The Key to Economic Expansion in Utilities by Chris Trayhorn, Publisher of mThink Blue Book, May 14, 2007 Today’s forces driving the global energy and utility market have never been more acute. Consumption increases and volatile fuel costs coupled with a major focus on the environment present the industry with some of the most significant challenges that it has faced in the last few decades. Diametrically opposed forces appear to have converged upon the industry, highlighting the importance of the policy and investment decisions currently made on a global basis. Understanding the impact of policy on the long-term investment decisions represents one of the most critical aspects in the industry’s current strategy and its future structure. How will the industry be poised in a future of competing scenarios and decisions? Energy Consumption Drives Economic Growth It is anticipated that world electricity consumption will double between now and 2030, with average annual increases of 2.7 percent. Developing markets such as India and China account for over 70 percent of that growth, with those markets projected to grow at average annual rates of 4.6 and 4.7 percent, respectively. While the 1.5 percent growth projected in the developed countries may seem small, one needs to realize the efficiency gains built into these projections. For example, the United States has seen a nearly 2 percent decline in energy intensity, which is the measure of energy use per dollar of GDP. Technological innovations have contributed to these gains. This represents good news for the developed economies as they continue to grow with less of a drain on energy resources. No one debates the importance of energy and the underlying infrastructure to expanding and sustaining economic growth in all markets. Without the underlying investment in all of the energy value chain, the world economy faces a daunting challenge. The generation needs to represent the majority of this necessary investment. While coal-fired generation has been – and is projected to be – the bulk of the world’s generation resources, investment in cleaner sources will be a critical component of the future portfolio. Developing and maintaining load capacity flexibility represents a key challenge for the industry in meeting current and future energy consumption. While these numbers are daunting, they represent just part of the story. Growing environmental concerns need to be integrated into the overall strategy. In addition, infrastructure requirements and capital availability magnify the problem. With this in the forefront of the minds of utility executives and policy makers, the future shape of the industry has begun to emerge. Environmental Concerns Versus Economics While the environment has always been important, its criticality seems to have risen over the past few years. Daunting statistics, such as the substantial increase in carbon dioxide emissions related to fossil fuel consumption, dominate the thinking of the public, policy makers and industry executives as they have never done before. The consumer’s awareness and willingness to engage in the debate drives the industry to proactive strategies. Building environmental concerns into overall capacity planning drastically changes the dynamic of this process. It will be a unique challenge to understand how to meet the demand discussed above without permanently damaging our environment in a world where coal represents the most available and economical commodity. This challenge leads to operational, policy and technology innovation. The past debate has in large part centered on economics versus environment. Innovations in the areas of clean coal, nuclear, and demand response affords the industry the ability to change the equation. The industry cannot afford to continue this trade-off resulting in transformational solutions. Public policy needs to be an integral component of this. Public Policy-Driven Goals Recognizing the criticality of the electric and gas utility infrastructure, policy makers have historically driven a monopolistic or governmental-owned business model. The model helped drive a relatively successful and nonduplicative investment in critical industry infrastructure, providing an adequate vehicle for large capital investments. Policy was focused on fair and equal access to the necessary commodity. While these models allowed for a thoughtful build-out of infrastructure, it resulted in certain market inefficiencies. Policy makers reacted in different ways to counteract these inefficiencies. In some jurisdictions, regulators sought to drive efficiencies through command and control mechanisms. Strict regulations coupled with post-mortem prudency reviews became the proxy for customer interests. Globally, policy makers continue to innovate in the areas of regulation and industry structure to effect this type of change. Some notable examples of this over the past decade include: As part of the restructuring and privatization of the electric industry, the U.K. implemented a performance-based price control system. Under this system, the electric industry has been able to achieve significant efficiency gains and lower overall customer costs. This system allows for flexibility and provides incentives for innovation. In 1999 the European Union began its journey toward an open electricity market. This called for a gradual introduction of competition to various customer classes, leading to a full open market in July of 2007. This policy has resulted in price reductions, especially in the wholesale market. Additionally, a fundamental shift in utility operations, strategies and business models has begun to emerge. In 2002 the state of Texas adopted energy deregulation. To promote fair competition, the incumbent companies split into retail electric providers, transmission distribution service providers and wholesale generators. Retailers offered consumer choices based on the market price of electricity and were allowed to switch suppliers to better meet their needs. This model has promoted efficiency and innovation in the market. While the tactics may change over the years, the fundamental goal of policy makers and regulators remains the same: Provide the consumer with access to costeffective and reliable energy on a sustainable basis. With these goals in mind, continued policy and regulatory innovation will emerge in both developed and developing markets. The regulatory bodies continue to face the challenge of balancing the needs of the consumer while promoting innovation and investment. Developing Markets Face Different Challenges While the developed markets strive to improve and strengthen their overall system, the developing countries strive to build theirs. Access and adequate supply lie at the core of the challenges for these markets. Reliability does not sit far behind these as the markets mature and compete in the global economy. Attracting and retaining capital represents the key issue in meeting these challenges. With estimates in the billions of dollars, these economies will struggle without sufficient outside investment in the industry. With this in mind, the major developing markets have begun a fundamental restructuring of the market, moving from a government-owned and fully integrated monopoly to a separated and privatized market. This has resulted in the creation of some of the largest stand-alone generation and distribution companies in the world. In addition to promoting focus, this allows for an entirely new set of investment sources for these markets. Retaining these new investments through fair and adequate returns remains critical to the sustainability of these markets. The financial community needs to be convinced of the long-term viability of the structure to continue its commitment. Even though the utility industry by its nature is local, global trends and forces are becoming more important to the industry. As the developing countries enjoy exponential growth, their needs account for a greater portion of the supply needs of the industry. Increased workforce and raw material demands in these markets influence the overall dynamics in the other markets. While commodity markets (other than oil) remain largely localized, the advent of LNG and other advances have a more global impact. In addition, local and global forces drive innovation in the industry. Industry Structure Continues to Evolve On a global basis, the ownership and operating structure of the industry continues to evolve as companies and markets emerge. While vertically integrated utilities continue to play an important role in the industry, functional and ownership separation of business has occurred in many markets. Jurisdictions have moved forward with these models to enhance the competitive market and focus investments in particular segments. Moving to a fully competitive market requires some level of separation of the various components of the value chain. Policy makers and strategists will continue to strive for the unique model that promotes competition while retaining the inherent efficiencies of a vertically integrated model. Consolidation continues to progress on a global basis. Large deals progress in Europe, creating some of the biggest utilities in the world. While scale remains important, these represent strategic deals that poise the companies for growth in a highly competitive market. While these large, complex deals present unique challenges to all the stakeholders, the overall benefits are significant. This marks the beginning of truly global utilities. Private equity investments continue to increase, but have not had the impact previously contemplated. It is likely that this activity will increase, but only in certain segments of the business. The current ownership structure of the utility industry will continue for the near future. What Does the Future Hold? The industry sits at somewhat of a tipping point as market forces converge in a unique way. While the past decade has been challenging and interesting, the next decade promises to be as exciting. The many decisions facing each of the key stakeholders require careful consideration as these will have a lasting impact on the industry. The trends that will follow are: Public policy and regulation will emerge that fosters innovation and drives investment; Consolidation will continue resulting in large multijurisdictional entities; Competitive markets will continue to emerge fueled by the consumers desire for greater control over their energy choices; Outside investment will foster significant innovation in the area of environmentally friendly generation sources; and Emerging markets will receive significant capitalization allowing a more rapid attainment of full access. The result of these future trends will be a stronger, stable industry that not only competes well in the global market, but also provides the underpinning for the expansion of the global economy. Filed under: White Papers Tagged under: Utilities About the Author Chris Trayhorn, Publisher of mThink Blue Book Chris Trayhorn is the Chairman of the Performance Marketing Industry Blue Ribbon Panel and the CEO of mThink.com, a leading online and content marketing agency. He has founded four successful marketing companies in London and San Francisco in the last 15 years, and is currently the founder and publisher of Revenue+Performance magazine, the magazine of the performance marketing industry since 2002.