Published In March 2000
Increasingly, electric utilities are making alternative sources of power and services available to customers. By the end of 1999, 21 states had passed legislation and three others had issued regulations phasing in competition among energy services providers. Traditional, vertically integrated utility companies, including those falling under power generation, transmission, and distribution categories, are being separated into three separate lines of business. Generation is spun off and deregulated by the Federal Energy Regulatory Commission (FERC), and distribution is regulated by the states. In addition, unregulated operations are being set up in several categories including power marketing, telecom/Internet and related lines, and energy services contracting. The latter includes services traditionally provided by mechanical/electrical contractors. As one contractor noted, "we must either partner with them, subcontract to them, or learn to compete with them." These changes are being driven by federal and state policies in response to organized efforts by consumer groups and large energy users striving to obtain benefits of increased competition. Measurable results attributed to increased competition in previously deregulated industries such as trucking, banking, telecommunications, and airlines have included: economic growth; accelerated technology; increasing employment; more consumer options; and arguably lower prices. Some readers may dispute these benefits of previous deregulation, but the trend toward enabling more consumer choice is now irreversible. The basic goal of electric industry restructuring is not only to reduce prices, but also to expand consumer choices and stimulate creative, innovative new energy services. The primary factors driving the push toward electric industry restructuring include the following positions: * Widespread perception that power is available on the national market at prices well below imbedded costs of many utilities. * Large regional and inter-utility variations in prices should no longer be permitted due to costs of prior investments, contractual obligations, regional differences in fuel costs, purchase power obligations, taxes, labor costs, environmental factors, and regulatory decisions. * Monopoly utilities exposure to competitive forces would produce cost reductions and additional consumer benefits through market innovations and technological improvements. * Members of the rapidly growing independent power marketing industry should be permitted to aggressively pursue their ability to sell power directly to consumers. * The history of previously deregulated monopoly industries stimulates political momentum to include the electric industry, although critics of deregulation may disagree. * Competition is reducing the profits in power generation for some utility companies, forcing their executives to reconsider their corporate strategies. They have three simultaneous challenges: * Offer new services to existing customers to prevent them from choosing competitors. * Expand their business in unregulated markets to compensate for lower profits from electric power sales lost to competitors. * Enlarge their territories through mergers that expand potential profits through larger economies of scale. One response of utilities has been to transfer assets to a holding company and organize operations into separate regulated and unregulated wholly-owned subsidiaries. Motivation for forming a holding company is, perhaps, best explained in the following statement published by Constellation Energy on its home page at www.constellationenergy.com after it was formed from the Baltimore Gas & Electric Company in April 1999. "BGE's traditional regulated business of providing electricity and natural gas to customers in its service territory is being opened to competition (on July 1, 2000.) Partially in response to this competitive environment, BGE has increased its unregulated, energy-related business. However, under Maryland public utility law, BGE cannot raise capital for its unregulated businesses. Since we anticipate that in the future the capital needs of the unregulated businesses will be greater than that of BGE, the holding company structure will separate the operation of the regulated business from the unregulated businesses, allowing Constellation Energy Group to raise capital for its unregulated businesses in the public markets, which is more efficient and cost effective. In addition, the capital structure of each unregulated business may be tailored to suit its individual business. These factors will enhance Constellation Energy Group's competitiveness. "A holding company structure is common for companies engaged in multiple lines of business and is preferred by the investment community because it is easier to analyze and value individual lines of business. A holding company structure also makes it easier for regulators to assure that there is no cross-subsidization of costs or transfer of business risk from unregulated to regulated lines of business. Finally, a holding company structure provides the regulated utility legal protection from the results of unregulated business activities." Immediately after Gov. George W. Bush signed the deregulation law in Texas, TXU (formerly Texas Utilities) offered Austin area developers a complete package including electric, gas, telephone, cable, and Internet services, including construction. A TXU representative said, "This thing is bigger than TXU, it is bigger than Texas. What you are seeing is a global change in business strategy, not just in electric services. All of our customer surveys indicate they want a single source." The unregulated utility subsidiaries commonly operate as energy services companies (ESCOs), or power marketing firms, or both. The National Association of Energy Service Companies (www.naesco.org) organizes ESCOs. Power marketers are organized by the Power Marketers Association (www.powermarketers.com). Sometimes also called energy services providers (ESPs) or competitive services providers (CSPs), these are a new breed of companies emerging to take advantage of opportunities created by restructuring of the energy industry. Their common goal as unregulated utility affiliated companies is to help users make and implement cost-effective decisions about their energy needs. According to the description provided by an industry trade directory available at www.espio.com, these companies typically perform the following energy management services: * Study energy use patterns and suggest ways that customers can reduce wasted energy and lower operations and maintenance costs. * Help customers select and install energy efficient equipment. * Provide equipment financing options, as well as maintaining and operating equipment at owners' facilities. * Offer advice about how to best purchase energy. * Analyze and offer the most cost-effective combination of these services. According to a report by Frost & Sullivan (www.frost.com), "North American Non-residential Energy Management Services Markets," the EMS total market generated revenue of $23.3 billion in the United States and Canada in 1998. These revenues represent everything beyond meter energy services, including performance contracting, energy audits, and equipment sales for energy management purposes and project management. (It excludes energy-efficiency retrofits.) Industry participants generating this revenue include several different types of competitors, such as ESCOs, ESPs, contractors, consultants, and facility management companies. Deregulation of the electric utility industry and continued advances in technology are anticipated to push EMS revenues higher, toward a predicted $43 billion by 2005. Downside to competition Although the goals of utility restructuring may be desirable for the overall economy, there is a downside to competitive electric power that includes transition costs. The downside includes the following concerns: consolidations that require restructuring and early retirements; the end of utility rate-based energy efficient retrofits; environmental impacts of relying upon low-cost, highly polluting coal/oil combustion generation; decline of system reliability; cost increases for some customers; and increasingly unfair competition for electrical/mechanical contractors. An undetermined portion of the market for electrical contracting is at risk because unregulated utility ESCOs can bundle power sales with contractor-like services in unregulated states. On the other hand, the vast marketing power of utilities enables them to uncover and develop entirely new markets for energy services that could benefit electrical contractors who can become involved in the energy services business. Most retrofit projects funded by shared energy savings through performance contracts would not be possible under conventional cost/payback analysis. Some utility ESCOs have learned that expected profits might be unrealized when they try to organize contracting operations internally. Although they are funded with the massive resources of utility holding companies, unregulated affiliates are mostly small organizations with fewer than 200 employees. Many of their executives have little or no experience in the contracting business. Nevertheless, they must deliver workers and materials on diverse ad hoc job sites regionally and nationally. That is what contractors do best. Without established experience or infrastructure, unregulated utility-affiliated ESCOs have three options for project delivery. They can: 1) become licensed contractors and go through the costly learning curve while building an internal workforce; 2) acquire contractors; or 3) outsource the work to qualified contractors. All three options are being employed by various energy holding companies. Optional strategic responses Optional strategies available to electrical contractors to survive utility deregulation were developed from surveys of customer groups and ESCOs by C-E-C Group in a December 1998 Electrical Contractor magazine report. That work was extended in this project through several mail surveys and industry focus groups. The opinions collected in this study about effective responses by contractors varied over a wide range. However, it was possible to obtain a useful ranking of possible responsive strategies from qualitative surveys of contractors and compare them to opinions of leading customer groups. Contractors who survive utility deregulation will likely implement one or more of these strategies to do so. Contractor participants in this study ranked the optional strategies, in the order of their potential value to electrical contractors, as follows: 1. Contractors should reorganize to stimulate innovations and creativity, and help identify niche markets they may service profitably that are not being met by unregulated utility affiliates. 2. Contractors should develop information sources, and keep themselves and their employees continually informed about the new energy services paradigm. 3. Contractors should encourage loyal customers to stipulate their firms as the preferred subcontractor to any ESCO making an energy services proposal. 4. Contractors should position their firms as outsource partners with ESCOs. 5. Contractors should organize statewide lobbies to assure adequate legislative representation during state deregulation deliberations and subsequent rule making. 6. Contractors should position their firms to offer energy management and mechanical trades work along with electrical services. 7. Contractors should consider forming a national brand-name roll-up organization to market competitive energy and integrated mechanical/electrical services. 8. Contractors should position their firms to bundle power sales and services with performance contracts in deregulated states. 9. Contractors should position their firms for possible acquisition by ESCOs and roll-ups. 10. (6 - As ranked by NECA Chapter Presidents) Contractors should develop and implement more aggressive marketing efforts to help assure that buyers of energy services will prefer them as energy services providers. The steps to decision-making about these strategies recommended for contractors are as follows: Step 1. Collect all information available about the law on utility deregulation and enabling regulations issued by the utility commission in your state. Step 2. Identify the ESCO companies operating in your area, including unregulated affiliates of incumbent utilities. Step 3.Contact the energy services providers operating in the area and determine their marketing programs. Step 4. Prioritize your options. Review the strategic options and determine how you will rank them in terms of potential benefits and burdens. Step 5. Develop a strategic plan. Select the top strategies that you rated as most beneficial, and begin to develop a plan of action. Step 6. Get help, if needed. If the above tasks seem daunting to you, consider getting help to administer this process. Step 7. Organize association resources. Many of the recommended strategies can be aided by cooperative efforts through membership in industry associations such as NECA (A full discussion of these responses is provided in the Foundation report). More opportunities than threats? Utility deregulation by half the states has stimulated organization and growth of a new competitive energy services industry. Utility executives used to operating a monopoly business must make difficult and risky adjustments to the competitive marketplace. Their focus is on marketing and financing of new service offerings, possibly bundled with power sales in deregulated states. Further deregulation by the lagging states may require federal legislation that seems to be difficult for Congress to enact. Business growth in energy services is concentrated in unregulated utility holding company subsidiaries. Although their strength is financial and marketing, their common challenge is profitably integrating labor and materials on diverse job sites nationwide. They can do so either by subcontracting to qualified contractors, acquiring contractors, or internal staffing. It may take several years for the experimental unregulated business ventures to mature into a new energy services infrastructure. While the outcome is uncertain, experience indicates that contractors who keep themselves informed and respond to new opportunities as they emerge will be more likely to survive and grow through utility deregulation. Ultimately, it will be the decisions of many contractors acting independently that determine the future of the industry. On balance, it may be that electrical industry restructuring is creating more opportunities than threats for electrical contractors as a whole. Although utility affiliates may offer new services that many contractors are unable to provide, such as engineering and financing performance contracts, contractors may benefit from new technologies and economic growth fostered by utility competition. Contractors are not without market power. The common need of all ESCOs is profitably managing labor and materials on the job site. They have very little experience and virtually no infrastructure for meeting this need. Contractors do, and they can use their market position to profit from the new energy services business. However, they will need to see ESCOs as potential customers rather than competitors. And, they will need to consider expanding the range of services they offer to customers who are looking for one-stop shopping for all future energy services needs. The Electrical Contracting Foundation has sponsored the development of a strategic response to utility deregulation for electrical contractors. The work was completed under a grant to C-E-C Group of Springfield, Va. The following is an executive review of the findings and recommendations. A copy of the full report may be obtained from the Foundation office by calling (301) 657-3110. TAGLIAFERRE, proprietor of the C-E-C Group in Springfield, Va., compiles news about the impact of utility deregulation for Electrical Contractor. He can be reached at (703) 321-9268, or by e-mail at firstname.lastname@example.org. Portions of this article will appear in "Surviving Utility Deregulation," research currently being conducted by The Electrical Contracting Foundation.