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`Changes Are Thundering Along'


Industry Outlook 1991: SERVICES

`CHANGES ARE THUNDERING ALONG'

When William T. McCormick Jr., chairman of CMS Energy Corp., the holding company for Michigan's largest electric utility, addressed shareholders last year, he got a tough question: When will CMS's dividend, now 48~ a share vs. its historic high of $2.60, be raised? McCormick was blunt: "Never." Instead, he said, bank on appreciation in CMS's stock.

It's a new day for the electric-utility industry, which enters 1991 facing a number of daunting challenges. Meeting the newly amended Clean Air Act's emissions standards will cost up to $105 billion by 2010, reports the Edison Electric Institute (EEI), an industry group. Federal regulators want companies to open transmission lines to competitors such as independent power producers. And in 1991, changes in federal law may give the independents a further boost--ushering in a new era of competition.

To get ready, utilities are dropping their slow-growth style, forming independent power subsidiaries, gobbling each other up, and slashing costs--trends that will spread in 1991. "Changes are thundering along," says Len Wohadlo, president of Harbert Power Group, a San Francisco independent. "This will make the wildest damn market I'll ever see."

Coping with the Clean Air Act looms as the industry's biggest hurdle. Pollution-control costs will rise only slightly in 1991, but planning must start now for installing scrubbers or using cleaner fuels. Worse, this pressure comes as many utilities still are paying for nuclear power debacles of the 1970s. The net effect is that they're reaping only a 10% average return on equity--even though state commissions typically allow nearly 13%, the EEI reports. And since 1985, utility credit ratings have slipped industrywide.

On top of this, the industry is entering a new building cycle: It plans to add some 94,000 net megawatts, about 14% of current capacity, in the 1990s. Daniel Scotto, director of high-grade credit research for Donaldson, Lufkin & Jenrette Securities Corp., says that utilities will be hard-pressed to finance such expansion unless they adapt to the competitive times ahead. "You have to wonder how long people can hold on to the old-style utility structure," he adds.

Many utilities already are changing. Some have turned to demand-side management--putting off new plants by hawking energy-saving plans. In one program, homeowners let utilities control their hot-water use in peak periods in exchange for a monthly credit. Others are examining the once-heretical idea of merging with, or acquiring, a neighbor. A study released by Edward J. Tirello Jr., managing director of research for Smith Barney, Harris Upham & Co., concludes that the resulting economies of scale could save the industry $3.6 billion a year--and cut the average customer's electric bill by $49.66 a year. Heading into 1991, six mergers are pending, including the combination of Southern California Edison Corp. and San Diego Gas & Electric to create the nation's largest utility.

There's a fly in this ointment, however. Before approving mergers, federal regulators often force utilities to ease their control of transmission lines. Current federal law requires utilities to buy power from independents, but they control it after that. The feds want to spur competition by letting independents find their own customers, then pay for use of transmission lines. Many utilities cry foul, claiming that independents could pick off their best customers.

But the momentum may be unstoppable. Last November's budget package reforms the Public Utility Regulatory Policies Act of 1978 in a way that helps independents. The original law allowed alternative energy producers--in solar and wind, for example--an unregulated rate of return. Independents rushed to this gold mine and now supply about 5% of all U. S. capacity. But their growth was checked by a rule that often limited plant size to 30 megawatts. The amendment effectively removes this cap, so independents should grow stronger.

Other assaults on traditional power producers lurk on the horizon. Senator J. Bennett Johnston (D-La.) will soon introduce a bill designed to loosen regulations on independents that burn conventional fuels such as coal and natural gas. Now, a company controlling 10% of such a facility must be regulated. Partnerships have been set up to bypass this, but they are unwieldy. "We're doing partnerships at tremendous legal costs and inefficiencies," says Nancy J. Zausner, strategic planning director for PG&E-Bechtel Generating Co., an independent set up by Pacific Gas & Electric Co. and Bechtel Group Inc., an engineering company.

LEAN AND MEAN. Backers of the amendment say liberalizing the 10% rule is vital to meeting future power demand. But many disagree. For example, regulated utilities must put some 50% of the money into new construction; unregulated companies could borrow that. Don D. Jordan, chairman of Houston Lighting & Power Co., says the change would jeopardize the flow of reliable power. "If this kind of high-risk financing is possible, we might as well be in the savings and loan business," he told an industry group in November.

That's a common view. But other utilities, such as CMS Energy, are ready to meet competition head-on. "There are going to be two types of utilities," says CMS boss McCormick. One will be the slow-growth plodder of old. The other will be like CMS, which has trimmed its work force from 13,000 to 9,500 in five years and has set up its own independent power ventures. Such companies see themselves as lean, mean, low-dividend machines--and as the future of the electric-utility industry.Robert Buderi in New York


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