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on Energy: Turmoil and Transition?

Contents

3 Introduction, by Bruce Tindale

5 ‘Trust busted’: regaining investor confidence and healthy markets in wholesale energy,by Bob Linden

16 Never forget the basics: refocusing on fundamentals to boost shareholder value, by Mike Korotkin and Jan PretoriusCase study: Calpine, Duke and Equitable Resources

25 Energy companies must actively manage balanced energy business models, by Jean-Louis PoirierCase study: Entergy

40 Power generation and industry cycles: lessons from other industries, by Mike Beck, Todd Filsinger and Craig Hart

50 Regulated electricity businesses: maximizing shareholder value through active management, by Edward KeeCase study: WPS Resources

63 ‘Double down or fold’: utility retail at a crossroads, by Derek HasBrouckCase study: Centrica

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nergy: Turmoil and Transition?

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1

Energy:Turmoil andTransition?This is a challenging time for the

industry and we believe that electric

power companies across the globe

must get back to basics: bearing down

on the fundamentals to get through this

troubled time and build a platform for

future success.

“ “

50

The recent financial performance of regulated electricity

companies is excellent in comparison to the market

losses suffered by unregulated generators and traders.

Regulated electricity companies are seen as sound

investments again, with the potential to build real risk-

adjusted value for shareholders.

The recent turmoil in the electricity industry may lead

some regulated electricity companies (along with

regulators, politicians, and investors) to adopt a do-nothing

strategy in the face of uncertainty. A significant part of the

electricity industry is – and will remain – regulated.

Transmission and distribution systems will continue to

operate under cost-of-service regulation even after industry

reforms are completed. Some vertically integrated utilities

will continue to be regulated during the transition period

to full competition in generation and retail.

Regulated electricity companies, however, are not

insulated from the effects of industry reform and face

significant opportunities and challenges. Regulated

electricity companies that adopt a do-nothing strategy are

likely to be less profitable than companies that actively

manage through this uncertainty. With much of the energy

industry in disarray, and investors re-thinking portfolios in

the midst of a widespread liquidity squeeze, this is a timely

and pivotal opportunity for financially sound utilities to

undertake a strategic review to:

• Assess and prioritize significant financial threats

and opportunities in your business and regulatory

environment

• Define corporate core objectives in light of your current

situation and the threats and opportunities

• Design, staff and implement responses to significant

threats and promising opportunities consistent with

core objectives.

Regulated electricitybusinesses:

Maximizing shareholder value through active management By Edward Kee

Before the Enron meltdown, regulated companies appeared to be under-performing

holdovers, while unregulated generators and traders looked like big winners.

Regulated electricity companies missed the gains seen by generating and trading

companies prior to the Enron meltdown, but they also missed the losses that followed.

51

This article reviews the potential threats and opportunities

in the regulated electricity business, explains why passivity

in the face of a changing environment may not represent

the best approach, and presents some alternatives for

active management (see Figure 1). My goal is to stimulate

discussion about the need for a strategy review at this

critical point in the industry.

EEnnvviirroonnmmeennttaall tthhrreeaattss aanndd ooppppoorrttuunniittiieess

While each company’s strategy must reflect its unique

situation, this article reviews the three areas of strategic

threat and opportunity and later offers some responses.

These threats and opportunities fall into three broad and

interrelated categories:

• Regulatory change

• Structural change

• Competitive threats.

Regulatory change

Regardless of the pace or direction of electricity industry

reform, significant portions of the electricity industry will

remain regulated. Electricity transmission and distribution

systems are critical links in the delivery of power from

generators to consumers and will be regulated for the

foreseeable future. Transmission will increasingly fall

under the jurisdiction of the US Federal Energy Regulatory

Commission (FERC) through the Regional Transmission

Organization (RTO) process, while distribution will remain

regulated by state or local jurisdictions.

Generation and retail, already partially deregulated, will

eventually be unregulated competitive businesses.

However, vertically integrated utilities will remain regulated

until the shift to markets and accompanying de-integration

is complete. Also, deregulation may be implemented

gradually by the use of transition arrangements, rate-freeze

agreements, or vesting contracts that keep these

companies under limited regulation for some time.

In the US, decades of experience with regulation have

provided a solid basis in law to support a fair return to the

owners of regulated assets. This relatively stable legal and

regulatory environment in the US should enable a smooth

transition to new regulatory regimes and new industry

structures as compared with countries (eg, Australia and

the UK) where legal and regulatory precedent on fair

compensation is much more limited.

Regulation will change over time as industry reform

is implemented. Past regulatory regimes were far

from perfect and were developed to control bundled

rates from vertically integrated electricity companies.

Regulatory regimes will be modified to correct the

mistakes of the past (eg, incentives for over-investment

and insufficient incentives for performance) and to fit

a vertically de-integrated industry structure.

Active management

Selectively outsource

Develop and introduce new technology

Take opportunities for horizontal consolidation

Upgrade and replace existing infrastructure

Invest in new infrastructure

Regulatory

change

Structural

change

Competitive

threats

Actively manage regulation

Figure 1: From ‘do nothing’ to active management

52

Regulatory transition may present financial risks

As the US electricity industry moves slowly into competitive

markets, the potential exists for extreme financial risk that

may make regulation and ratemaking difficult or impossible.

Regulation is not an ironclad guarantee of cost recovery

and a fair return on investments, as an earlier generation

of utility executives learned in the nuclear plant

disallowance proceedings in the 1970s and 80s.

The regulatory bargain has become even more uncertain,

with recovery of all operating expenses at risk, especially

those arising from spot market exposure, as seen

in California.

In California, regulated utilities relied on the traditional

regulatory bargain in 2000 when selling at low fixed prices

to customers while buying at high spot prices in the

wholesale electricity market. The magnitude of the

resulting financial losses pushed the California utilities to

the point of financial distress. In spite of the lessons of

California, some regulated utilities expect regulators to

make good on any losses from unhedged fixed-price

retail sales obligations in volatile wholesale electricity

spot markets.

Allowed rates of return are uncertain

As the electricity industry is de-integrated, regulators may

re-examine the current modes of economic regulation and

the level of allowed rates of return. As generation and

retail are divested, regulated utilities companies become

pure wires companies and may be perceived as having

lower risk, justifying lowered rates of return. This may be

the case even when industry uncertainty regarding the

regulatory bargain and a shifting of risks to regulated wires

companies (eg, liability limitation removal) may actually

increase risk and provide a valid argument for a higher

allowed rate of return.

In Australia, for example, the initial implementation

of electricity sector reform has had mixed results.

State regulators and the ACCC1, eager to contribute

to the success of electricity sector reform, developed

some innovative approaches2, but have typically allowed

relatively low returns, below those sought by the regulated

companies. These low allowed returns may present future

problems with financial viability and lowered incentives for

additional investment.

Regulated transmission companies will increasingly see a

shift toward RTOs that will act as a regional collector of

transmission and congestion tariffs that are allocated to

transmission owners. The transition arrangements from

past ‘wheeling’ tariffs to full network service will be

important to transmission companies. In the longer term –

after the transition arrangements are gone – transmission

owners should expect to earn revenues from a return on

assets, with the potential existing for stranded assets even

in transmission.

Structural change

Regulated electricity companies will inevitably face some

restructuring as a part of industry reform. As with

regulation, those companies that actively develop a

strategy to participate in this restructuring are more likely to

profit as compared to those that passively respond. In

some instances, this restructuring may present temporary

opportunities to grow through acquisition.

Industry will face vertical dis-aggregation

Transmission will be required to be independent of the

competitive sectors of generation and retail that participate

in the electricity market. In other market, such as Australia

and the UK, transmission and distribution were completely

separated from the generation and retail sectors to

facilitate competition and open access. The recent FERC

RTO initiatives have increased the pressure to make the

transmission business independent from the competitive

links in the electricity value chain. Transmission will also be

separated from distribution. Distribution utilities will remain

regulated at the state level while transmission will move to

FERC regulation, raising the costs to manage separate

regulatory regimes. The business of distribution is focused

on dense low-voltage networks serving local customers,

a fundamentally different business from transmission

with high-voltage lines serving the bulk power market.

If distribution companies remain in the retail business (even

as default suppliers), the independence of transmission

from market participants may be compromised.

1 The Australian Consumer and Competition Commission, the regulator for transmission companies.2 These innovations include links between allowed return and specific performance against operational targets such as frequency and duration of line outages.

53

A more pervasive issue in the US is the continued bundling

of retail commodity sales and distribution. Unlike industry

reform in other countries, such as Australia and the UK,

most regulated distribution utilities in the US also provide

retail electricity service to the customers they serve even

after retail competition is implemented. US distribution

companies often have retail provider-of-last-resort (POLR)

obligations. This preference for bundling regulated wires

and retail in a single company may result in a slower and

more difficult transition to a fully reformed electricity

industry in the US.

While properly separating distribution and retail is not

trivial, there are a number of compelling reasons why it

should be done. Distribution companies with POLR

obligations at regulated rates may face significant financial

risk, as discussed above. Competitive issues also arise in

a functioning competitive retail market with a distribution

company acting as a competing retailer. Even if rules and

regulations allow competition with this bundling, the

difference in the critical success factors in distribution and

retail suggest that it is unlikely that a single company will

succeed in both simultaneously. Finally, retailers will likely

be in direct competition with distribution companies by

selling products such as on-peak and off-peak power,

controllable appliances, non-interruptible power, and

curtailment discounts that may be specifically aimed at

reducing customer exposure to regulated transmission and

distribution charges.

Non-core functions should be divested

Regulated companies once built internal capabilities for

almost all activities, in response to the incentives of cost-

of-service regulation. As regulatory regimes are fine-tuned

and regulated companies become more focused on a

single vertical sector, the incentives for efficient operation

and improved performance of regulated companies should

become more pronounced. As unregulated companies

have learned, outsourcing can reduce costs and improve

performance. Regulated companies should seek to

enhance value through the de-integration and outsourcing

of some internal functions and activities.

In the distribution and transmission sector, these activities

may include: billing and collections; construction and heavy

maintenance (eg, replacement of major equipment);

regular operation and maintenance (eg, cleaning and

inspection, vegetation clearing).

Competitive threats

The traditional monopoly supplier status of regulated wires

companies may be diminished under industry reform.

Transmission is increasingly viewed as a substitute for

properly located generation and there is emerging

competition from new entrants. Regulated electricity

companies should examine the threat from competition to

their regulated business and prepare a strategy to counter

these threats.

Merchant transmission companies appear

A significant number of new non-regulated merchant

transmission projects are being developed in the US, many

of which are based on high-voltage DC technology. The

controllable nature of HVDC technology creates property

rights that facilitate recovery of investments through market

transactions. Merchant, unregulated, transmission projects

using this technology are operating or under development

in Australia and North America. Merchant transmission

projects, targeting the most lucrative bottlenecks, compete

for investment with regulated transmission assets.

On-site and near-load generation will expand

Generation located at customer sites, near load centers

or in areas of high locational prices, effectively competes

with investments in transmission. On a smaller scale,

such generation can even compete with distribution

investments. In some instances, on-site generators may

allow customers to operate with only minimal use of the

transmission/distribution system. Widespread use of

locational spot prices might lead to generation

development that would significantly reduce the use

of some existing transmission or even distribution lines,

raising issues of stranded assets.

Private distribution companies are considered

There is an additional threat to distribution companies in

the form of private distribution companies that take high-

value areas from a larger regulated distribution company.

54

Regulated distribution rates that are high (eg, due to

stranded cost and other transition charges collected

through ‘wires’ charges, plus normal distribution charges)

may lead to the formation of a new private distribution

utility, bypassing the regulated distribution utility. Private

distribution companies may, due to financing flexibility, use

of new technology, and a focus on high-density areas, be

able to achieve lower costs for end-use customers

compared to traditional regulated distribution utilities.

DDeeffiinniinngg ccoorrppoorraattee oobbjjeeccttiivveess iinn

tthhee nneeww eennvviirroonnmmeenntt

Having identified the strategic threats and opportunities

presented by the new environment, most companies move

directly to mapping previously identified responses with

powerful internal constituencies onto the new game board.

This approach may result in a plausible story for the annual

report or analyst conference call, but may lack a proper

screening of corporate strengths, weaknesses and goals in

light of the new strategic environment. Critical self-

assessment within a defined and open process can help

build an internal consensus and common understanding of

corporate priorities and the means and resources that will

be required to attain them.

Institutional strengths and weaknesses are difficult to

objectively assess, because measurement tools are

ad hoc, inconsistent or biased. Benchmarking is a

common and useful utility approach to introducing objective

measures of competence and performance. However,

benchmarking can be inadvertently subverted by the

definition of the relevant comparative universe. As noted

above, competitive challenges are emerging from new

directions. The upper decile of performance or cost control

among similarly sized electric utilities may not be the most

relevant measure of your relative ability to enter into new

ventures or repel the competitive advance of new market

entrants. New standards of performance from non-

traditional quarters may also be introduced by regulators

and legislators.

Similarly, corporate objectives may reflect decreasingly

relevant standards of success. For example, measures of

retail scope and scale based on the traditional utility

business model of vertical integration may no longer apply

in an era of horizontal specialization.3 Financial structures

and capital resources that proved ideal in one operating

environment may prove inadequate or inefficient in another.

Therefore, a crucial internal first step in evaluating

and prioritizing corporate objectives is to establish

– through structured debate, consensus and articulation –

a corporate ‘view of the world’. A well-articulated view of

the world places corporate strengths and weaknesses in

the context of future challenges and opportunities and

illuminates conflicts and limitations among established

corporate goals and individual agendas.

Organizations unaccustomed to this process, or those

seeking independent perspective on goals and capabilities,

often turn to outside consultants to provide a roadmap and

challenge internal assumptions. PA’s approach to

facilitating corporate strategy development is described in

the ‘strategic mapping’ panel overleaf.

SSttrraatteeggiicc rreessppoonnssee ttoo eennvviirroonnmmeennttaall cchhaannggee

The changing face of regulation, industry structure and

competitive threats outlined above strongly suggest that

any complacency by regulated utility management

(resulting from the serious problems affecting their

more aggressive industry brethren) is misplaced.

What follows is more of an enumeration of, rather than

a recommendation for, possible actions and responses

in light of these developments.

Actively manage regulation

US regulated electricity companies, with decades of

experience in managing regulation (and regulators), should

be able to successfully make the transition to new forms of

regulation that will be developed as a part of industry

reform. Managing this transition well may be the single

most critical activity for a regulated company.

3 For more on the retail marketing dilemma, see the following article by Derek HasBrouck.

55

Those regulated companies that actively participate in the

regulatory process have an opportunity to shape regulation

and to tailor company structure and strategy to reflect

current and expected regulatory regimes. Such an active

approach to regulation is likely to yield higher and more

certain profits.

Incentive regulation may be seen as a way to improve the

efficiency of the regulated parts of the electricity industry.

The CPI-X approach used in the UK is an example.4

Performance-based rate-making regimes, with a return on

assets adjusted for performance against specific

performance targets, have been suggested. Incentive

regulation may present the potential for significant profit

improvement for some companies, depending on the

details and the timing. Other companies may face sub-

standard returns and higher risk. Utilities that actively

participate in the development of incentive regulation

regimes are more likely to benefit from them, especially in

the early period.

In the UK, a recent report suggests that the incentive

regulatory regime adopted there may have some flaws,

including inability of regulated companies to generate ever-

increasing efficiency gains under the CPI-X regime.

Importantly, incremental new investments in infrastructure

may not occur because of uncertainties in the likely return,

or because of disagreements between regulators and

regulated companies on the amount and timing of such

investments.

A proper understanding of the contextual distinctions is

useful in deciding which lessons are applicable from

regulatory reform in other countries. US utility executives

would be well advised to familiarize themselves with past

regulatory successes and failures in other nations while

devising their individual corporate responses to state and

federal regulatory initiatives.

Respond to structural and competitive issues

While the industry is undergoing reform, there are some

opportunities for organic growth through building more

assets, replacing and upgrading existing assets, and

Strategic mapping

PA’s Strategic Mapping Process (SMP) is a three-step process designed

to help energy utility organizations address the central strategic

challenges that they face:

• How to take advantage of current market trends and create

sustainable revenue and income streams?

• What type of business model to adopt to achieve the best portfolio

of regulated and unregulated assets?

• How to implement the new business model?

SMP can be used at a subsidiary level, but is generally better applied at

a corporate level to design a strategic course of action which

accomplishes the best trade-off and migration path between legacy and

new (often unregulated) businesses and assets.

Step 1 involves a strategic-issue analysis to achieve agreement on the

current situation of the organization (strengths, weaknesses, business

philosophy preferences and corporate risk attitudes), followed by a

codification of the organization’s view of the world (generally for the next

5–7 years) to help rank the most attractive market and value-chain

segment opportunities.

Step 2 starts with a review of possible business models. Each candidate

model is articulated along five key dimensions: base value proposition

(ie, value chain positioning, underlying risk/reward choices, and level of

differentiation sought); overall scale and scope (mix of regulated and

unregulated activities, geographies, etc); core asset selection (type,

breadth and depth of both regulated and unregulated assets

emphasized, asset flexibility and migration potential by class of assets);

overall success/risk factors (top factors and risk mitigation approaches

on both the regulated and unregulated sides); and targeted durability

and scalability (replication and expansion potential of unregulated and

regulated activities, ability to achieve economies of scale or repeat

technology improvements, scalability of business processes).

Next, candidate business models are ranked against key criteria that

reflect the organization’s strategic position determined in Step 1. The

result is a preferred business model.

In Step 3, the implementation path for the winning model is specified in

detail (including timing, offerings, customers’ priorities, geography

targets, delivery system, growth avenues and risk mitigation for both

regulated and unregulated activities). Finally, the resulting likely

financial performance of the organization under the new model is

simulated to plan the desired level of investments, organization and

competence growth and types of alliances/mergers to be considered.

4 CPI-X is a form of price cap regulation that links tariffs to a measure of inflation such as the Consumer Price Index (CPI) in the US or the Retail Price Index (RPI)in the UK. In general, CPI-X regulation works by allowing tariffs to increase at the same rate as general inflation, less some amount (the ‘X’ factor) to reflectexpected/projected productivity gains by the regulated company. Regulated companies can realize the benefits of cost reduction efforts in excess of the X factoruntil the next review. This form of regulation typically has a multi-year (eg, every 3 to 5 years) review cycle, where the tariffs and the X factor are reset. For thenext period, the regulator is able to pass to consumers some of the benefits of the realized efficiency gains in excess of the X factor.

56

through investment in new technology. Careful

examination of, and investment in, these opportunities will

allow regulated electricity companies to achieve profitable

organic growth even during this period of uncertainty.

A decade of uncertainty about impending reform and

restructuring in the electricity industry has resulted in low

investment in transmission and distribution infrastructure.

Companies facing uncertain regulatory regimes and

potential corporate restructuring have postponed or

cancelled new infrastructure projects. Much existing

infrastructure is in need of extensive refurbishment or even

replacement. Little investment has been made in new

technology in the electricity transmission and distribution

business.

Invest in new infrastructure

During the last decade, growth in demand, the shift to

electricity markets, and ageing of existing assets has

created a need for considerable additional investment

in transmission and distribution infrastructure.

The transmission network was designed when its primary

purpose was to move power from power plants to load

centers within a single utility. Now, additional transmission

capacity is needed to facilitate emerging competitive

markets. Also, an increase in electricity demand over the

last decade has not been matched by a corresponding

increase in transmission.

The FERC has initiated incentive programs for

transmission infrastructure development. It remains to be

seen if these programs will spur additional investment, or

simply provide enhanced economics to projects that were

already under development. Regulatory certainty for the

long term will be a more significant driver of investment.

Other issues that will shape the investment in transmission

infrastructure include:

• Reliability requirements and responsibilities and

associated system planning responsibilities under new

RTO arrangements

• The use of ‘rate-freeze’ periods as a means of

extracting shareholder value, with the obvious limits on

increased investment under such arrangements

• The extent to which the extremely difficult and lengthy

process of obtaining siting and permissions for

transmission lines will be eased, perhaps through FERC

jurisdiction and eminent domain powers

• The allocation of transmission rights and revenues

flowing from new transmission investments.

The need for increased distribution and transmission

infrastructure will provide large investment opportunities for

companies that effectively manage the regulatory process.

Upgrade and replace existing infrastructure

Much of the US distribution network is old and in need of

replacement, with inner-city distribution systems

experiencing outages, fires, and manhole explosions due

to old and degraded wiring. In some cities, there is a

desire to move from overhead distribution wires to

underground systems for aesthetic, safety and other

reasons. Upgrading and replacing the existing distribution

systems will take an enormous amount of capital

investment. Even more will be required if lines are shifted

to underground.

On the bright side, recent initiatives by the FERC aimed at

providing incentives for participation in electricity industry

reform may mean higher returns for companies in some

instances. Incentive returns were offered to companies

that made near-term investments in transmission

infrastructure and to those transmission companies that

turned over control of assets to an approved RTO.

Participation in these incentive schemes can provide a

boost to profits for regulated electricity companies.

Take opportunities for horizontal consolidation

During the 1980s and 1990s the trading, generation and

retailing businesses underwent considerable consolidation.

The transmission and distribution sectors will also undergo

consolidation as the industry reform proceeds.

In the regulated wires sectors, some companies are

pursuing focused single-segment strategies, including

National Grid and Trans-Elect. Fundamentally, there is

little that prevents significant consolidation of the

transmission and distribution sectors and continued

consolidation will be facilitated by the divestiture (perhaps

57

forced) of transmission assets. Transmission is a small

percentage of an integrated utility’s asset base, when

compared to generation or distribution. Anticipating that

transfer of transmission ownership will be encouraged to

facilitate the electricity markets, some utilities are exploring

the divestiture of transmission assets.

The consolidation of distribution companies within states

may be the first move, with consolidation across state lines

being a little more difficult. However, there are several

utilities that acquired distribution assets in multiple states

as a result of the merger of integrated utilities or through

historic growth.

Develop and introduce new technology

The reform of the electricity industry may have the

unintended consequence of reducing R&D spending and

the development of new technology. Technologies such as

superconductors and more sophisticated transmission

metering and control systems could add capability to the

network without adding more power lines. Although the

Electric Power Research Institute remains in place, its

funding and ability to undertake fundamental research is

greatly impaired.

It remains to be seen if regulated companies will take on

additional risks and costs to develop or invest in new

technologies and approaches. Those that develop new

products for the industry could earn returns from their

intellectual property. The investment may also be an

effective way to increase regulated assets outside

traditional investment in poles and wires.

Selectively outsource

Contracting with outside providers can lower investment,

reduce operational risk, enhance flexibility, and lower

costs. Outside contractors can develop flexible

approaches to labor management, adopt new techniques

and approaches to lower cost, and develop economies of

scale that may not be easily attainable by the utilities they

serve. A regulated electricity company might only keep

critical activities such as financing, investor relations,

regulatory process management, and the management

of outside contracts. The lowered operating risk and cost

savings from outsourcing non-core activities will help

regulated utilities meet the demands of regulation and

create additional value for shareholders.

CCoonncclluussiioonn

A significant segment of the electricity industry will remain

regulated even after industry reform is completed. These

regulated companies are not immune to the changes from

industry reform and are presented with significant

opportunities and challenges in the next few years.

Regulated electricity companies can maximize their

shareholder value by actively managing these opportunities

and challenges.

With most of the non-regulated portions of the energy

industry in disarray, there is no better time for regulated

utilities that kept to their core business and maintained

a healthy balance sheet to re-examine their strategic

plans. A systematic review of the threats, opportunities

and available resources, preferably using an established

and demonstrated protocol, could prove the most valuable

allocation of your time and those of your management

team during this period of broad retrenchment, redefinition

and revised expectations.

The author, Edward Kee, is a Member of PA’s Management Group, and specializes in electricity industry restructuring

and market reform

Case study

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WPS Resources Corporation is a holding company based

in Green Bay, Wisconsin, with the following operating

subsidiaries:

• Wisconsin Public Service Corporation (WPSC) is a

regulated electric and gas utility serving Northeast

and Central Wisconsin and an adjacent portion

of Upper Michigan.

• Upper Peninsula Power Company (UPPCO) is a

regulated electric utility that serves approximately

50,000 customers in two-thirds of Michigan’s Upper

Peninsula. UPPCO’s corporate headquarters are

located in Houghton, Michigan.

• WPS Energy Services, Inc. (ESI) is a diversified non-

regulated energy company that targets retail energy

sales and related services. Principal operations are

located in Illinois, Maine, Michigan, Ohio and Wisconsin.

• WPS Power Development, Inc. (PDI) develops

and owns non-regulated electric generation projects

and provides services to the electric power

generation industry.

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WPSR is an excellent example of a regulated utility

company that sought to maximize shareholder value by

active management. In response to the liberalization of

the utility industry, WPSR went through a long and

detailed strategic planning process. The company started

with a deep commitment to a core vision and strategy and

developed a consistent detailed plan and budget.

In response to the changes taking place in the industry,

WPSR formed a holding company and set up two

unregulated subsidiaries, ESI and PDI, to take advantage

of new markets. Senior management constantly reviewed

the risks associated with the market and prescribed

the limits of their unregulated activities with a rigorous

process to approve investments. Careful investment

in the unregulated businesses kept WPSR from over-

extending itself.

A strategy that balanced regulated and unregulated

activities has produced significant value for the

shareholders. WPSR is one of the few ‘A’-rated companies

among the US utilities. Five years ago, WPSR common

stock was around $22. Two years ago it was $30.

The stock price currently stands at $36 after having gone

WPS Resources

A regulated electricity company that got it right – providing shareholders with 43 years of increasing dividendsOur thought-piece discussed the activities that a regulated electricity company should

undertake to maximize shareholder value. Our case study looks at WPS Resources (WPSR),

a regulated electricity company that has succeeded by actively managing its

regulated businesses.

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as high as $42. For 43 years, WPSR has announced an

annual increase in the dividend, with the current dividend

at $2.14 per share.

A major source of these financial results is the WPSR

focus on its regulated businesses, with the company

undertaking a range of activities, detailed below.

Actively manage regulation. WPSR has, through careful

management and cost control, maintained a position as

a low-cost provider of electricity in the region and in the

US. This position has allowed the approval of rate

increases and provided them with significant goodwill with

the Public Service Commission of Wisconsin.

The company’s loyal customer bases in Northeast

Wisconsin and its excellent service ratings were also key

factors in maintaining an excellent relationship with the

Commission. Customer forums, fast response in

emergencies, and effective customer consultation

processes have enhanced the public image of WPSR in

the communities that it serves, further reinforcing its

goodwill with the PSCW.

Invest in new infrastructure. WPSR has made, or is

making, incremental investment in new regulated assets,

including transmission lines and power plants. This has

allowed it to grow the regulated asset base (in the context

of good relations with customers and regulations), while

maintaining the relative security of regulated earnings in

its home market.

Tom Meinz, Senior Vice President of WPSC, said:

“In spring of 2001, we announced our plans to meet the

future electric needs of our customers. We expected to

build generation in the state as well as complete

construction of the Weston-Duluth transmission line.

Both are needed. Some of our power plants are getting

old and are more difficult to maintain. That, along with

steady growth in electric demand, are major reasons this

is a much-needed addition to the system.”

Upgrade and replace existing infrastructure.

WPSR has also maintained and upgraded its existing

infrastructure to enhance reliability, maintain low production

cost, and add to its regulated asset base. Two recent

examples of this are the major refurbishment of an aging

hydroelectric generation facility and the replacement of

steam generators at the Kewaunee nuclear power station.

These investments will extend and enhance the operation

of low-cost electricity generation plants. The Kewaunee

investment, in particular, will allow the plant to operate

for a much longer period with fewer outages and

should greatly facilitate the approval of a 20-year life

extension application.

Take opportunities for horizontal consolidation.

WPSR has acquired distribution assets in the surrounding

region, including the Upper Peninsula Corporation and

Wisconsin Fuel And Light. The company has also

constructed a gas storage facility in Michigan. The

company purchased the share of the Kewaunee nuclear

plant held by Madison Gas & Electric, bringing the WPSR

ownership to 59%. Over the years the company has

established an excellent record of operating the unit that

allowed them to make an informed decision in the

purchase.

Develop and introduce new technology. WPSR has

initiated a program to install new meters with automatic

meter reading (AMR) systems at all customer locations

for both gas and electric meters. AMR systems will allow

WPSR to obtain customer use data faster, more accurately

and have fewer estimated bills. AMR will also lower the

costs of meter reading and allow fast detection of

customer outages.

WPSR also makes available a time-of-use rate.

Customers can opt to take this rate for a small fee.

Included in the time-of-use rate is the installation of new

metering that will allow customer use to be measured in

real time.

WPSR has invested in its computer and information

systems to allow customers to conduct many routine

activities through the Internet, including billing. This

investment has significantly enhanced the level of service

offered to customers and lowered the cost of providing this

service.

Selectively outsource. WPSR, along with the other

utilities in Wisconsin, transferred control of its transmission

assets to the American Transmission Company. This

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transfer allows WPSR to maintain its investment in

regulated transmission assets, while facilitating the

development of regional electricity markets and the

orderly development of the regional transmission system.

It also ensures that WPSR will have access to regional

power markets.

The management and operation of the Kewaunee nuclear

power station was transferred to the Nuclear Management

Company, LLC. Nuclear Management Company was

formed to allow single nuclear plant owners, like WPSR, to

obtain the benefits of purchasing, staffing, and maintaining

a larger fleet of nuclear power stations.

WPSR has also implemented an asset management

program to review all assets owned by the company.

As a part of this program, WPS transferred ownership of

land associated with the Peshtigo River hydroelectric

property to the Wisconsin Department of Natural

Resources in one of the largest land sales in recent

Wisconsin history. The land will be used for public

recreation purposes, and was sold at a price that provided

fair value to shareholders.