The New Utility Chess Game

Like many other industries facing declining sales due to tepid economic growth, utilities have been waging a “Games of Thrones”-style battle for supremacy among their peers.

Their aim? To build or acquire growth-oriented assets before competitors in order to continue delivering long-term earnings and dividend growth.

Over the past few years, we’ve highlighted many of these strategies—from the mergers-and-acquisitions wave that’s further consolidating electric and gas utilities to the buildout of next-generation infrastructure and the pursuit of renewables.

But now the tenor of battle could become more personal, perhaps even vicious, as utilities start to go after their competitors’ biggest customers by persuading them to move to their service territories—or by winning contracts to develop and manage onsite generation for large customers wherever they are, thereby cutting out the local utility.

If this trend develops in a meaningful manner, it would be a major departure from the collegial relations that have always existed among utility executives.

To be sure, in competitive electricity markets, which are in half of the country, utilities do compete against others for retail, commercial and industrial business.

And states regularly compete for business by offering companies incentives to relocate headquarters or plants.

Further, some of this cross-state competition may come from customers themselves, who are increasingly “shopping” for utilities with the best rates in order to cut costs.

To get a better sense of this trend, last week your intrepid Utility Forecaster senior analyst attended the annual Edison Electric Institute Financial Conference, where utility executives, investment bankers, and asset managers meet to talk about all things electric and establish the investment framework for the coming year.

Certainly, the feeling among attendees this year was that, given the industry’s growth challenges, such competition will only become more intense—especially since some of the so-called growth strategies that were being touted by utility executives at the conference seem to be ultimately unsustainable, as I was told by many an asset manager and banker.

In fact, during one utility CEO’s presentation, a banker wondered aloud to me, “How long will state regulators rubber-stamp the replacement of aging infrastructure that some utilities are relying on to deliver 6% growth? How long will they allow infrastructure to be replaced years ahead of schedule? And if regulators start to balk at these requests, where will the growth be?”

These were questions I directed at a former state regulator attending the conference, who as you might expect, claimed regulators know exactly what they’re doing. But, I asked, “How will utilities deliver real growth on the back of expenditures such as making the electric grid smart?”

A Renewed Focus on Customers

The answer that seems to be understood, but few have voiced, is growth will be achieved by drawing new customers to these new technologies or networks, a strategy long embraced by telecom firms.

This would be the logical endgame for a sector comprised of haves and have-nots—utilities have experienced uneven recoveries in their service territories since the downturn.

Some utility service territories have seen demographic-driven long-term growth, such as Florida, which is a prime destination for retirees, while others are home to growing or resurgent industries, such as the automakers in the Midwest.

Nevertheless, it would appear that most utility executives are not taking such growth (or lack thereof) for granted. And now, they’re starting to use upgraded networks to win new customers, either as a strategy to overcome slow growth, bolster growth, or simply to retain customers that no longer have any loyalty to any one service territory.

Whatever the reason, it’s clear that in this brave new world customers are more willing and able to move their operations to reduce power costs.

Indeed, it was quite telling that the first panel at the conference was a discussion with executives from Microsoft and Facebook about how utilities can provide better service in today’s changing environment.

As these sophisticated tech executives noted, electricity is an all-important component of their business, and they have significant insight from a customer standpoint since they buy electricity from utilities all over the globe to power their data centers.

Though on balance, they felt utilities were becoming more sensitive to their needs, there was some criticism that service quality can decline once a utility has won their business. Also, they said that utilities need to get smarter about how they apply their tariffs.

Given most utilities’ monopoly status, it’s a rarity to see a panel at an industry conference where major customers are invited to offer constructive criticism. But it’s definitely a sign of the times.

Another rarity was the use of the word “customer” in CEO presentations and the phrase “customer needs.” Not since the dawn of electric competition have I heard such words and phrases spoken so often.

This is yet more evidence that the industry is going through a massive transformation. And we see a rising generation of utility leaders who understand these changes and are developing strategies to adapt to them, while continuing to deliver shareholder value.

At this year’s conference, we chatted with some of these new leaders, and we’ll share their insights in our annual “Insider Issue” of Investing Daily’s Utility Forecaster, which is due out on Dec. 3.

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