Regulated Electricity Utility Industry

The electric utility industry generates, transmits and delivers electrical power to

consumers, businesses and governments. Today there are three primary business

structures in the regulated electrical utility industry—public companies owned by

shareholders, municipally owned companies, and those owned and operated by the

federal government. Shareholder owned companies are the largest group, providing half

of all electricity in the United States.

Burning fossil fuels to power steam turbines produces over half of electricity

consumed today.1 Other generation methods include harvesting the power of nuclear

reactions to power turbines and, increasingly, renewable methods such as wind or water-

powered generation. Unlike most manufactured products electricity cannot be stored, so a

complex and delicate fabric of transmission systems (know as the power grid) exists to

deliver power when and where it is needed. Many firms involved in the generation of

power are also involved in its transmission and sale to end-users, making vertical

integration commonplace within the industry.

This end-to-end integration, as well as end users’ dependence on electricity, has

led to historically strict government control of the industry. The most significant piece of

regulation in the last century was known as the Public Utility Holding Company Act of

1935 also known as PUHCA. The act had a profound effect on the regulated electrical

industry. First, and most importantly, it set limits on the rates that electricity and natural

gas companies could charge payers. Secondly, it restricted the ownership structure of

firms involved in the electrical utility industry, preventing non-utilities from owning

interest in regulated businesses. Third, it formalized the jurisdiction that federal, through
the Securities and Exchange Commission, and state governments had over the structure

of utilities and established the framework for a robust system of checks on the industry.

For nearly a century PUHCA provided the framework for control over the regulated

power industry.2

By signing into law The Energy Policy Act of 2005, the President and Congress

have set new priorities in national energy policy, effectively repealing PUCHA and

changing the competitive landscape in this industry. The act provides incentives for

modernization and investment in infrastructure; it encourages continued exploration into

fuel diversity; and, finally, it lifts the strict controls previously in place governing the

ownership and corporate structure of companies within the industry.3

Steadily increasing demand and complex regulations governing investment and

growth have resulted in a power generation and transmission system nearing its limits,

and the Energy Policy Act was adopted to reverse that trend. Specifically’ it “provides for

enforceable mandatory reliability standards, incentives for transmission grid

improvements and reform of transmission sitting rules. These improvements will attract

new investment into the industry and ensure the reliability of our nation’s electricity grid

to stop future blackouts.”4 The need for these steps was perhaps best illustrated in

August, 2003 when New York City was hit by a blackout that cost the city an estimated

$500 to $750 million in lost revenue.5

The Act also encourages a wide array of cleaner fuel alternatives by investing

billions of federal dollars toward tax incentives and research and development programs.

It focuses many of those funds on the newest advances in the industries’ most used fuel.

Clean coal technology holds promise of meeting growing demand for electricity with less
harmful effects on the environment. The act provides companies with incentives to

pursue these and other cleaner fuel alternatives.

Finally, the Energy Policy Act opens the door to a new era of competition by

lifting restrictions on corporate structure that had been in place since 1935. Many predict

the impact of these provisions will increase the overall capital pool by allowing non-

utility investors to take positions in utility operations.6 Designed specifically to encourage

investment and competition, it is important to note that these provisions may be subject to

future restrictions by the Federal Energy Regulatory Commission and states—all of

which retain jurisdiction over the operations of the industry.

Porter’s Five Forces

As described in the previous pages, government regulation is a significant

competitive force in the electrical utility industry. However, it is not the only force at

play. Porter’s Five Forces model is a powerful tool to gain additional insight into what

drives competition within the electrical utility industry. Specifically, the model examines

the following five competitive forces: risk of entry by potential competitors, threat of

substitutes, bargaining power of suppliers, bargaining power of buyers, lastly intensity of

rivalry among established firms.

The risk of entry by competitors tends to be moderate due to geographic

domination of transmission and distribution functions, as well as the high costs of entry

for generation. Geographic dominance, though primarily an artifact of the previous era of

tight governmental controls, is likely to provide a competitive advantage in the decades to

come. While competition may bring choice to the customer, new entrants will be forced
to use the transmission assets of the dominant firm, making it difficult for newcomers to

offer competitive prices. Here again, the effect of EPACT2005 remains to be worked out:

“Transmission and distribution will likely remain regulated functions, but may be
subject to innovative forms of regulation that attempt to mimic some of the
incentives and pressures of a competitive market. Power generation will grow
increasingly competitive as states move to deregulation. Customers will be able to
choose an electricity supplier in much the same way they choose a long-distance
phone company.”7

The barriers to entry in the power generation sector, however, are certain to remain high,

with the cost of a power generation facility of commercially marketable capacity soaring

into the billions of dollars.

The threat of substitutes is low in the short term, but has the potential to

increase. Demographic and cultural forces solidify steady growth in demand for

electricity in the decades to come (see Exhibit 1), and practical substitutes for electricity

do not exist. However, there is intense interest, spurred in large part by environmental

concerns, to develop technologies that can reduce the rate of growth in demand and

develop innovative methods to provide the supply. Companies such as Evergreen Solar,

Suntech Power, and Sunpower for example are busy working on solar power systems that

could some day offer a viable alternative to traditional power delivery systems.

Suppliers—specifically those of fuel—have substantial bargaining power in the

electrical utility industry. Xcel Energy relies on one mining source, the Powder River

Basin in Wyoming, for 70% of its coal supply.8 Xcel and other utility companies attempt

to mitigate the risk of single supplier dependence through the use of long-term contracts.

However suppliers wield considerable bargaining power in the negotiation of these

contracts. Further exposure to risk in supply levels is a result of dependence on rail,

pipelines and other occasionally unreliable modes of transporting the fuel to the

generation facilities.

Bargaining power of buyers within the electrical utility industry lies primarily

with state lawmakers who draft rate legislation. Companies in the industry devote

significant resources to lobbying efforts in state capitals throughout the country. Their

efforts are aimed at securing rates that allow adequate returns on investments. Companies

must rely on legal teams to make the case for periodic increases when market forces

come to bear, or when significant capital investments are made on behalf of customers.

So while individual customers may not have bargaining power per se, the pressure of

buyer power is a significant force at the governmental level.

The fifth and final force Porter’s model examines is the intensity of rivalry

among competing firms. Most large utility companies like Xcel have a solid, slowly

increasing ratepayer base. Historically that base was a geographic monopoly for the firm.

With the repeal of PUHCA, however, an era of increased competition and choice may be

only a few years away. Until that time, utility companies can direct resources to other

priorities, knowing that the intensity of competition is relatively low.

Clearly, the electric utility industry is complex. For established firms, Porter’s

model suggests the industry is attractive. Geographic dominance and high barriers to

entry contribute most significantly to this conclusion. However, as will be noted later, the

industry has its drawbacks as well, including low- to moderate earnings potential, and

risk exposure due to environmental and other concerns.

Xcel Energy

Xcel Energy is a utility holding company comprised of the following regulated

utilities: Northern States Power Minnesota, Northern States Power Wisconsin, Public

Service Company of Colorado, Southwestern Public Service, and WestGas Interstate Inc,

an interstate natural gas pipeline. Xcel Energy sole non-regulated operating unit is

Eloigne Co., which invests in low-income rental housing projects. Exhibit 2 lists

revenues from all industry segments in which Xcel operates.9

Xcel Energy is headquartered in Minneapolis, Minn., and employs approximately

9,780 employees throughout the 10 western and Midwestern states it serves. Ranked

number 247 in the fortune 500, Xcel is one of the nations leading companies in the

electric and gas utilities industry. In 2004 the company’s total electricity customers

increased 1.1% to 3.3 million and its natural gas base grew 2% to 1.8 million customers.10

Its size and steadily increasing customer base represent a key strategic strength for Xcel.

1. US Energy Information Administration (1996). “The Changing Structure of the

Electric Power Industry”. p129. Retrieved from:
http://tonto.eia.doe.gov/FTPROOT/electricity/056296.pdf on Oct. 5, 2006.
2. Ibid. p29.
3. Gale, Ed. Lynn Pearce (2005). “Encyclopedia of American Industries”.
Vol. 2. p508.
4. Edison Electric Institute (2005). Edward Comer. “Effect of the Energy Policy Act
of 2005” p.1. Retrieved from
http://www.eei.org/industry_issues/electricity_policy/federal_legislation/implicati
ons_of_policy_act.pdf on Sept. 23, 2006.
5. CNN.com. (2003). Power Returns to Most Areas Hit by Blackout. Retrieved
from: http://www.cnn.com/2003/US/08/15/power.outage/ on 14 October 2006.
6. Op. Cit. EEI (2005) p.3
7. MN Legislative Reference Library (2005) “Resources on Minnesota Issues-
Restructuring the Electric Industry.” Retrieved from
http://www.house.leg.state.mn.us/hrd/pubs/restructure.pdf on Oct. 5, 2006.
8. Xcel Energy Inc. (2006). “Xcel Energy 2005 Annual Report.” p25.
9. Ibid. p5.
10. Hoover’s Inc. (2006). “Hoover’s Company Records-Xcel Energy Inc.” Retrieved
from http://web.lexis-nexis.com.floyd.lib.umn.edu/universe/xcelenergy/ on Sept.
19, 2006.