in energy service companies to boost earnings beyond the normal growth rate?Going on the "defensive-offensive."
In the early 1990s, flush with utility money from its corporate parent, Entergy Systems and Service, Inc. began expanding to provide competitive energy services.
Now called Entergy Integration Solutions, Inc., or EISI, the
Memphis, TN, company claims 815 employees and about 65 offices nationwide. The expansion appears extraordinary, considering that the company performs energy service contracting (em installing lighting, heating, and air conditioning and providing
maintenance services for small- to medium-sized commercial customers like convenience stores.
But there's more to the story.
In June last year, parent Entergy Corp., through a subsidiary, paid off $125 million in loans it provided to EISI's predecessor. Does that mean that the subsidiary actually grew the business by a like amount? It's hard to say, because EISI is an unregulated subsidiary, and releases limited financial information. Its executives, while helpful, won't discuss profits or losses.
But like other utilities and newcomers to the energy service company (ESCo) business, it appears that Entergy ate EISI's startup costs and still carries a healthy share of losses ... in hopes that red ink will someday turn black.
Hardly unique, this scenario will likely be repeated elsewhere en route to the new energy services world (em a world that bundles
supply- and demand-side services, and roots utility offshoots in what traditionally has been an independent ESCo market.
To get a feel for the trend, consider CSC Planmetrics, Inc., a Chicago management consulting firm that has seen its ESCo initiatives with utilities grow to a dozen during the past year. The utilities range in size from $700-million companies to those in the top 10. Some companies are defining what part, or how much, of the business they should enter. Others are drafting targeted business plans.
A war for market share lies ahead. The utilities see it as a price war for future payoff. The
independent ESCos have only their track records and faith in regulators to protect their place in the market.
The amount of money a utility can spend on an ESCo will depend on how comprehensive the startup offering is, says Jim Pardikes, CSC Planmetrics v.p. He adds: "If you make an acquisition, that will have an impact as well."
He says utilities can expect to invest $20 to $35 million a year for five years to maintain an earnings momentum that's five percentage points above their growth rate.
"If companies are not willing to make the necessary investments (em tens of millions of dollars (em and aggressively pursue the initiatives, then, based on what we've seen other utilities do, don't bother," Pardikes cautions.
Besides the prospect of bundling supply- and demand-side services, utilities find themselves propelled into this market by other factors.
"Utilities are faced with a shareholder-value gap (em in some cases very significant," says Pardikes. "The gap is being caused by discounting, lost volume in conjunction with increased wholesale competition, LDC [local distribution company] unbundling, and the prospect of retail wheeling. They're looking for new revenue sources to fill the gap."
But in view of the difficulties ESCos have faced and the failed efforts of others, most utilities are advancing very carefully. Two utilities known to be cautiously examining energy services markets are Con Edison Co. of New York City and Providence Gas Co. of Providence, RI.
Con Ed expects to submit a plan to the New York Public Service Commission by October 10, as part of the statewide restructuring plan, according to Richard Mulieri, a utility spokesman.
Providence Gas will confirm its heading on energy-efficiency services this month, says Jim DeMetro, senior v.p. of energy services. The utility may decide to steer clear
of the market, or to acquire an ESCo, an engineering firm, or another company working in the commercial-industrial sector. It would face tough competition from HEC, Inc. and EUA Cogenex Corp. (em established ESCos working in its territory (em but hopes that market research will find a niche those companies haven't sniffed out.
"There may be a gap, somewhere, in what the market would pay for," DeMetro says. "There's not many ESCos that are making money, so you have to wonder, Why is that? Is the market going to change sufficiently so that there will be new opportunities and they will be able to make money? That's really the reason we're starting with the market."
Like other utilities, Providence Gas understands first that its commodity will provide access to customers. Only then can the utility leverage its value-added services. But DeMetro believes any gold rush of utilities buying or building ESCos will prove to be a quiet one.
"Utilities don't want to be identified as being in the market [to buy] companies, because probably the price goes up as soon as people hear," he says.
Whatever the price, utilities will acquire ESCos. And ESCos will defend themselves with market-share protests. ESCos that paid their dues, or learned from market newcomers that went belly-up, are bound to put up a fight.
S. Lynn Sutcliffe, president of SYCOM Enterprises of Plainfield, NJ, may be one such defender. He refers to utility efforts at forming ESCos as "defensive-offensive" maneuvers (em utilities holding off other utilities while also retaining customers. The "action du jour," he says, is to downsize, form unregulated subsidiaries, and get into ESCos, gas or power marketing, and telecommunications.
But even on that path, "utilities as public entities are acting every bit as secretive as any other company," he says. "They are still using their monopoly status to try to create unregulated subs. There are just all sorts of issues that arise in terms of corporate resources devoted to the creation of these entities that are supposed to be independent.
"You can imagine an independent company that struggled to be profitable, and here its competitors are basically being fed by shareholder money," he adds. "But where does the shareholder money line stop and the ratepayer money line begin? It's a very, very fuzzy area. Those of us who have been through the crucible are correctly concerned about leakage between the ratepayer and shareholder issues."
Ken Black, EISI's marketing director, says that argument doesn't hold water in the battle for market share.
"We're a free-standing energy services provider and we have to make a profit," he says. "We're not in there just to suck money out of our shareholder's pockets. And if any company thinks we're out there surviving solely on shareholder dollars, at some point along the line, the stock market's going to adjust for that because there'll be much greater losses at the [parent] company."
He says Entergy did not invest $125 million just to support EISI. "That's money being invested in the marketplace. Those are our financed projects that have a return. Every one has an internal rate of return that satisfies the parent corporation."
But do those dollars constitute project capital or operating/equity capital?
"Well it depends on how you look at it," Black says. "It's equity from the corporation's perspective. On any one deal . . . it's all project. It's capital because the way we go to market, we're investing. It's our technology. We're putting in our equipment."
By year-end 1998, EISI expects to generate more than $500 million a year in sales and to move into a profitable position, according to a 1995 annual report.
Black says his company sees itself as a service provider, not an ESCo. "If we don't perform, you don't pay," he says.
And it won't stick to any geographic area.
"We're setting up beachheads in a lot of other utilities' service territories," Black says. "We're no different than other utility ESCos or other ESCos that are branching out and installing offices. ... We're going where the business is."
In fact, he says his company has chosen not to join the National Association of Energy Service Companies (NAESCO) because
of competition: "There's this
awkward sense of being in a room with all your competitors because you really can't talk openly to them."
Black says he doesn't know any utilities that don't have an ESCo, or an interest in buying or developing one. Meanwhile, the independents are "screaming and crying" that they can't make it. Black believes his company's success will lie in "overcoming the cost of the infrastructure and the overheads and all those kinds of things and being able to make enough profit on those individual jobs.
"We have to be profitable, or we ain't gonna be around."
SYCOM's Sutcliffe thinks startups underestimate the complexity of delivering retail energy services: "There's no energy services company that I know that hasn't gone through three, four, five years of substantial red ink in order to break into the black, including ourselves.
"There is no existing member of NAESCO that has a track record of more than three years that is a utility sub that is homegrown."
He asks: How many companies can sustain a $5- to $10-million-a-year loss for several years?
Somewhat ironically, SYCOM is funded by Public Service Conservation Resources Corp. (PSCRC) of Parsippany, NJ. PSCRC was formed by Public Service Electric & Gas (PSE&G) under a regulatory stipulation (New Jersey Board of Public Utilities, Docket No. EE92920105, December 15, 1992) that prompted the Standard Offer Program. This program, started in 1993, set a standard energy-efficiency contract under which PSE&G agreed to buy measured, verified energy savings over 5-, 10- and 15-year periods from customers or third parties like ESCos. To fuel competition, PSCRC was to act as an ESCo in its own territory while also acting as a lender for other ESCos.
"As a banker, they know us intimately," Sutcliffe says of PSCRC. "On another side, we compete with them head to head, day to day. And they try to keep a Chinese wall between those two functions."
A report on the program's outcome by The Results Center of Aspen, CO, gave generally high marks.
Arthur R. Coughlin, PSCRC president, points out that larger customers had anywhere from four to 12 bids on a standard offer contract (em a sign of healthy competition.
And despite concern that the most lucrative projects would be picked first, such "cream skimming" proved largely illusory. "Energy savings in customers' facilities have by and large been more comprehensive than feared, signaling strong competition between energy service companies and the rise of a sophisticated energy service infrastructure in New Jersey," the report reads.
However, the program has drawn criticism for PSCRC's role in providing financing to
companies that couldn't get it elsewhere. "This has raised concerns about competitiveness, underscoring a fundamental conflict with PSCRC's role," according to the report. "ESCos don't mind going head to head with PSCRC's delivery of energy-efficiency services, but don't want their competition to be bolstered by PSCRC as well."
The report also notes that the level of competition in PSE&G's service territory has driven some ESCos to other markets.
From PSCRC's perspective, Coughlin points to other program drawbacks: "Given where we are today, I'm not sure PSCRC would be a model for the future, not unless the utilities, especially given the uncertainty, would want to commit to 10- or 15-year pricing terms when they don't know if they're going to be buying their own generation in the future."
He says the next wave of business will entail expanded offerings, unrestrained by standard offer rules. PSCRC will develop performance-based contracts with longer terms and lower-to-no reliance on utility incentives. It also will combine gas-brokering services.
Energy services markets are developing in New Jersey, California, New York, and in nearly every other state. And everyone is watching as utilities, ESCos and evolving service companies stake out their claims.
Shrewd service may help decide the fight. But the winner could be the one with the deepest pockets. t
Joseph F. Schuler, Jr. is associate editor of PUBLIC UTILITIES FORTNIGHTLY.
California Mulls Surcharge to Boost Energy Efficiency
Working group would tap revenues for 1 to 3 percent
Two market for ESCOs: One Private, One Public
After debating the hot buttons of a competitive market, California ESCOs, utilities, and enviro-consumer groups have presented a plan to the state Public Utilities Commission (CPUC) for the post-restructuring energy services business.
The Energy Efficiency Working Group report, prepared by more than 15 stakeholder organizations, responds to the PCUC's December 1995 restructuring decision, which broad-brushed a two-track energy-efficiency services market: 1) a private market operating without incentives, and 2) a market boosted by a nonbypassable public goods charge (PGC). The transformation, of course, will come about via the second route.
The amount of the PGC was heavily debated by the Working Group, according to early drafts of the report. One point, however, became clear. "We have great consensus within our group that the charge is appropriate and that it should be collected on a nonbypassable basis," says Richard Sperberg, president of Onsite Energy of Carlsbad, CA, and a member of the Group. "We have very strong arguments that energy efficiency should be funded and there still are market barriers to cost-effective energy efficiency." Although the CPUC will endorse the charge and set the amount, the Group recommends that the surcharge form 1 to 3 percent of utility revenues (em potentially $235 to $705 million annually.
To overcome barriers and increase demand for technologies and services, the report suggests 13 principles, including:
. An independent administrative structure for California and all utility distribution company (UDC) service territories affected by the PGC
. Maximum access to PGC funds for companies that deliver eligible energy-efficiency services
. Separation between the entity administering PGC funds and those competing to receive them
. Guidelines to address market power and self-dealing abuses
. A mechanism to hold UDCs harmless from lost sales.
The PGC administrator would eliminate the inefficient DSM bidding of the past, the report notes. Funds would be disbursed on a standard-contract basis, using single or multiple prices determined by the administrator.
Since all three of California's investor-owned utilities (IOUs) have formed energy-service subsidiaries, the Group expressed concerned over market dominance.
"There are obviously sensitives in terms of potential market abuses, but at the same time the utility affiliates can be effective providers of these services," Sperberg explained. "So what we're trying to do is create a balance."
He says the Group also discussed guidelines to prevent improper interaction between regulated UDCs and unregulated affiliates. "And we're also talking about potential handicaps to allow the market to develop on a more level playing field." For their part, the IOUs have made it known that they want UDCs to play a role in the market-oversight mechanism.
The CPUC will have to act on the report quickly; restructuring kicks in January 1, 1998.
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