• Subscribe
  • Log In
  • Home
  • Daily Diary
  • Asset Class
    • U.S. Equity
    • Fixed Income
    • Global Equity
    • Commodities
    • Currencies
  • Sector
    • Basic Materials
    • Consumer Discretionary
    • Consumer Staples
    • Energy
    • Financial Services
    • Healthcare
    • Industrials
    • Real Estate
    • Technology
    • Telecom Services
    • Transportation
    • Utilities
  • Latest
    • Articles
    • Video
    • Columnist Conversations
    • Best Ideas
    • Stock of the Day
  • Street Notes
  • Authors
    • Bruce Kamich
    • Doug Kass
    • Jim "Rev Shark" DePorre
    • Helene Meisler
    • Jonathan Heller
    • - See All -
  • Options
  • RMPIA
  • Switch Product
    • Action Alerts PLUS
    • Quant Ratings
    • Real Money
    • Real Money Pro
    • Retirement
    • Stocks Under $10
    • TheStreet
    • Top Stocks
    • Trifecta Stocks
  1. Home
  2. / Investing
  3. / Energy

Changing Dynamics in the Utilities Sector

Customers are demanding more reliability and consuming less power.
By GLENN WILLIAMS Jan 27, 2014 | 05:36 PM EST
Stocks quotes in this article: NU, ED, FE, PEG, POM, TSLA

Some confusing information is circulating about electric and gas utilities. The issue is energy sales and utility profits. Many people believe that a utility becomes more profitable if it sells more energy. Alternatively, some may argue that if a utility's energy sales decline, the utility could be in financial jeopardy. It is not true.

The source of this information appears to be the Edison Electric Institute (EEI). Last year, the institute published "Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business." Since then, The Wall Street Journal referred to the document and suggested that "Utilities' costs and their return on investment are spread across the kilowatt-hours billed to consumers."

For some, the implication is that if customers change their consumption levels, shareholders could see dramatically different returns. In the regulated utility world, this is not always the case. In particular, in the 19 states where regulators decoupled their electric utilities and the 25 states where gas utilities were decoupled, utility returns have little to do with energy sales.

However, the larger point in Journal's article, "Turning Down U.S. Power's Dimmer Switch," is true. Consumers are demanding more from their distribution utilities while they consume less energy. As utilities invest more assets on a declining consumption base, the unit price of energy must increase.

A good example is the aftermath from a major storm. After Hurricane Sandy, consumers demanded costly upgrades to the utility's infrastructure. After the "derecho" storm, other consumers made similar demands. As a result, utilities such as Northeast Utilities (NU), Consolidated Edison (ED), FirstEnergy (FE), Public Service Enterprise Group (PEG) and Pepco Holdings (POM) were required by state regulators to infuse new capital investments as consumers began to withdraw consumption.

The algebra is simple. As regulated utilities are required to make additional investments, they must spread them over a declining customer base. The result is higher retail costs for consumers.

Shareholders should not be harmed. The state guarantees that utilities will receive a return on equity. Because the cost of capital has declined in recent years, the return dropped accordingly. Nevertheless, the guarantee is there, and shareholders are protected.

However, storms are only part of the picture. Big changes are emerging. Three changes will have consumers demanding more while consuming less.

One is solar power. Utility managers refer to solar power operating on consumers' properties as "distributed energy resources" (DER). Utilities do not care if it is solar, wind or fuel cells. Any energy produced on the property is less energy delivered to the property. Add all the DER assets together, and a lot less power needs to be distributed through the utility's system. As more solar is installed; the utility's unit cost of energy must go up.

Another change is demand response. Again, industry insiders prefer a different term. Demand response is part of demand-side management (DSM), which includes having the consumer invest in energy-efficiency technologies. Add all the DSM assets together, and a lot less power needs to be distributed through the utility's system.

Another change is energy storage. This could be in any form, including customer-owned pump storage or car batteries from Tesla Motors (TSLA). As customers combine distributed energy with energy storage, even less energy is needed from the native utility.

In the end, independently owned microgrids would combine all the technologies. The combined effect would reduce energy consumption even further.

For the foreseeable future, consumers will need the local distribution utility to provide reliable sources of energy. However, as consumers consume less and demand higher levels of reliability, their unit costs must increase.

The mistake is to position this issue as a price on energy. It is really a price for reliability. Utility shareholders want a return on their investments. If they do not get their returns, they will invest elsewhere.

The nation has about 3,000 electric distribution utilities. It also has about 1,200 gas utilities. All are regulated by their respective state governments. These utilities operate under government-guaranteed cost-plus arrangements. This means a return on equity at the top line. It also means repayment of debt.

Unfortunately, this could become a social issue. Those who cannot afford to invest in solar or other distributed energy or DSM will end up paying the most for their energy. In all likelihood, those will be lower- and middle-income customers.

This is a customer issue, not a shareholder issue. Since shareholders own a regulated asset, they are assured a prudent return by state regulators no matter how much energy is, or is not consumed. For those who are concerned about reliability costs, "prudent returns" mean reasonable returns, not sky-high returns.

Get an email alert each time I write an article for Real Money. Click the "+Follow" next to my byline to this article.

At the time of publication, Glenn Williams had no position in any of the stocks mentioned.

TAGS: Investing | U.S. Equity | Energy | Utilities

More from Energy

3 Oil & Gas Royalty Trusts For $100 Oil

Bob Ciura
May 20, 2022 2:05 PM EDT

For investors looking to take advantage of lofty oil and gas prices, we like these investment vehicles.

Exxon Mobil Nears an Historic Upside Breakout on the Charts

Bruce Kamich
May 20, 2022 9:56 AM EDT

Here's my advice for traders.

Constellation Energy Could Power 20% Higher From Here

Bruce Kamich
May 20, 2022 7:34 AM EDT

Shares of the clean energy power generator have rallied since going public in January.

Oil, War and Inflation: Here's Where Prices Are Likely Headed

Carley Garner
May 18, 2022 1:00 PM EDT

Oil has a war and inflation hedge premium, but those aren't permanent.

Occidental Petroleum Continues to Target Higher Prices

Bruce Kamich
May 16, 2022 2:52 PM EDT

Here's our first price target and our long term objective.

Real Money's message boards are strictly for the open exchange of investment ideas among registered users. Any discussions or subjects off that topic or that do not promote this goal will be removed at the discretion of the site's moderators. Abusive, insensitive or threatening comments will not be tolerated and will be deleted. Thank you for your cooperation. If you have questions, please contact us here.

Email

CANCEL
SUBMIT

Email sent

Thank you, your email to has been sent successfully.

DONE

Oops!

We're sorry. There was a problem trying to send your email to .
Please contact customer support to let us know.

DONE

Please Join or Log In to Email Our Authors.

Email Real Money's Wall Street Pros for further analysis and insight

Already a Subscriber? Login

Columnist Conversation

  • 02:24 PM EDT PAUL PRICE

    An Interesting Chart

    I'm betting heavily that stocks will be way up aga...
  • 10:10 AM EDT JAMES "REV SHARK" DEPORRE

    This Weekend on Real Money

    "Market Timing for Dummies"
  • 01:44 PM EDT STEPHEN GUILFOYLE

    Stocks Under $10 Portfolio

    We're making a series of trades here.
  • See More

COLUMNIST TWEETS

  • A Twitter List by realmoney
About Privacy Terms of Use

© 1996-2022 TheStreet, Inc., 225 Liberty Street, 27th Floor, New York, NY 10281

Need Help? Contact Customer Service

Except as otherwise indicated, quotes are delayed. Quotes delayed at least 20 minutes for all exchanges. Market Data & Company fundamental data provided by FactSet. Earnings and ratings provided by Zacks. Mutual fund data provided by Valueline. ETF data provided by Lipper. Powered and implemented by FactSet Digital Solutions Group.

TheStreet Ratings updates stock ratings daily. However, if no rating change occurs, the data on this page does not update. The data does update after 90 days if no rating change occurs within that time period.

FactSet calculates the Market Cap for the basic symbol to include common shares only. Year-to-date mutual fund returns are calculated on a monthly basis by Value Line and posted mid-month.

Compare Brokers

Please Join or Log In to manage and receive alerts.

Follow Real Money's Wall Street Pros to receive real-time investing alerts

Already a Subscriber? Login