United States: WiresCo Or IntegratedCo?

In The Information Age, Which Is The Best Model - A Wires Company Or An Integrated Utility?

Economic theories are not immune to Darwinian evolution. Theorists who came up with the idea of economies of scope in vertically integrated companies such as utilities must be turning in their graves as electric utilities unbundle into generation, transmission, distribution, and retail segments. Instead of creating value as one vertically integrated entity, companies are seeking to create value through specialization and expansion in just one or two segments of the industry. At the same time, to the chagrin of many utility executives and boards, stock prices are plummeting, and competition is emerging from some new quarters. For example, transmission is beginning to pose a threat to generation, distributed generation could cut into the market for both transmission and distribution, and marketers could erode the share for retailers. Some response to these changes is imperative.

Where is the impetus to unbundle coming from? On the one hand, from regulators. With the issuance of FERC Order 2000, incumbent utilities are required to form Regional Transmission Organizations (RTOs) by the end of next year, and to separate ownership from control of the system. However, market incentives also play a strong role, as progressive utilities are actively pushing to implement this restructuring of transmission and to capitalize on it through investment in other network services and cost cutting. The unbundling of the industry, active in generation and distribution in recent years, will soon hit the transmission segment with full force. Are you prepared?

What type of RTO is best, or "right"? The race is on, with the electric industry almost equally split between the Independent Transmission Company (ITC) and Independent System Operator (ISO) models. Some observers believe that the rigid standards for independence imposed by FERC Order 2000 on the formation of ITCs is an implicit endorsement of ISOs.

Could that be the reason why no operational ITCs yet exist in the U.S., while there are several ISOs? We wonder whether the FERC is being overly cautious, since ITCs have already been proven elsewhere. There are working examples of ITCs in the U.K. (National Grid), Spain (Red Electrica de España) and Australia (PowerNet in Victoria).

It seems to us that a for-profit ITC should operate the transmission network more efficiently than traditional utilities, and would have a greater incentive to invest in new transmission lines where profitable. As an independent entity it would be motivated, through both creative pricing and new lines, to capture some of the profits that merchant generators may seek to extract in congested load pockets. In an integrated utility, the decision to expand transmission versus installing new generation would have been coordinated, but not in a fragmented industry. Suddenly, as RTOs are formed, particularly if they are ITCs, transmission could become a real competitor to generation.

In this maelstrom of change, what should utility executives do - remain an integrated utility but transfer operational control of the transmission wires to an RTO; spin off transmission entirely to focus on generation and retail; or sell generation to focus on the network business? Or some combination of the above? The right choice may vary according to the company, but the market certainly seems to believe that there is a credible growth story in the wires-only (transmission and distribution) business. These companies are generally trading at much higher multiples than their integrated cohorts.

The strategies of such companies are worth noticing. They are not just yesterday's utilities, but rather information age network companies involved in delivering essential services such as power, gas, telecom, Internet, and other network-dependent products and services. These companies are becoming "delivery" companies, not "electric wires" firms.

This concept has been spreading on the distribution side. And now, it's the transmission side's turn. On March 21, six utility and communications firms combined 7,000 miles of fiber optics networks to create America's Fiber Network, a telecommunications system across 11 states.

We believe that the success and stock prices of electric companies hinges on their ability to see clearly and act effectively on their vision of the future. We further believe that the future wires business will be separated into two distinct areas: first, in competing with other segments of the industry and with other delivery businesses, and second, in making information and technology an integral part of the company, rather than just using it to enhance traditional utility services.