The Top Trends Behind the Growing, Multibillion-Dollar Market for Utility Mergers and Acquisitions
A look at the links between Exelon-Pepco, NextEra-HEI, and other large and small consolidations in today’s brave new energy world
The two-year battle over Exelon’s bid to acquire Pepco is finally over. In March, Washington, D.C. regulators approved the Chicago-based utility company’s $6.8 billion plan to scoop up Pepco’s three mid-Atlantic electric and gas utilities, giving it a bigger base of regulated revenue to offset the financial uncertainty in its unregulated generation business.
To win the deal, however, Exelon agreed to D.C. regulators’ demands to provide ratepayer rebates, energy-efficiency programs and smart grid pilots, as well as commitments to support solar power projects in the nation’s capital. And while the utility is hoping to bring out new solar and microgrid projects as part of its new regulated businesses, Exelon will also be required to open those opportunities to third-party competition.
The Exelon-Pepco deal is noteworthy for its size, creating the biggest utility in the country, with 10 million customers. It also indicates a new wave of consolidation in the North American utility sector, ranging from multibillion-dollar mergers to forays into new business lines, according to Matt Mooren, energy and utilities advisor at PA Consulting.
These drivers can be broadly separated into two categories, noted Mooren. First, there are the cyclical trends of low energy prices and financial struggles for the unregulated, independent power producer (IPP) portion of the North American utility sector. Second, there are the once-in-a-lifetime changes — the rise of utility-scale renewable energy, distributed energy resources and technology-driven customer energy empowerment.
In this environment, companies are seeking stable revenues and rates of return inherent in regulated utilities, as Exelon has done with Pepco. But they’re also seeking out opportunities in the emerging businesses of wind and solar power, distributed energy management and customer energy services — areas where regulated utilities are facing their own challenges.
“It’s a more progressive and innovative approach,” said Mooren. “People are in position to play both offense and defense, in terms of the distributed energy trends and the customer energy technology trends.”
Let’s start with the cyclical trends and a bit of history to explain how we’ve come to where we are today.
“In the mid-1990s, there was basically one business model — the vertically integrated electric utility,” Mooren explained. Then came the rise of independent grid operators, and the splitting of the utility business model into competitive retail energy providers, independent wholesale power producers, and transmission and distribution utilities, which in turn led to a lot of consolidation across those fields, he said.
But after a wave of boom-bust for the unregulated side of the utility business, along with the current trend of low natural-gas prices and thus low marginal electricity prices, “Wall Street and shareholders have been penalizing electric utilities in particular, and utilities in general, for any non-regulated investment,” said Mooren.
While publicly traded independent power producers such as Dynegy, NRG Energy and the bankrupt Energy Future Holdings have lost more than half of their market value over the past several years, regulated utilities have generally held steady or gone up.
“So you’re in a place where utilities are searching for growth, and that growth is very hard to accomplish with any sort of non-regulated investment that doesn’t fit trends that would be accretive to the regulated side of the business,” he said.
These trends are behind controversial proposals like the Exelon-Pepco merger, or NextEra’s $4.3 billion bid for Hawaiian Electric Industries. They’re also the driver of lower-profile deals, like Algonquin Power’s $2.4 billion acquisition of Empire District Electric, or a U.S.-Canadian investor group’s $4.7 billion purchase of Louisiana’s Cleco.
“Look at Exelon’s earnings and shareholder value,” he said. “Several years ago, they were substantially dependent on the non-regulated portion of the business — either their generation business or their competitive retail business. And those earnings are pretty volatile.”