The New Electric Industry: Reflections and Refinements
Silverman, Lester P., The McKinsey Quarterly
In the fall of 1996, when deregulation was picking up steam in the United States, three McKinsey consultants - William Heller, Paul Jansen, and I - wrote an article predicting how and where value would be created in the newly refashioned electric power industry.(*) Two and a half years and hundreds of mergers, asset sales, business restructurings, and CEO changes later, it is time to review our forecasts and see what, if anything, we would say differently today.
In general, the changes we expected have indeed come to pass. We made no serious gaffes. Our observations about the likely winners were correct, as far as they went. Our rough quantification of the amount of value at stake appears to have been on target: we said that although investor-owned utilities could collectively lose almost $30 billion a year, growth in new businesses could create as much as $45 billion a year - more than offsetting the loss.
Some of our thinking did not go sufficiently far, however. Three predictions in particular cry out for refinement and augmentation.
1. "This vertically integrated industry is about to fragment into three separate but linked businesses - generation, wires, and power services - plus a dispatch function. . . ."
We predicted that electric utilities would be unbundled once competition permitted customers to choose their electricity suppliers - much as, for a decade, they have chosen their long-distance telecommunications providers. New entrants would then compete in those parts of the business amenable to competition. In fact, rather than the one-off split-up implied by our prediction, the reality has been a dynamic and sometimes messy process, with businesses splitting, reaggregating, and fading. We probably also underemphasized the benefits of links across several businesses.
The experience of the power generation segment shows how dynamic this industry has become. As we expected, generation is developing into a separate business. With increasing competition, many companies have chosen to leave it, while others are expanding their stakes. In the past two years, almost 45,000 megawatts of capacity (about 6 percent of the US total) have been sold or put on the block. Among the biggest owners of generating capacity in the Northeast are the new entrant Sithe Energies (in which the French water company Vivendi holds a majority of the shares) and leading utilities from outside the region, such as PG&E and Southern Company.
It is even clearer now than in 1996 that distinct businesses will emerge within power generation. Entergy and PECO Energy have each acquired nuclear plants as a step toward becoming national nuclear companies. Reliant Energy (formerly Houston Industries) and Duke purchased generating plants in California to participate in the lucrative market for ancillary services (standby and ready-reserve power supplies, as well as voltage support), among other things. Many companies provide nothing but plant operations and maintenance services.
The services business, which the 1996 article described as supplying electricity and other energy and nonenergy products, is also proving to be dynamic. Wholesale services - commonly known as trading - quickly matured as a business, one that is now dominated by a few large companies. Margins have fallen and the predicted volatility has surfaced, much to the chagrin of those caught on the wrong side of price spikes in the Midwest last summer.
By contrast, the retail-services segment is developing more slowly. In fact, several different retail businesses are emerging. During the past two years, for example, the subsegment dealing with middle-market customers has taken shape: companies like Enron, New Energy Ventures, and PG&E Energy Services have signed up national chain accounts including Burger King, Safeway, Saks Fifth Avenue, and the California State University campuses. The mass-market subsegment is taking longer to emerge because of transitional arrangements that for the next few years will blunt any incentive residential and other small customers might have to switch suppliers. …