The new landscape
Ironically, plant managers have created the M&A-friendly environment that makes many of them anxious. Their consistent efforts to improve plant efficiencies, leading to the sector's profitability, have made utilities attractive to investors seeking to exploit recent changes in laws governing the U.S. electricity sector.
In 2005, Congress passed the Energy Policy Act, effectively repealing the Public Utilities Holding Company Act of 1935 (PUHCA). The repeal of PUHCA, which severely limited the types of ownership structures permissible in the utility industry, eliminated geographic and operational restrictions on utility holding companies seeking to enlarge and integrate their service territories. Having been freed from these constraints on maximizing economies of scale, U.S. investor-owned plants are now more attractive to investors.
As a result, we've seen companies such as FPL, a Florida-based generation company (genco), seek to merge with Constellation Energy, a Maryland-based expert in energy trading. Although the deal has stalled because of local political issues in Maryland, it represents the type of corporate M&A activity that the U.S. electric utility industry is already experiencing and can expect to see more of in coming years.
At another level, the Energy Policy Act is likely to accelerate companies' desire to make their generation portfolios more fuel-diverse, with the goal of minimizing price and supply risk. For example, Duke Energy arguably acquired Cinergy as much to diversify its generation base as to achieve economies of scale.
Obviously, large utilities find themselves at an advantage in the new environment. No longer constrained to a specific geography—and with the help of Wall Street advisors—they are freer to make strategic decisions to accelerate their growth. And growth has generally been difficult to achieve organically in the U.S., except in pockets of rapidly growing demand.
That's not to say that smaller utilities were severely disadvantaged by the repeal of PUHCA; in fact, they should consider themselves fortunate that it happened. Instead of facing possible irrelevance and formidable competition from larger companies, they can now position themselves for acquisition—and survival.
With a few notable exceptions (TXU Corp. of Dallas, for one), utilities are adding new generating capacity much less frequently than in the past. A recent EEI report found that most of the more than 8,600 MW that came on-line in 2005 represented upgrades of existing plants' ratings, rather than new facilities.
Why have utilities become more likely to invest in old plants than to build new ones? Stagnant load growth and the difficulties of getting a new facility permitted are factors, but so was the electricity sector's paradigm shift, which put a premium on operating efficiency. Since deregulation began ushering in competition and open access to regional transmission grids a decade ago, a power plant's production cost has largely determined how often it is dispatched. Accordingly, gencos have increasingly turned to asset optimization as a strategy and tool for becoming one of a region's low-cost producers. Strategies for maximizing the benefits of a merger or acquisition are expected to strengthen this trend.
Accepting the inevitable
Plant managers will be expected to spearhead, at the rank and file level, the drive for the even greater efficiencies and economies of scale that are the rationales of most M&As. Managers' willingness to accept new realities will be essential to the success of new operating models that merged entities will develop. Most, if not all, of these models assume that the destination—profitability—can be reached via three paths: the development and implementation of "lean" operating strategies, cost-cutting, and maximizing plant reliability and availability.
However, several studies show that M&A deals often come up short on delivering anticipated revenues, predicted cost savings, and successful integration of disparate IT systems and operational structures. In fact, research proves that most past mergers have not worked as expected. And the much-sought "synergies" between companies with similar business missions have all too often failed to materialize.
Why, then, should plant managers be excited about having to make sweeping changes to their daily routine that aren't likely to produce good results? Simply put: M&As are going to happen. The money men of Wall Street—and their overseas counterparts—aren't afraid of missing out on the perfect by foregoing a chance at the good. They embrace risks, especially those they can control. They would like nothing better than to replicate the rewards that shareholders reaped from the mega-mergers of the integrated oil companies—Exxon and Mobil, Chevron and Texaco, and Conoco and Phillips.
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