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Changing Direction

Issue 4 and Volume 105.

By Brian K. Schimmoller,
Managing Editor

The introduction of competition to the electric power industry is laying waste to the myths held by many regarding traditional utilities and laying a foundation for the evolution of novel business models. The fabric and pattern of the industry has changed so much in recent years – and so quickly – that I believe it’s time to take a step back and marvel at this mottled quilt we’ve created.

The utility industry has survived for the better part of a century with little deviation outside the confines of the vertically integrated business model. Control over generation, transmission, distribution, and customer service provided a static, safe framework from which to run a business, market a reliable product, and make a moderate return.

This model has been turned on its ear in recent years. The frightening “R” word – risk – has entered the fray, and risk tolerance has become the defining characteristic of a company’s business philosophy. And what is more surprising than the gradual disappearance of the traditional utility model is the range of successful business models that have emerged to take its place.

I attended Cambridge Energy Research Associates’ CERA Week in Houston in February and was struck by the wide diversity in business models represented throughout the week. Over the course of two panel discussions, the following companies were represented on stage: Enron, Williams, Calpine, Mirant, Duke and Cinergy.

It was an MBA student’s dream:

  • Enron, the industry behemoth, which has increasingly divorced itself from asset ownership in favor of a pure trading business model.
  • Williams, which has also adopted a trading-heavy business model, albeit supported through asset ownership (primarily natural gas pipeline capacity, but power marketing contracts as well).
  • Calpine, which probably has the purest asset development business model in the industry, focused almost exclusively on natural gas.
  • Mirant, recently spun off from Southern Company, and Duke Energy North America (DENA), which both see tremendous value in a scaled-down integrated business model equally strong in asset development and energy trading.
  • And Cinergy, which retains the appearance of a traditional vertically integrated utility, but which now achieves 50 percent of its business from unregulated subsidiaries.

Taken individually, each of these companies, and the business models they represent, are successful. Their stock performance, market capitalization and/or industry position mark them as such.

Taken together, however, it becomes difficult to identify the common threads underlying their success. And more questions than answers emerge. Will Enron be able to prosper in the long term in the historically asset-centric energy industry? Will Williams’ gas assets enable them to effectively hedge gas and power price risks in volatile markets? Will Calpine’s abundant reliance on natural gas scare away stockholders and hamper success? Will Mirant and DENA be able to shed their utility roots and thrive on their own? Will Cinergy’s unregulated business ventures benefit or suffer from the parent company’s vertically integrated business model?

Key questions, and applicable to a number of other companies not mentioned as well, but should they raise concerns?

I recently spoke with John Gregg, president of SCT Energy, Utilities and Communications, about the challenges facing the electric power industry from an IT perspective. During the course of our discussions, he shared his views on the utility industry’s strategic response to deregulation, outlining the three models he currently sees being adopted: (1) Genco – accumulate generation assets, focus on wholesale markets, ignore the customer; (2) Wires and Pipes – sell generation assets, focus on transmission and distribution, sell added-value services; and (3) “Just Say No” – don’t deregulate, remain active in generation and T&D, await future developments.

While probably over-simplified, most utilities and energy companies can be placed in one of these categories. Deregulation – or more broadly, the advent of greater competition in the industry – is the obvious driver behind this transformation. In the wake of California’s electricity crisis, however, Gregg believes it will take another 5-8 years for deregulation to evolve. “The winners will be those who know their direction,” says Gregg.

I think it will take even longer for full deregulation to materialize, but the message about winners and direction is important. I believe the message goes even deeper, however. Direction implies a course, and there is no set course for this journey. Like the salmon struggling upstream to spawn, the destination and route are known, but the specific path is not.

While I can’t pinpoint the specific business practices that will guarantee success in today’s energy world, I can confidently state that success will correlate closely with a company’s ability to change direction, as exemplified by the companies cited above.

True, the adult salmon perishes after its arduous journey upstream to spawn. But the outcome is new birth, and it is this new birth that redefines the species each year.