Strategy for Utilities

In April, Texas regulators rejected a bid by Florida utility giant NextEra Energy to acquire Dallas-based Oncor Electric, whose parent company was in bankruptcy. The regulators expressed concern that Oncor’s new board would be controlled by an out-of-state entity, which would impair local decision making. In May, Kansas regulators turned down the proposed sale of electric utility Westar Energy to Missouri-based electric utility Great Plains Energy, saying they were concerned about the financial leverage of the combined entity and its potential disadvantages for customers.

The deals are still pending. But these events show that mergers and acquisitions, which have been common in the utilities industry, could face heavier scrutiny going forward. That means utilities seeking to gain a competitive edge through M&A will have to convince regulators that the transactions will produce meaningful efficiencies and synergies. They must also show how their plans will translate into explicit benefits for ratepayers and improvements to transmission and distribution networks.

During the past two decades, the utilities sector has consolidated broadly.

Consolidation has been driven by several factors. Some utilities have been seeking to diversify regulatory risk by having operations in multiple states. Others have sought complementary assets, such as gas pipelines, or expanded into new service functions, such as gas distribution or electric generation. Regardless of the motivating factor, the overall outcome is clear. The utilities industry is top heavy; it has a majority of large companies and a shrinking minority of smaller companies.

As the opportunities for M&A narrow, the need for M&A as a vehicle for growth persists. Utilities face some significant challenges unique to their industry. Revenue gains from traditional areas such as power generation and distribution have stalled for most utilities. As services have accounted for a greater share of economic activity, demand for electricity in the economy has flattened. In some areas, demand is even declining, because population and business expansion is more than offset by energy efficiency and conservation efforts. In its annual financial review, the Edison Electric Institute reported that the number of gigawatt-hours available for distribution in 2016 was 2 percent lower than the 2008 figure.