Pipes & Wires
THE
UTILITIES & INFRASTRUCTURE COMMENTARY FROM UTILITY CONSULTANTS
Issue 28 – April 2004
From the
director…
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Pipes
& Wires #28 starts with a bit of a post mortem on New Zealand’s Project
Aqua and also considers what role distributed generation might play. We then
move to a discussion of how regulated utilities might grow their earnings in
the face of regulatory price caps, which is followed by a discussion of the
impending changes to electricity information disclosure requirements in New
Zealand. Part 2
of the 4 part series on consolidating electricity distribution in Africa
looks at the recent establishment of the RED’s in South Africa. We then conclude
with the first of a series of interviews on the theme of “Insights Into
Strategic Growth” which asks John Roberts from United Utilities plc about
their growth strategies. |
NZ - new opportunities for DG in the
post-Aqua era
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I guess the abandoning of
Project Aqua shouldn’t have been the huge surprise it was. With complex
factors eroding the profitability on many fronts, Meridian Energy was left with no
prudent alternatives. But where does this leave the
national interest ?? Although about 840 MW of new
capacity is expected to be available for the winter of 2007 will it really be
enough to meet dry-year demand ?? It would seem that
the shiny black stuff mentioned repeatedly in the flurry of industry comments
after the announcement might need to become a reality. The abandoning of Aqua has
created further opportunities for lines companies to consider distributed
generation (DG). As well as the benefits of avoiding network investment and
increasing supply security, DG will also be valuable for generating GWh. To
discuss the technical, commercial and regulatory issues surrounding DG, pick here
or call Phil on +64-7-8546541 or +64-21-606670. |
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Delivering the earnings growth
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Introduction Earnings growth is a key
component of winning the confidence of the equity markets to attract new
funding – without it new investment must be funded from revenue or debt
(which has its limits). But how can an increasingly regulated utilities
sector deliver earnings growth greater than other sectors, and how can
individual utilities deliver greater earnings growth than competing utilities ?? |
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Sources of earnings growth At a theoretical level there
are two sources of earnings growth – growing revenues faster than costs, or
cutting costs faster than revenue. Unfortunately the cutting costs method
usually erodes service potential which then in turn eventually erodes
revenue. So cutting costs faster than revenue would seem to be a bad idea
except in the specific instance of reducing an assets’ service potential to a
level commensurate with sustainable revenue. |
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The alternative of growing revenues faster than costs This technique most obviously
lends itself to the unregulated activities as it is rare for a regulated
utility to be allowed a revenue increase greater than its cost increases. In
reality this technique is being played out in very different ways and with
very different consequences…. |
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· The
high rewards of energy trading lead some utilities to divest their generation
and either acquire generation in more lucrative markets or become asset-less
traders. Little thought, however, appears to have been given to the downside
risks (refer back to Pipes
& Wires #24). Many of these utilities are now either
wounded and bleeding or totally dead. · Provision
of utility services such as electrical contracting, back-office services and
broadband have become very lucrative sidelines, but without the significant
downside risks of energy trading. This seems to be an increasingly attractive
and sustainable technique. · Acquisition
of pipes & wires businesses in jurisdictions with little or no regulation.
Earnings were boosted by revenue increases, by cost reductions through
transformational strategies, and by capital gains upon exit (although several
utilities have also made capital losses upon exit). |
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So … how do we get the earnings growth ?? It would seem increasingly
difficult (perhaps even impossible) to get sustainable earnings growth from a
regulated pipes & wires business. Therefore most utilities’ earnings
growth will need to come from unregulated activities, which will then have to
subsidise the regulated business as well as reward shareholders for their
innovation and risk taking. This doesn’t seem to be the best way of winning
the confidence of the equity markets but until the current era of regulatory
pressure eases it would seem the easiest way forward. |
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NZ - changes to the disclosure
requirements
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Previous disclosure requirements Disclosures for financial years
ending during 2003 were made pursuant to Section 170(k) of the Electricity
Act 1992, whilst the targeted control regime was developed pursuant to Part
4A of the Commerce Act 1986 and given legal effect from 6 June 2003 through
notification in the Gazette. This led to industry oversight by two agencies
within two separate legal frameworks. New disclosure requirements The Commerce Commission recently issued the
Commerce Act (Electricity Information Disclosure Requirements) Notice 2004
which came into effect on 1 April 2004 and applies to all financial years
ending during 2004. With the revocation of the |
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Electricity (Information
Disclosure) Regulations, responsibility for overseeing both the disclosure
and targeted control regimes will lie with the Commerce Commission within a
more streamlined legal framework. The Commission intends to use the 2004 year
to reassess the requirements for disclosure. |
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Consolidating electricity distribution
in Africa (Part 2)
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This article discusses the
present restructuring of South Africa’s electricity industry, and focuses on
the issues involved in identifying the optimum number of distribution
entities. Historically, Eskom
distributed about 60% of South Africa’s electricity, with a further 37% being
distributed by about 400 municipalities. Most of these municipal electricity
entities lacked scale and were facing financial difficulties. Restructuring objectives The government had a wide range
of objectives for the restructuring program, with universal access being the
objective primarily leveled at the distribution segment of the industry. |
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Defining the number of distribution entities The initial restructuring
framework suggested that between 5 and 15 Regional Electricity Distributors
(RED’s) be established. The RED’s would also provide a full range of retail electricity
services, with competition initially being in the over 100GWh per year
customer class. The issues considered were…
Two options were chosen for
detailed study – six RED’s with an average of about 930,000 customers and ten
RED’s with an average of about 550,000 customers. Although it was recognised
that ten smaller RED’s might be a better match with available managerial
talent, it was also noted that six larger RED’s would be financially stronger
and better able to further the governments’ electrification program. |
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Valuing the RED’s Two valuations were applied to
each RED… ·
A historical valuation of the assets
contributed to each RED that will form the basis of share allocations. ·
A deprival-based valuation that will be
used by the regulator to establish
tariffs. |
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Defining the boundaries of the RED’s Probably the single issue that
has gazzumped mergers everywhere is the allocation of value amongst the
owners of the enlarged entity. For this reason it was decided very early on
that RED boundaries should coincide with municipal boundaries to minimise
disagreement over how much value Eskom and the municipalities brought to each
RED. Other issues considered were… ·
The mix of customer numbers and classes
within each proposed boundary. ·
The socio-economic mix within each proposed
boundary and in particular the proportion of the national electrification
requirement within the boundaries. ·
The likely viability of each RED,
particularly its ability to fund electrification and the need to avoid
cross-subsidies and wide variations in tariffs between RED’s. ·
Geographical features that form obvious
boundaries. ·
Network configurations that form obvious
boundaries. |
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Ownership of the RED’s Shares in the RED’s will be
held by the municipalities and by a state-owned entity called Electricity
Distribution Industry Holdings (EDI). EDI has been established to hold the
shares that reflect Eskom’s contribution to the RED’s to reinforce the
guiding principle that generators must not own shares in transmission or
distribution. It is expected that the EDI will be dissolved in about 5 years,
with the shareholdings passing to the government. At this point “golden
shares” may be established to give the government power of veto over any
changes in ownership or capital structure that would be contrary to the
intention of the reforms. Next month we will examine the
consolidation of electricity distribution in Namibia. |
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Insights into strategic growth (Part 1)
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This article is the first of several in which we are interviewing
utility chief executives who have presided over significant strategic growth.
This month we are interviewing John Roberts, chief executive of United Utilities plc. Pipes &
Wires John, the
fact that United Utilities is the only REC not to have merged with any other
REC might create the impression that United is not growing strategically.
Reading your company literature, however, indicates a strong focus on growing
unregulated revenues. Can you please tell us about this growth strategy ??
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John Roberts Our growth strategy is based on deploying our core
utility skills of asset management and customer management in markets which
have potential for strong organic growth. Our asset management business, Contract Solutions, focuses on three
sectors - utility infrastructure, connections and metering, and green
energy. In utility infrastructure we
have an O&M contract to manage the assets of Welsh Water, and last year we signed a
contract to work as part of a consortium to manage the asset investment
programme of Scottish Water. We
also manage water utilities outside the UK, in Poland, Estonia , Bulgaria,
the Philippines and in |
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Australia. Our connections and metering business, which operates
under the name of UU Networks, provides multi-utility network connections to
property developers and house builders across the UK. It also provides metering services to other
utilities, which includes installation and maintenance, but excludes meter
reading. Our green energy business is one of the top five developers of renewable
energy in the UK. Our portfolio of
assets comprises mainly landfill gas and small scale hydro, but in future we
are looking to develop onshore and offshore wind. In total, Contract Solutions had a turnover in 2002/3 of nearly £400m, and net assets of just over £100m. Our customer management business, Vertex, is one of the leading
business process outsourcing companies in the UK. It manages back and front offices for
clients with large customer bases, specialising in process re-engineering to
enhance customer service and improve efficiency. Its key market sectors are: central and local government, utilities and
the private enterprise sector.
Examples of contracts currently operated by Vertex include:- § In the central and local government sector we
have a major contract with Westminster
City Council in London, to provide back office and customer contact
services to the citizens of Westminster.
For central government, we are working with the Department of Work and Pensions to
transform the payment of state benefits from a cash based system to
electronic payment. § In utilities we provide billing, cash
collection and customer contact services for over 5 million of Powergen’s customers in the UK. We provide a similar range of services to Hydro One, a Canadian utility based in
Toronto. § Our private sector clients include household
names such as Vodafone, Marks and Spencer and UPS. Vertex employs over 10,000 staff and in 2002/3 had a turnover of
£310m. |
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Pipes & Wires Can you talk a little more about this strategy
in relation to what role United sees its’ regulated pipes & wires
businesses playing in growing unregulated revenues?? |
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John Roberts In terms of our wires and pipes regulated
businesses, the key role is to provide a source of skills which can be
deployed into our asset management business.
For example, one of the directors of our regulated multi-utility asset
management business has now moved across to Contract Solutions to become
Chief Operating Officer of our consortium that manages our contract with
Scottish Water. In addition, the regulated business acts as a reference point for
potential clients of Contract Solutions, in which we can demonstrate the
extent of our multi-utility asset management skills. |
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Pipes &
Wires United is the
only one of three electricity & water utilities in the UK to have lasted
the distance. From what you know about the Hyder and ScottishPower multi-utility
models, what has made United’s business model more sustainable than theirs ?? |
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John Roberts The
United Utilities business model owes its sustainability to two key factors:- (a) we stick to our core skills with which we are
familiar and do not venture into areas in which we do not have relevant
experience; (b) we focus on market sectors which have strong
potential for organic growth, so we do not need to invest large amounts of
capital. Taken together, Contract
Solutions and Vertex have a combined order book of £2.5 billion, with only
£220m of net operating assets. |
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Pipes &
Wires John - thanks
for some really useful insights into making a multi-utility work in an era of
heavy price control. |
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