Low Utility Returns Drive Convergence
Convergence is going to continue in the energy industry because
it is what customers and financial markets want; the market signals
are unmistakable, according to an industry representative and an
investment funds manager.
"Today's market is incredibly punishing for those companies that
do not generate sufficient rates of return," said Michael Kerr,
senior vice president at Los Angeles-based Capital Research Corp.,
who offered what he called a "buy-side perspective" of the energy
industry. "Part of the result is that the utility industry has not
been competitive for capital in the last 10 years."
"The performance of the electric industry (in terms of average
annual returns on investment) has been absolutely terrible by any
measure," he told regulators gathered for the National Association
of Regulatory Utility Commissioners (NARUC) summer meetings
recently. "The fault is not necessarily with the people who run
those companies, but the rates of return and the ability to grow
earnings in that business has been unsatisfactory."
Kerr noted that rates vary for different segments, but for all
segments, there has been a "failure to perform. So the utilities
have failed to attract capital." Kerr manages about $500 billion in
predominantly equity investments for Capital Research.
Gas pipeline companies have done much better, Kerr said, but
that presents other problems in a consolidating industry. Electric
utilities because of their size tend to dominate mergers, so gas
shareholders may have to give up their stock for less valuable
His buy-side view of the gas/electric industry is that total
returns for energy industry companies are woefully inadequate
compared to the S&P 500 companies. The average compound rate of
return for S&P companies over the last five years was about 25%
or twice the 12% generated by LDCs.
"What fascinates me over the 1980s and 90s is that in the
utility sector the average returns are going down whereas
throughout the rest of corporate America the average returns are
going up. The outcome has been very unsatisfactory for the
shareholders of U.S. utilities."
Convergence, cost-cutting, diversification and better or more
targeted customer service are the avenues utilities are using to
improve their image and their bottom-line.
"One of the reasons we are moving to convergence is to allow us
to keep our revenue streams, and the fact is that we have to find
better ways to optimize our asset base and provide services to our
customers at lower costs," said Chris Helms, president of CMS's
Panhandle Pipeline. More than 95% of his contracts are discounted
and contract terms are shorter and shorter. This means he is in the
marketplace every day.
Michigan-based CMS has run a combined gas and electric utility,
Consumers Energy, for decades. In the last year it picked up two
major midwestern interstate pipelines, Panhandle Eastern and
Trunkline, and grew E&P activities and an energy marketing
unit. "The fact is we live in a competitive world and we are right
in the middle of it. It is truly a converging operation. We have
gone from a local Michigan utility to a regional and national,
"Our traditional revenue streams are going down over time. So,
what we have to be is more innovative-do more with less at a lower
cost. We've had to figure out ways to provide one-hour firm
transportation service. We are moving into an environment where we
need to be able to price to fit the market."