on Energy: Turmoil and Transition?

Contents
3 5 Introduction, by Bruce Tindale ‘Trust busted’: regaining investor confidence and healthy markets in wholesale energy, by Bob Linden Never forget the basics: refocusing on fundamentals to boost shareholder value, by Mike Korotkin and Jan Pretorius Case study: Calpine, Duke and Equitable Resources Energy companies must actively manage balanced energy business models, by Jean-Louis Poirier Case study: Entergy Power generation and industry cycles: lessons from other industries, by Mike Beck, Todd Filsinger and Craig Hart Regulated electricity businesses: maximizing shareholder value through active management, by Edward Kee Case study: WPS Resources ‘Double down or fold’: utility retail at a crossroads, by Derek HasBrouck Case study: Centrica

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Viewpoint is PA’s international thought leadership publication. It is designed to provide business leaders with insights on a single strategic business issue.

PA Consulting Group is a leading management, systems and technology consulting firm, with a unique combination of these capabilities. Established almost 60 years ago, and operating worldwide from over 40 offices in more than 20 countries, PA draws on the knowledge and experience of around 4,000 people, whose skills span the initial generation of ideas and insights all the way through to detailed implementation. PA builds strategies for the creation and capture of shareholder and customer value, and helps clients accelerate business growth through innovation and the application of technology. PA works with clients to improve performance, mobilize human resources and deliver change effectively, including managing major projects, and designing and implementing enterprise-wide systems and full e-business solutions. PA focuses on creating benefits for clients rather than merely proposing them, and this focus is supported by an outstanding implementation track record in every major industry and for governments around the world. PA also develops leading-edge technology both for its clients and within its own portfolio of venture companies in areas ranging from software to wireless technology to life sciences. PA distinguishes itself from its competitors through the range and quality of its people, the depth of its industry insight, its development and use of technology, and also its independence and culture of respect, collaboration and flexibility in working with clients. We are proud that our clients say “PA makes it happen”.

Energy: Turmoil and Transition?
must get back to basics: bearing down on the fundamentals to get through this troubled time and build a platform for future success.

This is a challenging time for the industry and we believe that electric power companies across the globe

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Regulated electricity businesses:
Maximizing shareholder value through active management
By Edward Kee

Before the Enron meltdown, regulated companies appeared to be under-performing holdovers, while unregulated generators and traders looked like big winners. Regulated electricity companies missed the gains seen by generating and trading companies prior to the Enron meltdown, but they also missed the losses that followed.

The recent financial performance of regulated electricity companies is excellent in comparison to the market losses suffered by unregulated generators and traders. Regulated electricity companies are seen as sound investments again, with the potential to build real riskadjusted value for shareholders. The recent turmoil in the electricity industry may lead some regulated electricity companies (along with regulators, politicians, and investors) to adopt a do-nothing strategy in the face of uncertainty. A significant part of the electricity industry is – and will remain – regulated. Transmission and distribution systems will continue to operate under cost-of-service regulation even after industry reforms are completed. Some vertically integrated utilities will continue to be regulated during the transition period to full competition in generation and retail. Regulated electricity companies, however, are not insulated from the effects of industry reform and face

significant opportunities and challenges. Regulated electricity companies that adopt a do-nothing strategy are likely to be less profitable than companies that actively manage through this uncertainty. With much of the energy industry in disarray, and investors re-thinking portfolios in the midst of a widespread liquidity squeeze, this is a timely and pivotal opportunity for financially sound utilities to undertake a strategic review to: • Assess and prioritize significant financial threats and opportunities in your business and regulatory environment • Define corporate core objectives in light of your current situation and the threats and opportunities • Design, staff and implement responses to significant threats and promising opportunities consistent with core objectives.

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Figure 1: From ‘do nothing’ to active management

These threats and opportunities fall into three broad and interrelated categories: • Regulatory change • Structural change • Competitive threats. Regulatory change

Active management

Selectively outsource

Develop and introduce new technology

Take opportunities for horizontal consolidation

Upgrade and replace existing infrastructure

Regardless of the pace or direction of electricity industry reform, significant portions of the electricity industry will remain regulated. Electricity transmission and distribution systems are critical links in the delivery of power from generators to consumers and will be regulated for the foreseeable future. Transmission will increasingly fall under the jurisdiction of the US Federal Energy Regulatory Commission (FERC) through the Regional Transmission Organization (RTO) process, while distribution will remain regulated by state or local jurisdictions. Generation and retail, already partially deregulated, will eventually be unregulated competitive businesses. However, vertically integrated utilities will remain regulated until the shift to markets and accompanying de-integration is complete. Also, deregulation may be implemented gradually by the use of transition arrangements, rate-freeze agreements, or vesting contracts that keep these companies under limited regulation for some time. In the US, decades of experience with regulation have provided a solid basis in law to support a fair return to the owners of regulated assets. This relatively stable legal and regulatory environment in the US should enable a smooth transition to new regulatory regimes and new industry structures as compared with countries (eg, Australia and the UK) where legal and regulatory precedent on fair compensation is much more limited. Regulation will change over time as industry reform is implemented. Past regulatory regimes were far from perfect and were developed to control bundled rates from vertically integrated electricity companies. Regulatory regimes will be modified to correct the mistakes of the past (eg, incentives for over-investment and insufficient incentives for performance) and to fit a vertically de-integrated industry structure.

Invest in new infrastructure

Actively manage regulation

Regulatory change

Structural change

Competitive threats

This article reviews the potential threats and opportunities in the regulated electricity business, explains why passivity in the face of a changing environment may not represent the best approach, and presents some alternatives for active management (see Figure 1). My goal is to stimulate discussion about the need for a strategy review at this critical point in the industry.

Environmental threats and opportunities
While each company’s strategy must reflect its unique situation, this article reviews the three areas of strategic threat and opportunity and later offers some responses.

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Regulatory transition may present financial risks

As the US electricity industry moves slowly into competitive markets, the potential exists for extreme financial risk that may make regulation and ratemaking difficult or impossible. Regulation is not an ironclad guarantee of cost recovery and a fair return on investments, as an earlier generation of utility executives learned in the nuclear plant disallowance proceedings in the 1970s and 80s. The regulatory bargain has become even more uncertain, with recovery of all operating expenses at risk, especially those arising from spot market exposure, as seen in California. In California, regulated utilities relied on the traditional regulatory bargain in 2000 when selling at low fixed prices to customers while buying at high spot prices in the wholesale electricity market. The magnitude of the resulting financial losses pushed the California utilities to the point of financial distress. In spite of the lessons of California, some regulated utilities expect regulators to make good on any losses from unhedged fixed-price retail sales obligations in volatile wholesale electricity spot markets.
Allowed rates of return are uncertain

problems with financial viability and lowered incentives for additional investment. Regulated transmission companies will increasingly see a shift toward RTOs that will act as a regional collector of transmission and congestion tariffs that are allocated to transmission owners. The transition arrangements from past ‘wheeling’ tariffs to full network service will be important to transmission companies. In the longer term – after the transition arrangements are gone – transmission owners should expect to earn revenues from a return on assets, with the potential existing for stranded assets even in transmission. Structural change Regulated electricity companies will inevitably face some restructuring as a part of industry reform. As with regulation, those companies that actively develop a strategy to participate in this restructuring are more likely to profit as compared to those that passively respond. In some instances, this restructuring may present temporary opportunities to grow through acquisition.
Industry will face vertical dis-aggregation

As the electricity industry is de-integrated, regulators may re-examine the current modes of economic regulation and the level of allowed rates of return. As generation and retail are divested, regulated utilities companies become pure wires companies and may be perceived as having lower risk, justifying lowered rates of return. This may be the case even when industry uncertainty regarding the regulatory bargain and a shifting of risks to regulated wires companies (eg, liability limitation removal) may actually increase risk and provide a valid argument for a higher allowed rate of return. In Australia, for example, the initial implementation of electricity sector reform has had mixed results. State regulators and the ACCC1, eager to contribute to the success of electricity sector reform, developed some innovative approaches2, but have typically allowed relatively low returns, below those sought by the regulated companies. These low allowed returns may present future
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Transmission will be required to be independent of the competitive sectors of generation and retail that participate in the electricity market. In other market, such as Australia and the UK, transmission and distribution were completely separated from the generation and retail sectors to facilitate competition and open access. The recent FERC RTO initiatives have increased the pressure to make the transmission business independent from the competitive links in the electricity value chain. Transmission will also be separated from distribution. Distribution utilities will remain regulated at the state level while transmission will move to FERC regulation, raising the costs to manage separate regulatory regimes. The business of distribution is focused on dense low-voltage networks serving local customers, a fundamentally different business from transmission with high-voltage lines serving the bulk power market. If distribution companies remain in the retail business (even as default suppliers), the independence of transmission from market participants may be compromised.

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The Australian Consumer and Competition Commission, the regulator for transmission companies. These innovations include links between allowed return and specific performance against operational targets such as frequency and duration of line outages.

A more pervasive issue in the US is the continued bundling of retail commodity sales and distribution. Unlike industry reform in other countries, such as Australia and the UK, most regulated distribution utilities in the US also provide retail electricity service to the customers they serve even after retail competition is implemented. US distribution companies often have retail provider-of-last-resort (POLR) obligations. This preference for bundling regulated wires and retail in a single company may result in a slower and more difficult transition to a fully reformed electricity industry in the US. While properly separating distribution and retail is not trivial, there are a number of compelling reasons why it should be done. Distribution companies with POLR obligations at regulated rates may face significant financial risk, as discussed above. Competitive issues also arise in a functioning competitive retail market with a distribution company acting as a competing retailer. Even if rules and regulations allow competition with this bundling, the difference in the critical success factors in distribution and retail suggest that it is unlikely that a single company will succeed in both simultaneously. Finally, retailers will likely be in direct competition with distribution companies by selling products such as on-peak and off-peak power, controllable appliances, non-interruptible power, and curtailment discounts that may be specifically aimed at reducing customer exposure to regulated transmission and distribution charges.
Non-core functions should be divested

may include: billing and collections; construction and heavy maintenance (eg, replacement of major equipment); regular operation and maintenance (eg, cleaning and inspection, vegetation clearing). Competitive threats The traditional monopoly supplier status of regulated wires companies may be diminished under industry reform. Transmission is increasingly viewed as a substitute for properly located generation and there is emerging competition from new entrants. Regulated electricity companies should examine the threat from competition to their regulated business and prepare a strategy to counter these threats.
Merchant transmission companies appear

A significant number of new non-regulated merchant transmission projects are being developed in the US, many of which are based on high-voltage DC technology. The controllable nature of HVDC technology creates property rights that facilitate recovery of investments through market transactions. Merchant, unregulated, transmission projects using this technology are operating or under development in Australia and North America. Merchant transmission projects, targeting the most lucrative bottlenecks, compete for investment with regulated transmission assets.
On-site and near-load generation will expand

Regulated companies once built internal capabilities for almost all activities, in response to the incentives of costof-service regulation. As regulatory regimes are fine-tuned and regulated companies become more focused on a single vertical sector, the incentives for efficient operation and improved performance of regulated companies should become more pronounced. As unregulated companies have learned, outsourcing can reduce costs and improve performance. Regulated companies should seek to enhance value through the de-integration and outsourcing of some internal functions and activities. In the distribution and transmission sector, these activities

Generation located at customer sites, near load centers or in areas of high locational prices, effectively competes with investments in transmission. On a smaller scale, such generation can even compete with distribution investments. In some instances, on-site generators may allow customers to operate with only minimal use of the transmission/distribution system. Widespread use of locational spot prices might lead to generation development that would significantly reduce the use of some existing transmission or even distribution lines, raising issues of stranded assets.
Private distribution companies are considered

There is an additional threat to distribution companies in the form of private distribution companies that take highvalue areas from a larger regulated distribution company.

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Regulated distribution rates that are high (eg, due to stranded cost and other transition charges collected through ‘wires’ charges, plus normal distribution charges) may lead to the formation of a new private distribution utility, bypassing the regulated distribution utility. Private distribution companies may, due to financing flexibility, use of new technology, and a focus on high-density areas, be able to achieve lower costs for end-use customers compared to traditional regulated distribution utilities.

Similarly, corporate objectives may reflect decreasingly relevant standards of success. For example, measures of retail scope and scale based on the traditional utility business model of vertical integration may no longer apply in an era of horizontal specialization.3 Financial structures and capital resources that proved ideal in one operating environment may prove inadequate or inefficient in another. Therefore, a crucial internal first step in evaluating and prioritizing corporate objectives is to establish – through structured debate, consensus and articulation – a corporate ‘view of the world’. A well-articulated view of the world places corporate strengths and weaknesses in the context of future challenges and opportunities and illuminates conflicts and limitations among established corporate goals and individual agendas. Organizations unaccustomed to this process, or those seeking independent perspective on goals and capabilities, often turn to outside consultants to provide a roadmap and challenge internal assumptions. PA’s approach to facilitating corporate strategy development is described in the ‘strategic mapping’ panel overleaf.

Defining corporate objectives in the new environment
Having identified the strategic threats and opportunities presented by the new environment, most companies move directly to mapping previously identified responses with powerful internal constituencies onto the new game board. This approach may result in a plausible story for the annual report or analyst conference call, but may lack a proper screening of corporate strengths, weaknesses and goals in light of the new strategic environment. Critical selfassessment within a defined and open process can help build an internal consensus and common understanding of corporate priorities and the means and resources that will be required to attain them. Institutional strengths and weaknesses are difficult to objectively assess, because measurement tools are ad hoc, inconsistent or biased. Benchmarking is a common and useful utility approach to introducing objective measures of competence and performance. However, benchmarking can be inadvertently subverted by the definition of the relevant comparative universe. As noted above, competitive challenges are emerging from new directions. The upper decile of performance or cost control among similarly sized electric utilities may not be the most relevant measure of your relative ability to enter into new ventures or repel the competitive advance of new market entrants. New standards of performance from nontraditional quarters may also be introduced by regulators and legislators.

Strategic response to environmental change
The changing face of regulation, industry structure and competitive threats outlined above strongly suggest that any complacency by regulated utility management (resulting from the serious problems affecting their more aggressive industry brethren) is misplaced. What follows is more of an enumeration of, rather than a recommendation for, possible actions and responses in light of these developments. Actively manage regulation US regulated electricity companies, with decades of experience in managing regulation (and regulators), should be able to successfully make the transition to new forms of regulation that will be developed as a part of industry reform. Managing this transition well may be the single most critical activity for a regulated company.

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For more on the retail marketing dilemma, see the following article by Derek HasBrouck.

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Strategic mapping PA’s Strategic Mapping Process (SMP) is a three-step process designed to help energy utility organizations address the central strategic challenges that they face:

How to take advantage of current market trends and create sustainable revenue and income streams?

Those regulated companies that actively participate in the regulatory process have an opportunity to shape regulation and to tailor company structure and strategy to reflect current and expected regulatory regimes. Such an active approach to regulation is likely to yield higher and more certain profits. Incentive regulation may be seen as a way to improve the efficiency of the regulated parts of the electricity industry. The CPI-X approach used in the UK is an example.4 Performance-based rate-making regimes, with a return on assets adjusted for performance against specific performance targets, have been suggested. Incentive regulation may present the potential for significant profit improvement for some companies, depending on the details and the timing. Other companies may face substandard returns and higher risk. Utilities that actively participate in the development of incentive regulation regimes are more likely to benefit from them, especially in the early period. In the UK, a recent report suggests that the incentive regulatory regime adopted there may have some flaws, including inability of regulated companies to generate everincreasing efficiency gains under the CPI-X regime. Importantly, incremental new investments in infrastructure may not occur because of uncertainties in the likely return, or because of disagreements between regulators and regulated companies on the amount and timing of such investments. A proper understanding of the contextual distinctions is useful in deciding which lessons are applicable from regulatory reform in other countries. US utility executives would be well advised to familiarize themselves with past regulatory successes and failures in other nations while devising their individual corporate responses to state and federal regulatory initiatives. Respond to structural and competitive issues While the industry is undergoing reform, there are some opportunities for organic growth through building more assets, replacing and upgrading existing assets, and

What type of business model to adopt to achieve the best portfolio of regulated and unregulated assets?

How to implement the new business model?

SMP can be used at a subsidiary level, but is generally better applied at a corporate level to design a strategic course of action which accomplishes the best trade-off and migration path between legacy and new (often unregulated) businesses and assets. Step 1 involves a strategic-issue analysis to achieve agreement on the current situation of the organization (strengths, weaknesses, business philosophy preferences and corporate risk attitudes), followed by a codification of the organization’s view of the world (generally for the next 5–7 years) to help rank the most attractive market and value-chain segment opportunities. Step 2 starts with a review of possible business models. Each candidate model is articulated along five key dimensions: base value proposition (ie, value chain positioning, underlying risk/reward choices, and level of differentiation sought); overall scale and scope (mix of regulated and unregulated activities, geographies, etc); core asset selection (type, breadth and depth of both regulated and unregulated assets emphasized, asset flexibility and migration potential by class of assets); overall success/risk factors (top factors and risk mitigation approaches on both the regulated and unregulated sides); and targeted durability and scalability (replication and expansion potential of unregulated and regulated activities, ability to achieve economies of scale or repeat technology improvements, scalability of business processes). Next, candidate business models are ranked against key criteria that reflect the organization’s strategic position determined in Step 1. The result is a preferred business model. In Step 3, the implementation path for the winning model is specified in detail (including timing, offerings, customers’ priorities, geography targets, delivery system, growth avenues and risk mitigation for both regulated and unregulated activities). Finally, the resulting likely financial performance of the organization under the new model is simulated to plan the desired level of investments, organization and competence growth and types of alliances/mergers to be considered.

4

CPI-X is a form of price cap regulation that links tariffs to a measure of inflation such as the Consumer Price Index (CPI) in the US or the Retail Price Index (RPI) in the UK. In general, CPI-X regulation works by allowing tariffs to increase at the same rate as general inflation, less some amount (the ‘X’ factor) to reflect expected/projected productivity gains by the regulated company. Regulated companies can realize the benefits of cost reduction efforts in excess of the X factor until the next review. This form of regulation typically has a multi-year (eg, every 3 to 5 years) review cycle, where the tariffs and the X factor are reset. For the next period, the regulator is able to pass to consumers some of the benefits of the realized efficiency gains in excess of the X factor.

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through investment in new technology. Careful examination of, and investment in, these opportunities will allow regulated electricity companies to achieve profitable organic growth even during this period of uncertainty. A decade of uncertainty about impending reform and restructuring in the electricity industry has resulted in low investment in transmission and distribution infrastructure. Companies facing uncertain regulatory regimes and potential corporate restructuring have postponed or cancelled new infrastructure projects. Much existing infrastructure is in need of extensive refurbishment or even replacement. Little investment has been made in new technology in the electricity transmission and distribution business.
Invest in new infrastructure

• The extent to which the extremely difficult and lengthy process of obtaining siting and permissions for transmission lines will be eased, perhaps through FERC jurisdiction and eminent domain powers • The allocation of transmission rights and revenues flowing from new transmission investments. The need for increased distribution and transmission infrastructure will provide large investment opportunities for companies that effectively manage the regulatory process.
Upgrade and replace existing infrastructure

During the last decade, growth in demand, the shift to electricity markets, and ageing of existing assets has created a need for considerable additional investment in transmission and distribution infrastructure. The transmission network was designed when its primary purpose was to move power from power plants to load centers within a single utility. Now, additional transmission capacity is needed to facilitate emerging competitive markets. Also, an increase in electricity demand over the last decade has not been matched by a corresponding increase in transmission. The FERC has initiated incentive programs for transmission infrastructure development. It remains to be seen if these programs will spur additional investment, or simply provide enhanced economics to projects that were already under development. Regulatory certainty for the long term will be a more significant driver of investment. Other issues that will shape the investment in transmission infrastructure include: • Reliability requirements and responsibilities and associated system planning responsibilities under new RTO arrangements • The use of ‘rate-freeze’ periods as a means of extracting shareholder value, with the obvious limits on increased investment under such arrangements

Much of the US distribution network is old and in need of replacement, with inner-city distribution systems experiencing outages, fires, and manhole explosions due to old and degraded wiring. In some cities, there is a desire to move from overhead distribution wires to underground systems for aesthetic, safety and other reasons. Upgrading and replacing the existing distribution systems will take an enormous amount of capital investment. Even more will be required if lines are shifted to underground. On the bright side, recent initiatives by the FERC aimed at providing incentives for participation in electricity industry reform may mean higher returns for companies in some instances. Incentive returns were offered to companies that made near-term investments in transmission infrastructure and to those transmission companies that turned over control of assets to an approved RTO. Participation in these incentive schemes can provide a boost to profits for regulated electricity companies.
Take opportunities for horizontal consolidation

During the 1980s and 1990s the trading, generation and retailing businesses underwent considerable consolidation. The transmission and distribution sectors will also undergo consolidation as the industry reform proceeds. In the regulated wires sectors, some companies are pursuing focused single-segment strategies, including National Grid and Trans-Elect. Fundamentally, there is little that prevents significant consolidation of the transmission and distribution sectors and continued consolidation will be facilitated by the divestiture (perhaps

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forced) of transmission assets. Transmission is a small percentage of an integrated utility’s asset base, when compared to generation or distribution. Anticipating that transfer of transmission ownership will be encouraged to facilitate the electricity markets, some utilities are exploring the divestiture of transmission assets. The consolidation of distribution companies within states may be the first move, with consolidation across state lines being a little more difficult. However, there are several utilities that acquired distribution assets in multiple states as a result of the merger of integrated utilities or through historic growth.
Develop and introduce new technology

serve. A regulated electricity company might only keep critical activities such as financing, investor relations, regulatory process management, and the management of outside contracts. The lowered operating risk and cost savings from outsourcing non-core activities will help regulated utilities meet the demands of regulation and create additional value for shareholders.

Conclusion
A significant segment of the electricity industry will remain regulated even after industry reform is completed. These regulated companies are not immune to the changes from industry reform and are presented with significant opportunities and challenges in the next few years. Regulated electricity companies can maximize their shareholder value by actively managing these opportunities and challenges. With most of the non-regulated portions of the energy industry in disarray, there is no better time for regulated utilities that kept to their core business and maintained a healthy balance sheet to re-examine their strategic plans. A systematic review of the threats, opportunities and available resources, preferably using an established and demonstrated protocol, could prove the most valuable allocation of your time and those of your management team during this period of broad retrenchment, redefinition and revised expectations.

The reform of the electricity industry may have the unintended consequence of reducing R&D spending and the development of new technology. Technologies such as superconductors and more sophisticated transmission metering and control systems could add capability to the network without adding more power lines. Although the Electric Power Research Institute remains in place, its funding and ability to undertake fundamental research is greatly impaired. It remains to be seen if regulated companies will take on additional risks and costs to develop or invest in new technologies and approaches. Those that develop new products for the industry could earn returns from their intellectual property. The investment may also be an effective way to increase regulated assets outside traditional investment in poles and wires.
Selectively outsource

Contracting with outside providers can lower investment, reduce operational risk, enhance flexibility, and lower costs. Outside contractors can develop flexible approaches to labor management, adopt new techniques and approaches to lower cost, and develop economies of scale that may not be easily attainable by the utilities they

The author, Edward Kee, is a Member of PA’s Management Group, and specializes in electricity industry restructuring and market reform
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Case study

Case study

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WPS Resources
A regulated electricity company that got it right – providing shareholders with 43 years of increasing dividends
Our thought-piece discussed the activities that a regulated electricity company should undertake to maximize shareholder value. Our case study looks at WPS Resources (WPSR), a regulated electricity company that has succeeded by actively managing its regulated businesses.
Background
WPS Resources Corporation is a holding company based in Green Bay, Wisconsin, with the following operating subsidiaries: • Wisconsin Public Service Corporation (WPSC) is a regulated electric and gas utility serving Northeast and Central Wisconsin and an adjacent portion of Upper Michigan. • Upper Peninsula Power Company (UPPCO) is a regulated electric utility that serves approximately 50,000 customers in two-thirds of Michigan’s Upper Peninsula. UPPCO’s corporate headquarters are located in Houghton, Michigan. • WPS Energy Services, Inc. (ESI) is a diversified nonregulated energy company that targets retail energy sales and related services. Principal operations are located in Illinois, Maine, Michigan, Ohio and Wisconsin. • WPS Power Development, Inc. (PDI) develops and owns non-regulated electric generation projects and provides services to the electric power generation industry.

Active management brings results
WPSR is an excellent example of a regulated utility company that sought to maximize shareholder value by active management. In response to the liberalization of the utility industry, WPSR went through a long and detailed strategic planning process. The company started with a deep commitment to a core vision and strategy and developed a consistent detailed plan and budget. In response to the changes taking place in the industry, WPSR formed a holding company and set up two unregulated subsidiaries, ESI and PDI, to take advantage of new markets. Senior management constantly reviewed the risks associated with the market and prescribed the limits of their unregulated activities with a rigorous process to approve investments. Careful investment in the unregulated businesses kept WPSR from overextending itself. A strategy that balanced regulated and unregulated activities has produced significant value for the shareholders. WPSR is one of the few ‘A’-rated companies among the US utilities. Five years ago, WPSR common stock was around $22. Two years ago it was $30. The stock price currently stands at $36 after having gone

Case study
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Case study

as high as $42. For 43 years, WPSR has announced an annual increase in the dividend, with the current dividend at $2.14 per share. A major source of these financial results is the WPSR focus on its regulated businesses, with the company undertaking a range of activities, detailed below. Actively manage regulation. WPSR has, through careful management and cost control, maintained a position as a low-cost provider of electricity in the region and in the US. This position has allowed the approval of rate increases and provided them with significant goodwill with the Public Service Commission of Wisconsin. The company’s loyal customer bases in Northeast Wisconsin and its excellent service ratings were also key factors in maintaining an excellent relationship with the Commission. Customer forums, fast response in emergencies, and effective customer consultation processes have enhanced the public image of WPSR in the communities that it serves, further reinforcing its goodwill with the PSCW. Invest in new infrastructure. WPSR has made, or is making, incremental investment in new regulated assets, including transmission lines and power plants. This has allowed it to grow the regulated asset base (in the context of good relations with customers and regulations), while maintaining the relative security of regulated earnings in its home market. Tom Meinz, Senior Vice President of WPSC, said: “In spring of 2001, we announced our plans to meet the future electric needs of our customers. We expected to build generation in the state as well as complete construction of the Weston-Duluth transmission line. Both are needed. Some of our power plants are getting old and are more difficult to maintain. That, along with steady growth in electric demand, are major reasons this is a much-needed addition to the system.” Upgrade and replace existing infrastructure. WPSR has also maintained and upgraded its existing infrastructure to enhance reliability, maintain low production cost, and add to its regulated asset base. Two recent examples of this are the major refurbishment of an aging

hydroelectric generation facility and the replacement of steam generators at the Kewaunee nuclear power station. These investments will extend and enhance the operation of low-cost electricity generation plants. The Kewaunee investment, in particular, will allow the plant to operate for a much longer period with fewer outages and should greatly facilitate the approval of a 20-year life extension application. Take opportunities for horizontal consolidation. WPSR has acquired distribution assets in the surrounding region, including the Upper Peninsula Corporation and Wisconsin Fuel And Light. The company has also constructed a gas storage facility in Michigan. The company purchased the share of the Kewaunee nuclear plant held by Madison Gas & Electric, bringing the WPSR ownership to 59%. Over the years the company has established an excellent record of operating the unit that allowed them to make an informed decision in the purchase. Develop and introduce new technology. WPSR has initiated a program to install new meters with automatic meter reading (AMR) systems at all customer locations for both gas and electric meters. AMR systems will allow WPSR to obtain customer use data faster, more accurately and have fewer estimated bills. AMR will also lower the costs of meter reading and allow fast detection of customer outages. WPSR also makes available a time-of-use rate. Customers can opt to take this rate for a small fee. Included in the time-of-use rate is the installation of new metering that will allow customer use to be measured in real time. WPSR has invested in its computer and information systems to allow customers to conduct many routine activities through the Internet, including billing. This investment has significantly enhanced the level of service offered to customers and lowered the cost of providing this service. Selectively outsource. WPSR, along with the other utilities in Wisconsin, transferred control of its transmission assets to the American Transmission Company. This

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transfer allows WPSR to maintain its investment in regulated transmission assets, while facilitating the development of regional electricity markets and the orderly development of the regional transmission system. It also ensures that WPSR will have access to regional power markets. The management and operation of the Kewaunee nuclear power station was transferred to the Nuclear Management Company, LLC. Nuclear Management Company was formed to allow single nuclear plant owners, like WPSR, to obtain the benefits of purchasing, staffing, and maintaining a larger fleet of nuclear power stations. WPSR has also implemented an asset management program to review all assets owned by the company. As a part of this program, WPS transferred ownership of land associated with the Peshtigo River hydroelectric property to the Wisconsin Department of Natural Resources in one of the largest land sales in recent Wisconsin history. The land will be used for public recreation purposes, and was sold at a price that provided fair value to shareholders.

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