. "It has to," he says. "We have something to prove. We need to prove to the government and the public here that privatization works and is going to be successful."

The way to improve reliability and service is to improve processes, he says. You get rid of work that doesn't need to be done, and organize work around process flow. For example, he offers, Eastern Energy discovered it had eight points of contact with a customer on a service request; the number was cut to two or three. And although the company's employees have dropped from 1,400 to 1,000 over two years, customer growth has increased 2 percent annually.

"I think the public's going to have to judge the companies on fundamentals," he says. "Are we really responding by improving service? Are we maintaining and improving reliability? It's up to individual companies to prove that." t

Joseph F. Schuler, Jr. is associate editor of PUBLIC UTILITIES FORTNIGHTLY. Email: schuler@pur.com

U.S. Distco Acquisitions to Date

. United Energy, the first distco auctioned, was bought by Australian institutions and UtiliCorp United's UtilCo Group for $1.21 billion.

. General Public Utilities' Energy Initiatives acquired a 50-percent stake in Solaris Power, Ltd., a 230,000-customer distribution company, for $746 million.

. PacifiCorp's unregulated subsidiaries, PacifiCorp Holdings, Inc., and PacifiCorp Australia Holding, Pty., Ltd., bought Powercor, another distco, for $1.6 billion. Some 1,250 Powercor employees serve 537,000 customers and bring in revenues of $557 million.

. Entergy Corp.'s holding company, Entergy Power Group, bought Citi-Power for $1.2 billion. CitiPower serves nearly 250,000 customers.

. Texas Utilities Co.'s new unregulated subsidiary, Texas Utilities Australia, Pty., Ltd., bought Eastern Energy, Ltd. for $1.6 billion. The distco's 1,000 employees serve 470,000 customers.

Pooling in Victoria

Competition among participants in Victoria's electric supply industry takes the form of the Victoria Power Exchange's (VPX's) trading forum: VicPool.

VicPool is transitional. A National Electricity Market has been proposed for Australia, scheduled to start up by January 1997. Participants include generators, distributors/retailers, and industrial users or nonfranchise, "contestable" customers with demand over 1 Mw.

The market revolves around a spot price. Wholesale or pool price for power can vary on the half-hour, depending on demand, bid prices, and availability of generation and transmission.

Each Wednesday, generators submit bids to the pool for their generating units, advising how much electricity they're prepared to produce, for the following Sunday to Saturday. Customers can bid the amount they're prepared to reduce their demand to if the pool price rises above a nominated level. The load reduction is under control of the VPX. However, customers can respond to expected prices without placing bids with the VPX.

The pool price is determined "after the event" and is set at the price of the highest bid used in the half-hour. All wholesale electricity is traded through the pool at the pool price. All generators are paid the pool price for their energy. Energy losses in the transmission system are paid for by pool customers.

According to Jim Gallaugher, technical director of national markets for VPX: "One feature of the VicPool market which U.S. participants may not have experienced is the price volatility. Volatility can expose generators, retailers, and potentially, customers to financial risks when prices are high, necessitating a particular approach to risk management."

Larry Folks, Entergy Power Group's v.p. and g.m. responsible for Australian activities, says CitiPower, Ltd. takes advantage of bilateral trades, hedging its energy costs over several years: "It's a question of each distribution business having a different strategy on how much hedging they would want in terms of matching what they've quoted the customers on the retail side. And CitiPower's plan is to be conservation and have a substantial amount of hedging matching the sell side."

Billateral trades can be settled through the VPX, but aren't conducted through VicPool. Such trades are subject only to the provisions of Australian competition legislation.

With all its promise. Gallaugher acknowledges certain problems with VicPool, including:

. Lack of demand-side participation and demand-side response to price signals

. Scheduling of, and payment for, reserve

. Complexity of the price-setting process

. Lack of commercially focused risk-management arrangements to deal with high pool prices

. Small market size and lack of competition.

However, the problems are being addressed, Gallaugher says, and most will be further addressed by the proposed National Market.

Dan Spalding, PacifiCorp senior v.p. and Powercor chairman, appears to concur: "There is still not as much price discovery on the demand side as people would want," Spalding says. "The big players in the pool, the distribution businesses have it, I think. ... As the market evolves further, more price discovery will emanate."

From Idaho to Indonesia

Overseas investment isn't just for the "big guys."

The unregulated subsidiaries of two utilities (em one in Idaho, the other in Montana (em have set their modest sights on overseas opportunities in Jamaica, Great Britain, and Indonesia. The utilities, each with revenues of less than $550 million, seek higher returns than the United States offers.

"We're going to see increased international activity by companies who you would have never have thought about as being interested in going abroad," says John Easton of the Edison Electric Institute of Washington, DC.

Case in point: Next month, Idaho Power Co. subsidiary Idaho Power International, a joint venture with Community Power Corp. of Virginia, will submit a business plan to provide photovoltaic power to remote Indonesian island villages. At stake: A chance to win part of a $100-million contract.

"There's a lot of opportunity there," says Dennis Lopez, Idaho Power spokesman. "And for a company like ours, which has been bound by the high desert of the west where we live, there's a whole new market out there that we never considered. It allows small utilities like ourselves, who have taken the time and made the investment in learning about photovoltaics... to go and make some money."

Idaho Power has 340,000 customers in Nevada, Oregon, and Idaho.

"Certainly there are better returns to be had elsewhere," says Dean Conklin, a Montana Power spokesman. "We live in a state with 850,000 people. And we don't even serve the entire state. ... Obviously, the growth opportunities for us are going to be beyond the service territory of our utility."

Montana Power has invested outside its geographic and service area for years, beginning in 1951 when it started piping in Canadian natural gas. It later got into coal, oil, and lignite (brown coal). In 1986, it invested in one-sixth of a Brazilian gold mine. Montana Power Co.'s independent Power Group, a $100-million unregulated subsidiary, invested in a barge-based generating plant in Jamaica in 1995, and a cogeneration plant in Great Britain in 1993. Montana Power has also considered investments in China.

Financial reasons brought the company overseas, however, not the desire to learn how to operate in different regulatory climes.

Conklin says he knows of few other small utilities expanding overseas, but believes we may see more. Consortiums, with a bank or investment-house partner to split up the risk, could become popular.

"The question is: Where are the opportunities for growth?" he asks.

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