Overseas Utilities Look to the U.S.

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The $43.8 billion private-equity-led acquisition of Texas utility TXU (BusinessWeek.com, 02/26/07) dominated last year's activity, but European players also got in on the action. Portugal's Energías de Portugal (EDP.LS), for example, paid $2.3 billion in May, 2007, for Houston-based Horizon Wind Energy, and Germany's E.ON (EONG.DE) forked out $1.4 billion in October, 2007, for the North American operations of Irish renewable company Airtricity.

Few European companies have embraced the U.S. market as wholeheartedly as Britain's National Grid (NGG), which grew out of the privatization of Britain's energy sector in the 1980s. Specializing in electricity and gas transmission and distribution, the dual-listed company first crossed the Atlantic in 2000 when it gobbled up a string of small utilities in New England. National Grid generated 50% of its $17.2 billion in 2007 revenues from its New England businesses.

National Grid upped the ante last year, paying $7.3 billion for Brooklyn's KeySpan to increase its customer base to 7 million across New York, Massachusetts, New Hampshire, and Rhode Island. After the deal, National Grid jumped to the second-largest player in the U.S. by number of customers, and the largest company in the Northeast in both electricity and gas transmission.

According to Tom King, National Grid's executive director of electricity distribution and generation and the former president of PG&E, the company's ability to navigate the local regulatory minefield has been key to its success in North America. That has involved everything from calming local concerns about the environmental impact of new facilities to winning over skeptical state regulators who first balked at a European company buying domestic assets. "Understanding the U.S. culture has been critical," he says.

Going Green Could Undermine Profits

Now National Grid is on the lookout for further acquisitions. While it won't comment on possible deals, the company wants to increase its footprint in the U.S. by 25% over the next four years through organic growth. "There's real opportunity to create value," says Nick Winser, National Grid's director of British and U.S. transmission operations.

The biggest question about continued U.S. expansion for European utilities is the possibility that pressure to go green could undermine future profits. Most U.S. jurisdictions enforce stringent rate-of-return caps that force utilities to return profits to customers if they exceed yearly targets. That helps prevent monopoly profit-taking, but can throttle risky investments in new technologies—especially renewables such as wind and solar.

These profit restrictions also could lead European players to turn their attention to less stable but faster-growing markets in Eastern Europe and Russia. In 2007 alone, 5 of the 10 largest electricity and gas deals involved Russia companies. E.ON, for instance, paid $8.4 billion in September, 2007, for Russian energy company OGK-4, and Italy's ENEL (ENEI.MI) spent $6.2 billion in June, 2007, for utility OGK-5.

Looking at Riskier Markets

Doug King, vice-chairman of the energy, infrastructure, and utilities team for Britain at Deloitte Consulting, figures such deals can offer rates of return as high as 7% to 8%, vs. the 1% to 2% typical for U.S. acquisitions. With that much upside potential some European utilities are willing to risk their capital in a country with a track record of regulatory uncertainty. "The Russian market is huge," King says. "Unlike other parts of the economy, investing in the Russian utilities sector seems to be acceptable."

That said, recent skirmishes in Russia's oil and gas extraction sector have demonstrated that the rules of the road can shift quickly for foreign investors. That may persuade European utilities to forgo the potential riches of the East for the safer, more stable profits on offer in the U.S.. Cash-rich and hungry for growth, the U.S. market may be just what's needed to keep Europe's utilities powering ahead.

Scott is a reporter in BusinessWeek's London bureau .