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The Color of Money

Wall Street sees “green” in demand response, energy efficiency, and distributed generation. Will the industry step up?

Fortnightly Magazine - October 2007

Today’s energy utilities face an unprecedented number of challenges, including infrastructure needs, rising energy costs, public demands for environmental stewardship, and investor calls for a sustainable business model.

We recently conducted research to evaluate whether innovative solutions for meeting future energy needs such as demand response (DR), energy efficiency (EE), and alternative distributed generation (DG) ( e.g., photovoltaic cells, wind, energy storage) could become a sustainable and viable part of the future energy infrastructure. Critical to whether the alternative solutions can become part of the future energy infrastructure is Wall Street’s view of utilities that pursue these options. Implementing the alternative solutions will require capital as well as an understanding of the risks.

Our findings indicate that Wall Street is paying attention, but the jury is still out concerning the role of alternative solutions in the energy utility’s future. As part of the research, we interviewed Wall Street utility analysts to obtain a financial perspective on how investing in these options could affect Wall Street’s view of a utility. Our research found that, as expected, the primary focus of Wall Street when evaluating companies is earnings. However, we also found that Wall Street is becoming more favorable toward investment on DR, EE, and DG activities. This change is occurring because utilities are being allowed to earn a return on these investments, and there is a growing recognition that these investments assist in managing business risk as well as contribute to the sustainability of the business.

When viewing DR, EE, and DG activities, Wall Street analysts consider the size of the effort to determine if it will have any financial impact. To attract attention, DR, EE, and DG investments need to reach a level that will affect earnings and attract the attention of investors. The specific level of investment that attracts investor attention will vary depending on the utility, regulatory environment, and other investment requirements. However, a general rule of thumb is that an investment of 2 to 4 percent of revenue in DR, EE, and DG will have an impact on earnings, and attract attention, if the appropriate regulatory policies are in place. This investment level includes program costs, rebates, research, measurement and verification, and infrastructure investment to support DR, EE, and DG.

The View From Wall Street

Analysts focus on the following specific areas when considering the impact of DR, EE, and DG. First and foremost is the ability to earn a return on the investments.

It is no surprise that the ability to earn on invested capital was the primary focus for analysts. While it is understood that there may be a qualitative value to investments in “green” or alternative solutions, unless there is the ability to earn a comparative rate of return, capital could be put to use in higher returning opportunities. Analysts also look at fixed costs and revenue recovery,