When utilities pull out a “back to basics” strategy, you know their drive for growth from unregulated operations didn't work out and the steady earnings from regulated operations suddenly look appealing.
In the early 2000s, after too many power plants were built, several utility holding companies dumped their unregulated merchant power operations. Xcel Energy got rid of NRG Energy. PG&E Corp. dropped PG&E National Energy Group. And Southern Co. shed Mirant.
Several utility companies reversed some of their more head-scratching moves. Alliant Energy decided to sell unregulated businesses, which included a planned resort in Mexico, and Allete, parent to Minnesota Power, dropped plans for making money in the Florida real estate market.
Recently, Ameren sold its unregulated power business in Illinois to Dynegy so the company could focus on its regulated utilities.
Now, FirstEnergy is adopting a version of the “back to basics” strategy. The company plans to focus on its regulated utility and transmission businesses, but will keep its competitive supply operations in hopes the market will rebound.
Competitive business seen as growth engine last year
A year ago, FirstEnergy viewed its competitive power supply business – FirstEnergy Solutions and Allegheny Energy Supply Co. – as the main avenue for company growth, according to the Akron, Ohio-based company's annual report.
“Combined, our regulated distribution and transmission operations provide a solid foundation, with strong and stable cash flows to support our dividend,” FirstEnergy said. “Our competitive operations are expected to provide a growth platform.”
FirstEnergy expected to grow its competitive operations through modest customer and volume growth, focusing on higher margin customers, and by growing the generation fleet “to match customer growth.” FirstEnergy's Competitive Energy Services segment participates in deregulated energy markets in Ohio, Pennsylvania, Maryland, Michigan, New Jersey and Illinois.
The company was well aware of the challenges it faced, noting that low natural gas prices had driven down wholesale power prices, reducing margins in the competitive businesses. “We expect the soft economy, weak demand for electricity, energy efficiency mandates, demand response initiatives and other regulations as well as increased costs related to more stringent environmental regulations to continue to impact our results of operations into 2013,” the company said.
But it wasn't all doom and gloom. “We continue to believe FirstEnergy is one of the better positioned companies in our industry and region to benefit from increases in energy and capacity prices as economic conditions improve over time,” FirstEnergy said.
At the time, FirstEnergy owned 18,096 MW of competitive generation.
FirstEnergy switches gears in 2014
Sluggish demand growth and low power prices forced FirstEnergy to change its tune in 2014. The company has taken a three-pronged approach in its modified “back-to-basics” strategy.
In late January, FirstEnergy said it would cut its dividend by 35%, savings about $320 million a year. Cash for the dividend had been coming from FirstEnergy's regulated utilities.
Earlier, FirstEnergy had sold some of its competitive power plants, reducing its unregulated capacity to about 13,000 MW.
The company plans to keep its unregulated operations, but will focus on its regulated utility and transmission operations. “As we see the company today and the opportunities going forward, we believe that focusing our efforts primarily on regulated operations is the best thing for the company,” Tony Alexander, FirstEnergy president and CEO, said January 22 during a conference call with analysts.
There had been rumors that FirstEnergy would try to sell its competitive business, the second largest in the U.S., but the company wants to keep it. “It's a strong business with good assets, lots of good people and 2.7 million customers,” Alexander said.
It may be a “strong business,” but FirstEnergy expects its competitive operations will drag down company earnings this year by about 10%. No wonder FirstEnergy is shifting its focus to its regulated utility and transmission operations.
Moody's sees risk on regulated side
The decision to cut the dividend was good for FirstEnergy's credit, but not good enough for Moody's Investors Service to change its negative outlook. Before changing the company's credit rating, Moody's wants to see how New Jersey regulators handle a proposed rate increase for FirstEnergy's Jersey Central Power and Light (JCP&L) subsidiary.
Some parties in the rate case contend that JCP&L has been earning more than it should have been, according to Moody's. “There is a concern that a rate reduction could potentially be an outcome from the pending rate case,” the ratings agency said. (Who said regulated utilities were risk-free?)
On the positive side, Moody's likes FirstEnergy's plan to spend about $2.8 billion on regulated transmission in the next four years. “We view investment in transmission assets positively as they typically earn a strong FERC-approved return in excess of 11%, generate predictable cash flows and have minimal operating risk,” Moody's said.
Other companies like Ameren held onto their unregulated operations for years, hoping that the Midwest wholesale market would rebound. In a couple years, we will see if FirstEnergy made the right decision in keeping its competitive supply business. Focusing on its regulated operations makes sense for now.