2013 Utilities Industry Perspective
published December 13, 2012 | by Christopher Dann, Todd Jirovec, and Tom Flaherty
Even if policies change in Washington, states are likely to pursue their own agendas. The same election that gave President Obama four more years also brought the number of Republican governors to 30, promising a sharp divergence in policy perspectives at the federal and state levels.
For example, recent years saw a surge of support among federal and some state policymakers for investments in smart-grid upgrades to utility transmission and distribution systems and renewable fuel technologies. But that support has been dwindling in many states and localities. Regulators (and consumers) have been skeptical of the benefits of “behind the meter” smart-grid technologies, such as enabling customers to control power usage. Similarly, the high cost of renewable energy has some policymakers balking at requiring consumers to purchase pricier electricity from renewable sources at a time of economic hardship.
Meanwhile, as ancillary investments lose favor, regulators are refocusing on the utility’s core mission of providing electricity safely, reliably, and affordably. Recent events such as the nuclear power-plant failure in Japan and the powerful storms causing widespread outages in the U.S. reinforce these concerns.
This trend suggests that utilities will reap better returns from investments that strengthen their essential capabilities. At the same time, Superstorm Sandy could be the catalyst for wider deployment of upgrades to the grid—by demonstrating the need for technology that could help restore power more quickly by providing better information to field crews during mass outages.
The risks of recovery. The favorable investment climate for utilities stems largely from the sluggish economic growth that has plagued the U.S. since 2008. Interest rates are at historic lows because the Federal Reserve needs to stimulate growth. Natural gas prices continue to remain low, because anemic economic growth has slackened demand.
There’s no doubt that these conditions are good for regulated utilities, whose earnings are not dependent on market power prices and which feel less regulatory pressure when prices are low. The opposite is true for merchant power generators, whose profits rise and fall with gas prices.
Executives at utilities should avoid getting too accustomed to the current economic environment. Although dramatic change isn’t likely in 2013, history shows that prices can rise quickly when conditions shift. For example, natural gas prices shot up 500 percent between the late 1990s and their peak in 2005.
In the short term, an economic recovery could lead to higher interest rates, gas prices, and electricity rates. The current favorable investment climate would give way to conditions that make it more difficult for utilities to finance new infrastructure. Higher costs of capital make projects more expensive, while rising electricity bills make regulators reluctant to approve new investments.
Over the longer term, these variables will fluctuate with the economic cycles. Executives should keep this in mind as they contemplate 50- to 60-year investments in new infrastructure. Investments should enhance the core performance capabilities that generate strong returns in any economic or pricing environment.
New digital technologies give utilities the tools to build systems that are more resilient, intelligent, and responsive. These technical advances will improve efficiency, reliability, and productivity. They also set the stage for a new utility business model. Utilities in the future will become larger, leaner, and more performance-driven. An explosion of data (and insight) from new technologies will drive long-term strategy and day-to-day decision making.
As executives weigh investment choices today, they should consider the capabilities their company will need to capitalize on these technologies, and build a best-in-class operating model for the future. The capabilities each company needs will vary based on the strategy it chooses. For example, some will opt for a low-cost, core utility model, whereas others will adopt a customer-centric, retail-oriented approach.
Whatever your strategic focus, your company will need suitable capabilities in four key areas:
Transmission and Distribution Delivery
Utilities have a rare opportunity to invest in 21st-century electrical systems. Choosing the right investments is critical, as executives must take into account shifting regulatory policies, new technological options, and potential economic changes. Amid such uncertainty, investments that advance the utilities’ core mission of providing safe, reliable, and affordable power are most likely to pay off over the long term. In making these investments, utilities should aim to enhance the capabilities that serve their broader corporate strategies.
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