Convergence is going to continue in the energy industry becauseit is what customers and financial markets want; the market signalsare unmistakable, according to an industry representative and aninvestment funds manager.
“Today’s market is incredibly punishing for those companies thatdo 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 energyindustry. “Part of the result is that the utility industry has notbeen competitive for capital in the last 10 years.”
“The performance of the electric industry (in terms of averageannual returns on investment) has been absolutely terrible by anymeasure,” he told regulators gathered for the National Associationof Regulatory Utility Commissioners (NARUC) summer meetingsrecently. “The fault is not necessarily with the people who runthose companies, but the rates of return and the ability to growearnings in that business has been unsatisfactory.”
Kerr noted that rates vary for different segments, but for allsegments, there has been a “failure to perform. So the utilitieshave failed to attract capital.” Kerr manages about $500 billion inpredominantly equity investments for Capital Research.
Gas pipeline companies have done much better, Kerr said, butthat presents other problems in a consolidating industry. Electricutilities because of their size tend to dominate mergers, so gasshareholders may have to give up their stock for less valuableelectric shares.
His buy-side view of the gas/electric industry is that totalreturns for energy industry companies are woefully inadequatecompared to the S&P 500 companies. The average compound rate ofreturn 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 theutility sector the average returns are going down whereasthroughout the rest of corporate America the average returns aregoing up. The outcome has been very unsatisfactory for theshareholders of U.S. utilities.”
Convergence, cost-cutting, diversification and better or moretargeted customer service are the avenues utilities are using toimprove their image and their bottom-line.
“One of the reasons we are moving to convergence is to allow usto keep our revenue streams, and the fact is that we have to findbetter ways to optimize our asset base and provide services to ourcustomers at lower costs,” said Chris Helms, president of CMS’sPanhandle Pipeline. More than 95% of his contracts are discountedand contract terms are shorter and shorter. This means he is in themarketplace every day.
Michigan-based CMS has run a combined gas and electric utility,Consumers Energy, for decades. In the last year it picked up twomajor midwestern interstate pipelines, Panhandle Eastern andTrunkline, and grew E&P activities and an energy marketingunit. “The fact is we live in a competitive world and we are rightin the middle of it. It is truly a converging operation. We havegone from a local Michigan utility to a regional and national,international player.
“Our traditional revenue streams are going down over time. So,what we have to be is more innovative-do more with less at a lowercost. We’ve had to figure out ways to provide one-hour firmtransportation service. We are moving into an environment where weneed to be able to price to fit the market.”
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