Navigant Research Blog

Is Warren Buffet Betting Wrong on Utilities?

— March 18, 2014

In Warren Buffet’s famed letter to shareholders of March 1, 2014, the Oracle of Omaha made it clear that following Berkshire Hathaway’s $10 billion buy of NV Energy last year, he is still shopping for utilities.  Analysts are throwing around names like Wisconsin Energy, Westar Energy, and Alliant Energy because they each provide the returns on equity (historically) that Buffet demands and operate in states with favorable regulatory climes.

Now, Warren Buffet has more investing savvy in his little finger than I’ll ever have.  But is he right on this one?

The Berkshire Hathaway website offers a succinct list of Buffet’s investment requirements.  He’s looking for big (but simple) businesses with consistent earnings, low debt, and good management.  In the latest letter to shareholders, he notes that utilities have “recession-resistant earnings, which result from these companies exclusively offering an essential service.”

The Figures Don’t Lie

There may be a few cracks in the foundation of Buffet’s premise, especially because his broader investment theme has always been an unshakeable belief in America’s ability to innovate and grow over the longer term.  We’re talking 20 to 100 years, not 5.

I examined recent financial reports for MidAmerican Energy Holdings, the subsidiary that includes Berkshire Hathaway’s utilities, and also those of NV Energy.  The buy of NV closed in mid-December.  Here are the MidAmerican figures as shown in Buffet’s letter:

 

Overall, healthy growth for Warren’s shareholders, but look what happened with the utilities (HomeServices is a real estate company).  U.K. utilities (i.e., Northern Powergrid) have experienced a 12% average annual decline in earnings since 2011.  Earnings at the Iowa utility (MidAmerican Energy) have fallen 9%, on average.  Western utilities (PacifiCorp) enjoyed a nice bump in earnings last year, but at NV Energy, revenue was down 2%, cost of fuel rose 38%, and operating income fell 7.5%through September 30, 2013.

In the discussion of results for the various utilities, there are other worrisome comments.  From the discussion of PacifiCorp:  “Certain large industrial customers with generation capabilities began to self-generate in 2012 resulting in lower industrial customer usage across PacifiCorp’s service territories,” and “Net income increased $55 million primarily due to higher retail prices approved by regulators and higher retail customer load, partially offset by higher energy costs, lower renewable energy credit (REC) revenue and higher depreciation and amortization.”

Still Coal-Dependent

Growth is largely predicated on regulators raising rates.  Large commercial and industrial (C&I) customers are beginning to self-generate, and fuel costs are rising.  Buffet also likes to tout his companies’ diversification and investment in renewables.  But at PacifiCorp, it was coal (as a percentage of overall energy sources) that rose from 59% in 2011 to 62% in 2013.

In his letter, Buffet also said, “Our confidence is justified both by our past experience and by the knowledge that society will forever need massive investments in both transportation and energy.  It is in the self-interest of governments to treat capital providers in a manner that will ensure the continued flow of funds to essential projects.”

That may be true, but that American entrepreneurial spirit that Buffet so believes in is exactly why he should be worried.  Cheaper and better solar and wind options for residential – and C&I – customers will affect utilities’ bottom lines whether regulators like it or not.  And they won’t just keep raising everyone else’s rates in response.

 

Facing Solar Waves, Utilities Should Learn to Surf

— March 5, 2014

In my last blog, I described the relatively rapid fall that many incumbent telephone companies have suffered as wireless technology has replaced landlines as the dominant service providers for not only our voices, but also our data communications needs.

Why, as a participant in the electric utility industry, should you care?

Because the very same thing could happen to incumbent electric utilities, and maybe sooner than you think.  Solar panels and plug-in electric vehicles (PEVs) are spreading rapidly, allowing consumers to generate and even store their own power.  Prices are falling, and with or without government incentives, the penetration of renewable, distributed generation will continue to accelerate.  Storage will get better and commercial customers like Walmart will put panels across thousands of acres of rooftops.

All of this creates challenges for grid operations and (especially) electric utility business models.  (See my blogs on net metering and feed-in tariffs.)  As the fight over net metering has made abundantly clear, the century-old utility business model wasn’t designed for distributed generation – and this transformation is still in its early days.

Ride the Wave

But, couldn’t it also provide an opportunity?  In the first 10 years of wireless telecom service (according to surveys by CTIA), subscribership grew to just under 34 million.  In the second 10, it added 174 million, and since 2005, that figure has nearly doubled again.  That hockey stick phenomenon will happen in the solar and PEV industries, too.

NRG Energy, a retail energy marketer based in Princeton, New Jersey, has taken a proactive stance to solar.  Its NRG Solar division creates large-scale solar facilities and performs installations on commercial rooftops.  The NRG Residential Solar Solutions (RSS) division leases solar systems to homeowners, providing the panels, system design, monitoring, and performance guarantees, as well as several termination options (system removal, lease extension, or purchase).  RSS operates in 10 states, plus the District of Columbia, and has expansion plans in more states.  What’s more, NRG’s eVgo network is a privately funded electric vehicle infrastructure network of home charging stations and public fast charging stations.

NRG’s Alternative Energy division (which encompasses its solar activities) grew revenue to $83 million in 3Q 2013, up from $49 million the year before.  And while it still bleeds red ink, I can assure you that telcos lost money on their wireless divisions for many years before those units became the cash machines they are today.

Sizing the Competition

Vivant, SunRun, SolarCity, and SunPower are the big names among standalone solar financing and installation companies today; $1 billion was raised in 4Q 2013 alone for solar system financing.

SolarCity intends to grow its customer base to 1 million by 2018, while SunPower is reportedly about to announce a deal with Meritage Homes.  SolarCity earns about half of its revenue from solar system sales, with a low 5% operating margin, but it earns an attention-getting 66% margin on its lease business.

The level of competition and the public valuations of many of these solar companies demonstrate the market’s belief that solar (panels, financing, installation) will be a growth market for some time to come.

In order to enter the fray, regulated utilities will have to run their alternative energy ventures as unregulated subsidiaries (that’s how the telcos got into cellular), but the consolidated bottom line is what matters to investors.  And, as a consumer, I’m more likely to trust my solar installation and management to my longtime local power provider than an unknown, independent installer.  Ride the wave!

 

Like Telecoms, Utilities Must Adapt or Perish

— February 25, 2014

I’ve read many articles from pundits that suggest the electric utility industry today is facing challenges similar to those the telecom industry faced 20 years ago.  Frequently, commenters vehemently disagree.  From where I’m sitting though – having spent 20 years as a telecom industry analyst – I see key similarities and some important takeaways for utility management teams.

Both industries operate in a critical infrastructure business that Uncle Sam long ago determined would best serve the American public in a regulated monopoly model – one designed to ensure availability of service to all, at a reasonable price, while allowing a fair return on investment to the utility/telecom.  Massive networks were built across the country and the farmer in Middleofnowhere, Iowa didn’t have to pay an order of magnitude more for his kilowatt-hours or voice minutes than the customer in downtown Des Moines.  Both businesses are subject to federal and state level oversight, and both have been deregulated in the last couple of decades.

Solar = Cellular

Both have also seen emergent technologies threaten their business model.  However, while electric utilities are still in the early days of grappling with the demands of distributed generation (mostly solar) and electric vehicles, the once-dominant landline telephone companies have struggled for years to reinvent themselves.  Today, wireless connections account for more than 80% of the voice market (ignoring VoIP, more on that below).

Telecom Providers: Then and Now

Telecom Providers Then and Now 2-20-14

(Sources: Navigant Research, Securities and Exchange Commission, AT&T, and Verizon)

The irony?  Incumbent telecoms were given wireless spectrum for free in the early days of cellular.  A lot of telecoms sold off their wireless divisions, plowing that money into their landline networks.  Still, as recently as 10 years ago, telecom valuations were strong and the deal market was hot.  Even as the Verizons of the world began selling off their regulated access lines to (later bankrupt) buyers like FairPoint Communications and Hawaiian Telcom, many companies firmly believed that cellular would never overtake the ubiquitous, five-9’s service provided by POTS – Plain Old Telephone Service.

Today, wireless spectrum is worth billions; Verizon is paying Vodafone $120 billion for the 45% of Verizon Wireless that it doesn’t already own.  Meanwhile, telecoms like CenturyLink, which acquired the former Qwest in 2011, have seen their share prices fall as much as 20% in the last year.  CenturyLink, which sold its wireless division to Alltel in 2002, has focused on broadband, data/business services, and fiber.  And guess what?  Broadband and business services are going wireless too.

The point is, old school technology companies need to embrace the disruptors, not fight them – especially not via lawyers and regulatory restrictions, which is what electric utilities seem to be trying when it comes to the solar industry.  In the end, technology advances get cheaper and better, and consumers change their behavior and their spending habits.  As detailed in Navigant Research’s report, Solar PV Market Forecasts, solar is expected to reach grid parity without subsidies in a few years.

In other words, you’re not going to beat ‘em, so you’d best join ‘em.  In my next blog I’ll describe a few fledgling efforts on the part of electric utilities to enter the solar installation and electric vehicle charging businesses and explain why more should do so.

 

For Utilities, New Technology Brings Promise and Pain

— January 15, 2014

The double-edged sword of technology is on full view in the electric utility industry today.  Conservation voltage reduction (CVR) and demand response (DR) programs are helping utilities reduce load and adapt to the effects of distributed generation (DG) on the grid – but what about replacing the revenue “lost” through DG?  Distribution automation (DA) can improve reliability and reduce outage times, but it also comes at a price.  The need for resiliency in the face of increasingly severe storms is adding further stresses to utility industry bottom lines.  Meanwhile, big data is both exciting in its potential and intimidating in its volume.  “May you live in interesting times” is often called a Chinese curse, and indeed, these are interesting times.

A glance at the jam-packed program for the electric utility industry confab DistribuTECH, to be held in San Antonio from January 28 through the 30, highlights just how critical new technology is to the industry.  The presence of exhibitors like Verizon, AT&T, Oracle, Accenture, and Waterfall Security Solutions, to name just a few, demonstrate just how important new communications, information technology, and cyber security have become.  Transmission and distribution may be the nuts and bolts, but the other smart grid technologies are clearly top of mind for utility executives.

Progress and Possibility

The show boasts 15 tracks and 74 panel discussions, as well as 5 mega sessions, including “Lessons Learned From Superstorm Sandy,” “Chapter 2:  What Happens to Smart Grid Initiatives After DOE Funding,” and “A Global Look at Smart Grid’s Progress and Future.”

More than 9,500 attendees participated in DistribuTECH 2013, held in San Diego last January, up 15% from the year before.  This year more than 400 companies will be exhibiting their products and services.  In conjunction with the conference, Utility University will offer in-depth courses for utility execs on topics ranging from communications and customer strategies to system integration and standards.

International buyers will also be on hand; DistribuTECH organizer Pennwell Corporation announced last July that the trade show is one of 26 selected to participate in the U.S. Department of Commerce’s 2014 International Buyer Program (IBP).  The show will feature an International Trade Center onsite where foreign buyers can meet and negotiate with sellers, obtain assistance identifying potential business partners, and efficiently navigate the exhibition floor.

Six Navigant Research analysts from the Smart Utility program will be at DistribuTECH this year:  myself (richelle.elberg@navigant.com), Kris Torvik (kristoffer.torvik@navigant.com), Neil Strother (neil.strother@navigant.com), Jim McCray (james.mccray@navigant.com), Brett Feldman (brett.feldman@navigant.com), and Lauren Callaway (lauren.callaway@navigant.com).  Feel free to reach out to our Smart Utility team to arrange for briefings; see you in San Antonio!

 

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