While it is true that the utility industry in the United States has gone through major changes in the past few years, what we have seen to date is only the tip of the iceberg. What will this industry look like in the near future?

There will be fewer companies, and they will look very different. The electric utility industry of the future will have far fewer companies, and each company will be much larger than the typical utility of today. Furthermore, these new large companies are not going to look the same as the typical, vertically integrated electric company of today. Today's electric companies own and operate power plants that produce electricity, transmission systems that deliver electricity over long distances at high voltages, and distribution systems that connect to every customer.

In the future, most electric companies will specialize in either electricity generation and supply or electricity delivery. Why? Because deregulation has made generation and supply into a fully competitive business but has kept transmission and distribution as a regulated monopoly. Therefore, these two businesses now do not have to be part of the same corporation. And, most experts believe that competition will come faster if the owners of generation don't also own and control the transmission and distribution system.
Mergers and asset sales will become commonplace. There are presently about 90 to 100 investor-owned electric utilities in the United States, as well as a few dozen natural gas utilities and pipeline companies. In the past five years, we already have seen more than 25 utility mergers, and this is only the beginning. We also have seen several large acquisitions of natural gas companies by electric utilities.

By 2010, it is likely that there will be only about 10 very large electricity generation and supply companies in the United States. These industry giants will be national or multi-regional, and most of them also will have a large presence in the natural gas industry. We also should expect to see another 10 to 15 large generation and supply companies that are likely to concentrate on selling to just one multi-state market such as the Southeast or the Northeast.

These large generating and supply companies will be formed mostly by mergers but also by the acquisition of existing power plants from utilities that are selling their generating assets. Already, several utilities have divested all or most of their power plants, mostly in California, the Northeast and Illinois. Many of these plants have been sold off through competitive auctions, and it appears that the same short list of buyers is outbidding all others in an effort to create large concentrations of unregulated generating capacity.

The companies selling their power plants, on the other hand, want to stay in the lower-risk transmission and distribution (T&D) side of the business, which will remain regulated for the foreseeable future. But here, too, we should expect to see a wave of mergers and consolidation. By 2010, it is likely that there will be only about 20 large multi-state electric distribution companies in the United States, and most of these companies will also be large natural gas distributors.

Advice for Investors
Investors, like consumers, will be in a better position to take advantage of electric competition if they understand its implications in the marketplace. In the not-too-distant future, utility stocks will not be the same kind of investment they used to be. As monopolies with slow growth potential, utilities used to be very low-risk, defensive investments. This is not necessarily true any more.

Because of deregulation, investors will have two different types of electric utility stocks to consider in the near future-either the distribution utilities or the generation-and-supply companies. The stocks of the distribution utilities will be much like the old-fashioned utilities-low risk, relatively slow earnings growth, very predictable earnings and cash flows, and relatively high dividends.

However, the stocks of the electric generating and supply companies will have much different characteristics. They will likely have higher earnings growth, moderate risk, a moderate degree of earnings volatility, and pay little or no dividends. In other words, the generating and supply companies should not be viewed as defensive investments. They should be viewed instead as diversified energy companies that produce and sell a valuable commodity-electricity-in a competitive market.

By Barry Abramson, C.F.A.
http://www.washingtonpost.com/wp-adv/specialsales/energy/report/article3.html