The Economic Consequences of New Models

The Economic Consequences of New Models Utilities in a Time of Change & Challenge Conference

At the Public Utilities Fortnightly event, Stuart Pearman, partner and energy practice leader at ScottMadden, presented his views on the economic consequences of new models.

Traditionally, utilities have been known for their security as an investment, their regular dividend payments, and their long-term dependability. They have been well rated by the agencies, and their stock has done well in a time of low interest rates. But some say their future is cloudy. If the traditional model is changing, what do they offer investors? Will their Wall Street ratings decline? Will raising money be more difficult?

This presentation explores the evolution of the business model—the current business model, future potential models, risks, reactions from financial markets, and the process to get from here to there.


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Utilities in a Time of Change & Challenge Conference


  • The Economic Consequences of New Models
  • November 18, 2015

Economic Consequences of New Models


  • What Drives Our Current Model? SoWhat Could Be Changing? What Are Some Future Potential Models? Whats at Stake? How Might Financial Markets React? What Does Good Look Like? How Do We Get from Here to There?

Business Model


  • What Drives Our Current Model?
  • So, whats a model? What givens drive the current model?
  • The system of activities that determines how a company: Does business Creates value Sustains advantage
  • Activity System
  • Obligation to serve Universal service Any color he wants so long as it is black Henry Ford Least cost Exclusive franchise territory Natural monopoly
  • Utility Role
  • Rate-Based Cost-of-Service Recovery Utility Earnings
  • Return on rate base assets cost of debt plus a reasonable return on equity, commensurate with risk Recovery of prudently incurred operating costs and taxes Pass-through of fuel costs Below-the-line revenues from business activities: In which utility shareholders bear the primary risk Do not leverage ratepayer assets without compensation or, where applicable, fair opportunity provided to non-affiliates
  • Bonbright
  • The skills, practices, processes, and innovations that are essential to serve customers and markets, perform the activity system well, and animate the business model
  • Technical Competencies
  • Markets and Customer Set
  • The geographies, segments, customers, partners/ecosystem, and product arenas in which the company operates and competes

SoWhat Could Be Changing?


  • Regulatory and public policy objectives What we are solving for, in some cases, is very different from the givens
  • Stroke of the Pen Change
  • Enabling technology Customer tastes and preferences Market ecosystem
  • Fits and Starts Evolutions
  • Obligation to serve Universal service Any color he wants so long as it is black Henry Ford Least cost Exclusive franchise territory Natural monopoly
  • Utility Role
  • Call into Question
  • In Sync?

What Are Some Future Potential Models?



What Are Some Future Potential Models? (Contd)


  • U.K. RIIO Revenue = Incentives + Innovation + Outputs Price controls: allowed revenue over multi-year period (eight-year period, reviewed at mid-point) ED-1 (electric distribution) recently instituted (Apr. 2015) for 201523 period Distribution costs = about 16% of electricity bill Totex (vs. capex or opex bias) indifferent once revenues set Distribution network operators No integrated utilities Filed business plans with annual reporting obligations Regulated on outputs, not inputs, with emphasis on societal goals (e.g., customer satisfaction, low carbon alternatives, worst-served customer)

Whats at Stake?



How Might Financial Markets React?


    • Changing investor expectations Long have moved from widows and orphans, but still perceived as relatively low risk Lack of clarity on returns on equity as Utility 2.0 proceedings are in play
    • Investors and credit agencies criteria may need adjustment to account for potentially changing business and regulatory models; awaiting further clarity.

S&P

  • Moodys
  • Utility operates in regulatory climate that is transparent, predictable, and consistent Incentives in regulatory scheme are contained and symmetrical Utility can fully and timely recover all fixed and variable operating costs, investments, and capital costs (including a reasonable return on assets) Tariff includes mechanisms for timely recovery of volatile or unexpected operating and capital costs
  • Regulatory Environment and Asset Ownership Model

What Does Good Look Like?


  • It is all about alignment and coherence among more independent actors, with potentially differing interests.
  • Activity System
  • Regulatory Construct
  • Enabling Technology
  • Technical Competencies
  • Financial Market Outcome
  • Customer Tastes and Preferences
  • Markets, Customers, and Market Ecosystem

How Do We Get from Here to There? Technical Competency and Business Model Evolution



Closing Thought What Is This?


  • The best way to predict the future is to invent it. Alan Kay


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