The Key to Economic Expansion in Utilities

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
  • Consolidation will continue resulting in
    large multijurisdictional entities;
  • Competitive markets will continue to
    emerge fueled by the consumer’s desire
    for greater control over their energy
  • Outside investment will foster significant
    innovation in the area of environmentally
    friendly generation sources;
  • 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.