Utilities are facing the very real and imminent threat of open competition in their core business, not a pleasant prospect for an industry that has been protected by regulation for more than 50 years. Most utilities acknowledge that their most profitable customers--local, state and federal agencies as well as large industrial and commercial companies--will be selecting their electricity provider in the near future.

Customers Power the Future Consider the initiatives being taken by The Rouse Co., a big electricity consumer and a major U.S.-based commercial property developer. Rouse Co. executives are tracking events in the electric utility industry and are positioning the company to benefit financially as opportunities arise.

George Owens is "the man" at The Rouse Co. He is the individual responsible for providing energy-related services for more than 200 commercial buildings. Any utility interested in providing electricity or energy services to Rouse Co. properties must deal with Owens. As director of engineering, Owens is responsible for the purchase of US$75 million of electricity from 45 electric utilities across the United States. The price Owens pays for electricity varies from 3.5 to 12 cents per kWh, depending on the state, the region and even the property line. But Owens' job is not really about purchasing kilowatts. Owens is charged with providing comfort for Rouse Co. tenants and customers. His tenants want conditioned space, hot water and proper lighting and they want these services properly priced and reliably delivered. Electric utilities who want to do business with The Rouse Co. must be on the same page with Owens. This requires that they provide his company with quality services at the prices required to keep the company's clients happy.

When Does Competition Arrive? In California, choice arrives for all customer classes on January 1, 1998. Throughout the rest of the United States, the deadlines are being set on a state-by-state basis. Utilities are busily preparing for competition. Based on the results of earlier deregulation initiatives in England and Australia, utilities in the United States can expect to lose up to 30% of their customers as electricity begins to take on the attributes of a commodity. To replace lost income as customers leave the system, utility executives are committed to augmenting electricity sales with higher-margin, value-added services. Many utilities have already created for-profit subsidiaries that provide engineering, power marketing and construction services. These for-profit companies are competing with established businesses that have vowed to fight to maintain market share.

Utilities looking to expand their customer base typically want to leverage existing knowledge or assets. Leveraging existing knowledge might take the form of providing engineering studies and power quality audits or even managing construction projects. Leveraging existing assets might include leasing rights to distribution and transmission structures for installation of fiber optic lines or the installation of personal communications services (PCS) equipment.

Most large utilities are also creating energy services companies (ESCOs) to provide services including energy audits, motor retrofits, lighting upgrades and heat rate evaluations to their large industrial and commercial customers. These ESCO subsidiaries must compete with a steadily increasing number of independent ESCOs for projects that could include the installation and maintenance of central cooling systems, compressed air facilities and on-site co-generation facilities. Increasingly, ESCOs are enhancing their offerings with financing and performance contract options.

Engineering Services for Sale Tampa Electric Co. (TECO), Tampa, Florida, U.S., is one utility that has found a way to increase revenues while infusing entrepreneurial spirit into a regulated electric utility. TECO executives created a for-profit subsidiary, Power Engineering & Construction, Inc. (PE&C), to offer planning, design, analysis, construction and maintenance services on the open market. PE&C is also pursuing other opportunities including metering consulting, emergency restoration services and power quality solutions. In business since September 1996, the subsidiary has a diverse client base including municipal electric authorities, industrial customers and even other engineering firms. To meet the competitive pressures of the marketplace, PE& C matches the resources of a central core PE&C team with client needs.

The subsidiary is also finding work outside the power industry. At the same time PE&C was being formed, the U.S. Federal Communications Commission was selling PCS licenses and providers were beginning to enter the Tampa Bay market. These providers were in need of contractors to develop sites and erect antennas. PE&C, backed by years of experience in constructing substations and transmission lines at TECO, could offer all the skills and equipment necessary to install a PCS site. PE&C and TECO have completed dozens of PCS projects in west central Florida. Services provided by PE&C range from structure erection and antenna installation to complete turnkey site installation. PCS towers are being installed at existing TECO substations and on TECO transmission structures.

Collecting the Rent But what about electric utilities that do not report to shareholders? Public utilities are not under the same cost pressures as investor-owned utilities. Or are they? Consider the case of Snohomish Public Utility District #1(the District). Linda Finley, telecom project manager, acknowledges that the District's customers are looking for low electric rates and reliable service.

"If we can leverage existing assets to bring in additional revenue, we will be able to lower electricity bills, thus responding to what our customers want," says Finley. In 1996, the District was contacted by PCS, cellular and cable companies who wanted to license various sites or facilities. The District, working with a telecommunications consultant, reviewed outcomes of similar initiatives at neighboring utilities. The District ultimately signed master license agreements with each telecommunications company. Individual site licenses were also issued with three to five year terms with an option to renew. The market-based rents vary from site to site depending on factors such as real estate values. The rents are comparable to those being charged by neighboring utilities and local landowners.

The District is flexible in arranging to meet each telecommunication company's needs. Some telecom companies are installing and maintaining their own equipment. One company has hired the utility's crews to install and change-out equipment.

As more telecom companies approach the District, the revenues continue to grow, allowing the utility to reduce the electricity bills of its customers.

The District has installed new financial software to enable staff to track appropriate internal expenses and bill telecom customers.

"Working through the process of tracking internal expenses and billing telecom customers, the District has gained additional insights in how to successfully configure and install its new financial software. The District will then be ready for all types of new businesses and services," Finley says.

Utilities Have Inherent Advantages Owens acknowledges that for-profit utility subsidiaries, including ESCOs, may have several inherent advantages over the smaller services companies that seemingly spring up overnight. Owens is willing to set aside time to meet with utility ESCO representatives, time he might not make available for other service providers. He acknowledges that the backing of a utility gives ESCO subsidiaries inherent credibility.

"Utility ESCOs might not necessarily be good competitive players, but they will be around and they will meet their obligations," Owens says. He also says that utilities' reputations for good service and reliability give them a marketing advantage.

Owens is willing to work with start-up utility ESCOs but is unwilling to let them learn on his dime. To shorten the learning curve, Owens has a suggestion, "Bring in people who have experienced the competitive world. Even though you think you know what competition is about, you will never truly know until you've lived it."

Owens works closely with utilities and develops agreements with them on a case-by-case basis. In Baltimore, Maryland, for example, The Rouse Co. has contracted with Baltimore Gas & Electric to maintain selected distribution class switchgear and equipment. The Rouse Co. is considering additional offers from electric utilities to maintain power distribution facilities at voltages ranging from 480 V to 33 kV. Utilities are providing lighting for Rouse Co. properties. The Cleveland Illuminating Co., Cleveland, Ohio, U.S., was selected to upgrade parking lot lighting when a shopping mall was recently expanded.

Performance Contracts Take Hold Although The Rouse Co. prefers to work with utilities on individual projects, other commercial and industrial customers would prefer to use performance contracting, which enables them to roll multiple projects under one agreement. Performance contracts are increasing in popularity because customers gain contractual assurances that installed systems will operate properly while delivering the promised energy efficiencies. In many cases, customers can finance system lighting and conditioned air upgrades based on savings from reductions in energy use.

HL&P Energy Services (HL&PES), a for-profit subsidiary of Houston Industries, recently signed a major performance contract to perform upgrades at the central campus of the University of Houston (UH).

"This contract would guarantee (US)$10 to (US)$20 million to cover the expense of capital improvements with a payout in energy savings over a 10-year period," says Marcel Blanchard, UH services director. Blanchard is working with HL&PES to identify ways to reduce overall operating costs, improve the efficiency of existing facilities and upgrade the physical plant without requiring any new funding from the state.

Ray Ehmer, director of HL&PES, realizes performance contracting provides an enticing mechanism for some companies to make capital improvements.

"The installation of new equipment and energy efficient technologies is paid for through guaranteed future utility savings, backed by the integrity of a company with more than a century of experience in the electric utility industry," Ehmer says.

HL&PES and UH representatives have identified several areas for potential energy savings. The list includes improved energy efficiency of interior lighting, HVAC enhancements, improved energy efficiency of chillers, replacement of CFC-based refrigerants and construction of a new on-site electric substation. HL&PES will contract with sister subsidiary Houston Lighting and Power, Houston, Texas, U.S., to design the electric substation, which will allow UH to purchase its electricity at a higher voltage and a lower rate.

Just how successful are most utility ESCOs in understanding a customer's needs and packaging services to meet those needs? In many cases, there is a disconnect between a utility's lofty goal of providing high profit, high value services and the reality of successfully marketing and delivering the services customers want at prices they are willing to accept.

Former utility personnel who represent newly formed ESCOs might encounter rough going if they call on the Rouse Co. Owens has less than glowing reports of his early experiences with ESCO representatives. According to Owens, utilities show up with a glossy brochure, a few marketing "types" and a promise to tackle any project independent of in-house experience. He acknowledges that even large utilities often lack the depth of staff to draw upon when responding to customer requests.

Going Down the Partnering Path The Omaha Public Power District (OPPD), Omaha, Nebraska, U.S., decided it would be too costly and time consuming to grow an ESCO and realized a partnership would be a preferred strategy.

"Energy services performance contracting enables OPPD to enhance customer relations by being a solutions provider while providing an additional source of revenue for the utility," says Tim Burke, vice president of energy services at OPPD. Burke wants to tap into current ESCOs' experience in performance contracting. At the same time, OPPD brings a ready market that is based on relationships developed with customers over many years.

Another utility that would rather partner than compete is the Kansas City Board of Public Utilities (BPU), Kansas City, Kansas, U.S. Faced with the prospect of offering energy services to large commercial and industrial customers, BPU opted to enter a joint venture agreement with Viron Energy Services, Kansas City, Missouri, U.S. (an independent subsidiary of conditioned air manufacturer York International). BPU Director George Powell believes that the agreement with Viron gives his company the ability to respond in a fashion the market will demand.

"Through this strategic alliance, Viron Energy Services will function like a department of BPU, providing reasonably priced performance contracting lighting and engineering services," Powell says.

John Mahoney, president of Viron, acknowledges that many utilities see energy performance contracting as a new source of revenue as well as a value-added energy service to help retain large customers. But Mahoney is not sure how many utility ESCOs will succeed. He believes that "time to market" is a critical parameter for success. He expects that few small to mid-sized utilities have the time or track record to offer the services that would keep a customer from switching electricity suppliers.

A significant amount of potential energy services work exists but utilities must compete hard to get this work. Unless utilities have both the skills and the attitude that customers are looking for, they won't get to first base. Consider a recent case at the Rouse Co. where Owens was replacing an aging chiller to hold down maintenance costs and improve efficiencies. Owens would have considered contracting the work through an ESCO performance contract, but he ended up tackling the retrofit in-house. Why? Because he could handle the project internally at a lower cost. Owens has file folders full of brochures from utility and independent ESCOs promising they can tackle any project. But when it comes down to credentials, Owens finds that most ESCOs are unable to say, "Here is a project similar to yours that we completed last month."

As utilities look to increase their customer base and increase revenue to their parent companies, they must convince potential customers like Owens that they can deliver. This requires that they outperform both in-house staff and a growing number of independent services providers. Successful for-profit utility subsidiaries will learn to lean on their strengths and minimize their weaknesses. These companies will look less and less like their parent companies and will increasingly take on the attributes of vibrant, risk-taking entrepreneurial companies.

Are electric utilities now ready to compete in the unregulated arena? Let's hope so. Otherwise history may repeat itself. Utilities are in a far more difficult position today than they were with the rate of return situation experienced a decade ago. Let's take a minute and go back 10 years to an era when electric utility executives decided they could generate higher rates of return in unregulated businesses than was allowed in their core business. Remember when utilities invested in banks, real estate and retail outlets? Many utilities found that they were ill-prepared to compete in unregulated industries. In short order, losses eclipsed predicted profits. Utilities across the country, realizing the error of their ways, began to divest themselves of these enterprises, deciding to refocus on generating and delivering electricity with a guaranteed rate of return.

Today, with imminent deregulation, times have changed. Now, if a utility attempts to provide "value added services" and falls short, there will be no retreating to the protected confines of a cost-regulated business. A utility's success in diversifying will hinge on how it anticipates and meets the needs of present and future customers.

In an effort to track ESCO activities in the United States, the Furst Group, Rockford, Illinois, U.S., surveyed 30 utilities representing a gross sales revenue of US$50 billion from 21 states in the United States. Sixty-one percent of respondents had already formed an ESCO subsidiary or division. Of the utilities that had not yet formed an ESCO, 70% planned to create one within three years.

The primary reason cited for creating an ESCO was to gain a competitive edge. More than half the utility ESCOs were staffed with personnel from other divisions within the parent utility.

"It is interesting to note that utilities are starting ESCOs to obtain a competitive edge, yet many are hesitant to hire staff with free market experience," says Steve Bois, vice president with the Furst Group.

Twenty percent of the utilities had acquired an existing independent ESCO. The remaining 15% had combined an internal services department with an acquired ESCO.

Utilities are rewarding their top ESCO executives. The average salary for the director/manager is US$108,000 with salaries ranging from US$70,000 to more than US$180,000. A bonus of at least 30% was available for most ESCO executives based on the performance of their business unit.

The most commonly provided ESCO services as determined by the Furst survey were performance contracting (88%), energy efficiency programs (82%) and power quality services (65%). Other services included power marketing, power factor correction, electrical testing, chilled/hot water and steam services, energy consumption reports and emergency generation equipment and services.

The Rouse Co. develops, acquires, owns and manages commercial real estate projects including regional shopping centers, mixed use projects, office buildings, business/industrial projects and large scale master planned land developments. The Rouse Co. has more than 58 retail centers in operation including such exclusive properties such as Fanuel Hall Marketplace in Boston, South Street Seaport in New York City, Fashion Show Mall in Las Vegas, Bayside Marketplace in Miami, and Harborplace in Baltimore. Office and mixed use properties include the Arizona Center in Phoenix and the Westlake Center in Seattle. Consolidated office properties include the Hughes Airport Center in Las Vegas and the Columbia Office and Industrial in Columbia, Maryland.

The Rouse Co. also focuses on the development of premium properties. The company has 14 retail centers and five mixed use properties under construction or under development.