Rewiring the Utility Business

Posted by: John Carey on October 01

Peter A. Darbee used to dock his three children 50¢ when they left a room without turning out the lights. Now, as CEO of PG&E (PCG), the former investment banker and high school wrestling champion is trying to save energy on a grander scale. Paradoxically, he is helping his customers buy less of his product. “When I tell big customers we would be happy if we sold them less electricity, they look at me like I’ve burned out a few brain cells,” says Darbee. But the logic is inescapable. “You are not making a lot of money anymore building large power plants,” says Jon Wellinghoff, chairman of the Federal Energy Regulatory Commission. “You have to figure out what business you are in, big time.”

How can utilities make more by selling less? Instead of spending $2 billion on a new 1,000-megawatt power plant, it can use the money to insulate homes, pay customers to install more efficient equipment, and make the grid smarter. Those steps would slash power consumption, eliminating the need for the power plant. The CEO would then ask the state public utility commission to raise electricity rates enough to pay for the $2 billion investment—plus a negotiated profit—just as he would for a new power plant. If the commission agrees, the utility gets revenue from its investment.

At the same time, customers’ bills may go down. The reason: Even though the price of electricity will be higher, customers who comply will be using much less power—and those who don’t will effectively subsidize those who do. “Energy-efficiency programs cost electricity customers less than half what they pay to help fund a new power project,” explains Darbee. Boosting efficiency also reduces greenhouse gas emissions, which will provide another monetary gain for utilities if the nation puts a price on such emissions (page 55).

PG&E has spent hundreds of millions handing out energy-efficient light bulbs and performing energy audits for companies to identify potential savings. In return, the California public utility commission has granted PG&E an extra payment representing a share of the energy savings. On Sept. 24, California approved $3.1 billion in additional spending on energy-efficiency efforts by the state’s utilities. Other states are taking similar steps. “This is where we will make our money in the future,” says James E. Rogers, CEO of Duke Energy (DUK). “The business model fundamentally changes in the 21st century.”

Success isn’t a sure bet. “Some regulators have not yet understood and embraced this,” says Darbee. “It really entails stepping through the looking glass.” What’s more, the same innovations that produce efficiency gains also bring competition. A number of companies have sprung up to work directly with customers to save energy, snaring the profits that come from efficiencies. And utilities will face rivals on the power generation side as entrepreneurs develop solar, wind, or other sources for homes and businesses that may be as common as refrigerators. “I’ve got to believe that energy production and storage [systems] become commodities,” says Ralph Izzo, CEO of Public Service Enterprise Group (PEG), a New Jersey utility. “It would completely eliminate the utility as a monopoly.”

As a result of these pressures, many companies will suffer the fate of the dinosaurs, says industry consultant Roger W. Gale. David Crane, CEO of NRG Energy (NRG) in Princeton, N.J., acknowledges the threat: “If we are not doing things completely differently by 2030, we will be in a world of hurt,” he says.

This article was published in the Oct. 12, 2009 issue of BusinessWeek magazine