The structure of the utility and telecommunications industries has changed significantly since I began my role as a regulator 15 years ago. Technological developments and a competitive environment, as opposed to regulation, have provided the major catalyst for change. As a result, utility companies, which have historically enjoyed the favor of Wall Street investors, will soon face unprecedented revenue growth problems. Because of the industry's maturity, its limited growth potential, and the possibility of facing mandatory retail wheeling from other utilities with lower production costs, utilities can no longer afford to operate under traditional management principles. Regulators must adapt policy to these changes to minimize uncertainty in investment as well as to balance consumer welfare with sound economic and financial principles.
Electric and gas utilities, and gas pipeline companies, face increasingly competitive markets as state governments attempt to eliminate barriers to competition. Some
state regulators (em the California Public Utilities Commission, for example (em are considering retail competition in local power generation and distribution markets. Technological advances are also contributing to the growth of competition. New power generation technologies can now provide energy at a lower cost than existing utility power systems.
Last year Congress failed to pass long-overdue legislation to replace the Communications Act of 1934; this year it has set an aggressive agenda to that end. New legislation will likely eliminate some of the barriers that prevent utilities and other companies from offering telecommunications services.
Many communications companies currently are considering partnerships with utilities. Four of the nation's five largest cable companies (em TCI, Cox, Comcast, and Continental (em recently formed Cable Utility Communications Services (Cable UCS) to explore potential alliances with electric, gas, and water utilities. Telephone companies are also forming partnerships with utility companies. Sprint and Entergy are currently participating in a home automation/energy management project in Little Rock, AK. In addition, utilities are being approached by companies bidding on personal communications services (PCS) frequencies. For example, DukeNet Communications, a subsidiary of Duke Power Co., has formed an alliance with BellSouth to bid on PCS licenses in Duke's service area.
Money and Leverage
While customers may benefit, the primary motivation behind the joint effort of these companies is to increase revenues by providing customers with a variety of services over a single network. Both cable and telephone companies are positioning themselves to provide high-speed, two-way digital video services, and high-quality telephony. These mergers could lead to more services at a lower cost to consumers. Utility companies make attractive partners, given their access to virtually every home in the nation.
Utilities also have assets that will be useful in deploying telecommunications services. They can call on extensive experience in the areas of billing and customer service. They already possess field maintenance fleets with trained technicians, as well as conduits and rights of way. And they have private communications networks (PCN) similar to those of local telephone companies, which can be used to increase service efficiency. More important, utilities can leverage their physical plants to provide telecommunications services or lease this capacity to other telecommunications providers.
First, telecommunications systems provide the capabilities that utilities need to be competitive in their core businesses. Currently, utilities have the single greatest commercial need for "real time" communications capabilities in the nation. New supply-side and energy information services will require additional telecommunications capacity. Current estimates of the utility industry's operating costs for telecommunications range from $2 to $4 billion a year, growing 25 percent or more annually. Second, utilities could provide additional services to customers, including automated meter reading and "smart home" technologies. These services would allow customers to monitor and control energy use through "real time" communications.
Still, lest we forget, the primary push behind the entry of utilities into telecommunications is the need for additional revenue and earnings growth. Currently, the telecommunications industry accounts for almost 5 percent of the Gross National Product and generates approximately $200 billion in combined revenues. Of these, wireline service providers account for total earnings of about $160 billion. In addition, studies estimate that PCS/PCN providers could serve 60 million users and generate revenues exceeding $50 billion by 2000. With so much potential revenue at stake, utilities must carefully explore new revenue opportunities and expansion into new markets.
A utility company, in leveraging its network to provide telecommunications, faces many options with different levels of investment and risk. In its publication, Business Opportunities and Risks for Electric Utilities in the National Information Infrastructure, the Electric Power Research Institute outlines various investment options, which include constructing stand-alone telecommunications networks dedicated to core business needs or developing networks to provide local telephony, cable, and value-added services. The most natural course for utilities entering the telecommunications market is to build transmission facilities alongside existing transmission and distribution routes.
The utility industry already has in place many essential components that could be used to provide telephony. Utilities own large telecommunications networks (em with over 18,000 fiber cable miles combined, microwave networks, and extensive rights of way (em and have access to all segments of society, including industrial, commercial, and residential customers. While conventional copper phone wires carry only a few conversations at a time, a single strand of fiber, about the size of a human hair, can carry at least 32,000 conversations at once. Ordinary phone calls, however, will be just one of a half-dozen forms of digitized information that can flow across these networks.
Two Early Forays
Several utilities have already successfully entered the telecommunications market.
In 1985, Williams Pipeline Co.,
a petroleum and natural gas provider, installed 11,000 miles of fiber-optic cable inside its unused pipelines. A small plastic cylinder designed to pull fiber through unused pipelines allowed Williams to install fiber without excavation or the need for additional rights of way. The Williams network cost $120 million to build and extends from Kansas City to Los Angeles. The telecommunications portion of Williams became known as Wiltel Communications Systems. This year, Williams sold its network service operations, Wiltel Network, to LDDS Communications, Inc., for $2.5 billion. However, this transaction did not include the sale of Wiltel Communications Systems.
Entergy, an electric utility, currently uses its PCN to offer telecommunications services to consumers. Entergy's network was first installed to monitor company operations and provide preliminary links for demand-side management (DSM). Since DSM uses only about 5 percent of any system's capacity, Entergy began to explore other services that could be provided over its network. With a fiber-optic network nearing 1,100 miles in its Arkansas, Mississippi, Louisiana, and Texas service areas, its system could easily double as a commercial communications network. Thus, Entergy began its "Customer Control 2000 Project" in Chenel Valley, AK. This system, provided over a single coaxial cable, offers consumers a wide array of services, including pay-per-view movies, Sprint long distance, and Southwestern Bell local telephone services.
The Role for PCS
Utilities are also exploring the potential benefits of offering PCS over their wireless networks. Most utility communication systems currently occupy frequencies below 3 GHz, the only frequencies allotted for PCS. The Federal Communications Commission requires a PCS license winner to relocate an incumbent user's microwave system to a higher frequency and gives parties three years to negotiate this relocation. By forming joint ventures with utility companies, potential PCS providers can decrease costs, eliminate the burdensome relocation process, and enhance their competitive positions.
Some bidders have already begun to approach utility companies. Most recently, Potomac Electric Power Co. (PEPCO) joined with Metrocom, Inc. to build a wireless communications network that would enable customers to send and receive electronic mail and tap into commercial online services. Aimed at a potential market of 4 million residential customers, businesses, and government agencies, the system would consist of a series of small radios attached to street lamps, power lines, and buildings. The wireless network will be PEPCO's first foray into competitive communications.
BellSouth Personal Communications, Inc., a subsidiary of BellSouth Corp., bid $70.9 million for the right to build a PCS network covering parts of North and South Carolina. BellSouth plans to transfer this license to a consortium it has formed with DukeNet Communications, Inc.; CaroNet, a subsidiary of Carolina Power & Light; and 32 other independent telecommunications companies. The consortium plans to begin constructing digital systems this
summer, so that service can begin by the middle of 1996.
The Southern Company has created a subsidiary, Southern Communications, Inc., to market excess capacity from its 800-MHz digital packet radio system. Southern currently owns major utilities in Alabama, Georgia, Florida, and Mississippi. By pooling resources from these operations and using Motorola's Integrated Radio System technology, Southern will be able to offer digital dispatch, paging, data, and telephone interconnect service in a wide-area seamless network.
Regulation Won't Go Away
Congressional efforts at deregulation may eventually eliminate many of the barriers utilities now face in attempting to leverage their systems for telecommunications. Still, regulations to prevent cross-subsidization and self-dealing are likely to continue. Separate subsidiary requirements may also be implemented, depending on the type of utility and degree of interaction between utility and nonutility operations. Moreover, issues will arise concerning the division of network costs between utility and nonutility businesses for the purpose of rate base regulation. These concerns become even more important in a competitive environment.
Registered utilities must also consider restrictions imposed by the Public Utility Holding Company Act of 1935 (PUHCA). Under the Act, registered holding companies must obtain Securities and Exchange Commission (SEC) approval to provide telecommunications services. Traditionally, the SEC has imposed conditions when permitting a utility to diversify or acquire extraneous lines of business. Under PUHCA, these diversified ventures must be "reasonably incidental" and bear a "functional relationship" to the utility's core business. These conditions often require the nonutility subsidiary to earn 50 percent of its revenues from the same geographic region served by its registered holding company.
The proposed telecommunications bill, adopted by the Senate Commerce Committee this March, would end restrictions on utilities entering the telecommunications market and repeal SEC authority under PUHCA. It would also prohibit cross-subsidization, provide for state commission audits, and require separate books and records for telecommunications activities. Further, states would retain the authority to regulate any public utility associated with a registered holding company.
The Electricity Consumers
Resource Council (ELCON) is concerned about proposals to eliminate PUHCA restrictions that govern utilities entering the telecommunications market. According to ELCON, electric utilities not subject to PUHCA show extremely poor results in diversification activities over the past 20 years. These efforts have lost billions of dollars, sometimes leading to higher consumer electric rates or lower bond ratings. ELCON contends that any proposal allowing utilities to offer telecommunications services must contain tighter rules for separate subsidiaries. ELCON's concerns merit serious consideration, given that many of the same executives are still around who told us in the 70's and early 80's that nuclear energy would be "too cheap to meter." ELCON also contends that any proposal allowing registered electric utility holding companies to venture outside their core business would be premature unless their own markets were opened to competition.
PUHCA reform also garners opposition from the personal communications industry and the regional Bell operating companies (RBOCs). The Personal Communications Industry Association voices concern that ending PUHCA restrictions without adequate safeguards may lead to anticompetitive abuses, such as self-dealing and cross-subsidization of telecommunications ventures with utility assets and revenues. Ironically, but not surprisingly, this same position is echoed by the RBOCs, notwithstanding their own legislative efforts. The RBOCs fear that broad PUHCA reform could allow electric utilities to compete unfairly in local exchange markets, free from regulations imposed on telephone companies.
Remember Stockholders
In any event, deregulatory measures and advanced technologies will continue to emerge. At this juncture, utilities must exercise caution when entering the telecommunications market. Although utilities are ideally positioned to enter this industry, it is likely in their best interests to form alliances with experienced telecommunications service providers. As past experience has demonstrated, utility efforts at diversification have garnered mixed results. In seeking new growth opportunities, utilities must ensure that their efforts lead to increased revenues, rather than higher consumer electric rates or lower utility bond ratings.
Alternatively, utilities may "create two classes of stock," one for the core business and another for new ventures into telephony. The two classes of stock would reflect the differing values of its traditional utilities and telecommunications-related holdings. This bifurcation would allow investors to target their investments to a particular aspect of the utility's operations, without necessarily creating the need for a separate subsidiary.
Finally, as utilities face increased pressure from both individual and institutional investors to continue and increase dividends, they will need management teams with a visionary approach to marketing and quality customer service to succeed in any endeavor outside their core business. This could mean bringing in an outsider who possesses the skills developed in a competitive environment.
In an effort to generate additional revenues, utilities are exploring opportunities in the telecommunications sector. While utilities explore this additional revenue potential, it is important for them to recognize that their core competencies remain the generation and distribution of power and gas. With regulation moving toward an increasingly competitive model, utility managers seeking to enter the highly competitive telecommunications industry should consider a broad range of options to minimize risks for ratepayers and increase investment and growth opportunities for investors. t
Andrew C. Barrett has served as a commissioner on the Federal Communications Commission (FCC) since September 1989. His current term will expire at the end of June. Before coming to the FCC, Barrett served as a commissioner at the Illinois Commerce Commission. He is currently a member of the executive committee of the National Association of Regulatory Utility Commissioners as well as of NARUC's Committee on Communications.
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