Why North American utilities are a smart bet

Eight Steps Utilities Can Take To Continue Solid Earnings Growth

The warnings of competitive threats to the US utility industry have sounded as the new smart electric network begins to evolve and develop and new distributed solar and wind generation finds traction in the market.

Many recent analyses focus on the bleak outlook and dire consequences that the competitive dynamics of the new smart electric grid will have on utilities, especially electric utilities. Our new analysis evaluates and focuses on the strong foundation that utilities have, especially with future rate base and earnings growth, to be successful in the energy market. During the next 15 years, Oliver Wyman expects utility earnings will grow 3% to 4% annually, with upside if utilities change smartly in the face of the new competition. The smart grid can enable utilities to thrive, not wither.

Eight Management Levers

The industry can expect a steady, 3 percent to 4 percent base of growth for the next decade-and-a-half thanks to requirements for infrastructure investment. To do better, utilities must pull eight management levers to improve their performance:

1. Undertake solid business planning now

To build a business plan robust enough to capture the opportunities created by all of the challenges utilities face, companies need to design operating and profit models that focus on the new grid, distributed resources, micro-grids, energy storage and other initiatives. Good planning may still be followed by bad outcomes, so a clear focus and commitment in strategic planning to implementation and communication will help set the stage for earnings growth.

2. Become customer-centric

Our research suggests utilities that deliver exemplary customer focus earn 50 to 100 basis points more than those with less customer focus. Happy customers lead to more responsive and flexible regulators, which lead to greater opportunities to achieve higher levels of earnings. The days of putting the company first, speaking from a script and talking at customers are over. Customers want to buy from companies that show empathy, have conversations with them and make eye contact.

Consumers will be open to leaving the utility if new entrants are able to show they are truly customer-centric.

3. Use natural gas expansion to focus on customers

The US will be awash in natural gas for a good while. Many utilities also have a natural gas distribution business. What better time to make it easy for utility customers to convert or expand their use of natural gas?

4. Position for increased electric transmission and distribution investment

The infrastructure is more than aging, and could use more investment than is planned. Utilities must set the customer and regulatory stage to accelerate investment in the future, including capturing the value from distributed resources.

5. Expand participation by taking the regulatory initiative

Utilities have delivered big time to both their customers and regulators. They need to tell their story. Be a leader with the state executive branch, the legislature and big-city mayors to infrastructure investment in innovative ways.

6. Develop a fresh approach to non-regulated activities and business models

The last round of energy retail and wholesale deregulation went down in flames, capped by the Enron fiasco. If non-regulated earnings growth is needed, do not repeat those mistakes. Avoid embracing nonregulated initiatives if you do not have a snowball’s chance to execute effectively and sustain profitability.

7. Focus on cost management to earn allowed returns

The average utility does not earn its allowed return on equity. To earn their allowed returns, utilities would need to reduce non-fuel operating and maintenance expenses by about 10 percent annually. For many utilities, trying to hold expenses flat represents a good first step. The future business environment may require more.

8. Reconsider mergers and acquisitions, especially small acquisitions.

Go after the big utilities if you can make it work. But remember, there are still more than 200 small utilities with a $30 billion rate base and $1.3 billion in annual earnings that could fit nicely into growth strategies.

Why North American utilities are a smart bet