You'd think the lights were going out all over the world the way investors have been dumping electric utility stocks. Since September, utility shares on average have lost 30% of their value; stocks of California utilities have been in a swan dive for the last month.
Rising interest rates and a profound, historic change in the electric power business are behind the headlong plunge.
But panic is always unwise. Cooler analysis of trends in the utility business shows real value and an exciting future there.
First, understand the factors that have caused the decline. Rising interest rates are partly to blame because they reduce the investment attraction of utility dividends. However, on Tuesday, as the Federal Reserve Board again hiked short-term rates, the Dow Jones utility average rose 2.38 points, reflecting investor belief that rising rates may now pause, allowing utility shares to shine.
But far more important is the competitive change in the business. Utility stocks began falling in September when the credit rating agency Standard & Poor's issued re-evaluations of electric companies based on their "competitive business position," a ranking based on how vulnerable a company would be to competition from other suppliers selling cheaper power to its customers.
And California utilities sank last month after the Public Utilities Commission proposed total deregulation by 2002, which would allow all customers to shop around for power. One Wall Street analyst called it a "populist, damn-the-torpedoes restructuring of a major part of the economy with no evidence that the existing system can be improved in efficiency."
But that reaction is off the mark. The California regulators simply recognized that competition has already come to the business. Big industrial users exercise options in buying power today. Ohio and other states have bills before their legislatures proposing deregulation of electric power.
To understand what's happening, ask yourself this question: If McDonald's can order all its hamburger rolls from a single baker in Kansas City, why can't it buy electricity for all its stores from a single supplier, rather than paying electric companies in each state and locality?
In England, McDonald's now buys electricity for roughly 200 stores from a single supplier rather than a dozen. The savings begin with a reduction in paperwork.
National Westminster Bank is headquartered in London but buys its electricity from a utility in the eastern part of Britain. "It saves $15 million a year doing so," reports Edward Tirello, a utility analyst for NatWest Securities, a U.S. subsidiary of the British bank.
Britain has separated electric power generation from transmission and distribution to homes and businesses and found that this produced economies. By 1998, Britain plans to have a switch in every home, allowing residential customers to go from coal-generated to gas-generated electricity at will, depending on which is cheaper at the moment.
And that British model is very much on the minds of the Federal Energy Regulatory Commission in Washington. That agency, with responsibility for utilities, knows that U.S. "national chains, supermarkets, shopping malls, local school boards want to buy electricity competitively, the way they buy telephone services," says Richard O'Neill, director of economic policy for the FERC.
Long-distance telephone competition was opened up 10 years ago with the breakup of American Telephone & Telegraph, and local competition is spreading today. Many experts envision a similar breakup pattern for electric power, with nine regional power generation providers and numerous transmission and local distribution companies.
Future transmission and distribution companies may remain as local monopolies, such as the Baby Bells, with regional generating companies freed up to compete--to take risks like any other business.
McDonald's in the United States might buy power from regional suppliers who would arrange distribution to stores in each locality for a package-deal price.
Investors ultimately may get hybrid holdings, one part regulated company paying a relatively safe dividend, the other a competitive company taking the risk of huge power plants, fuel prices and the battle to win customers.
There is nervousness, but also opportunity.
Duff & Phelps, the Chicago-based credit rating agency that specializes in utilities, notes that California companies--Pacific Gas & Electric, Southern California Edison and San Diego Gas & Electric--have been forced to buy high-priced power from independent suppliers, a boondoggle dating to the energy-crisis 1970s. But under deregulation, the utilities should be able to dispense with such purchases or reduce what they pay.
To be sure, if you need steady dividend income now, utilities might not be the best place for your money. But for ambitious employees and investors, the once-sleeply utility business will prove very interesting in this decade.
The successful utility of the future would keep costs low and be aggressive. Other than that, no particular advantage stands out among companies qualifying for Standard & Poor's list of those with an "above average business position." Subsidiaries of Columbus, Ohio's American Electric Power are on the list, and so is Pacificorp, the Portland, Ore.-based company that wants to sell power in California.
Analyst Tirello wrote to clients that "while competition will create a multitude of losers," some companies will prosper--among them, Duke Power of Charlotte, N.C., and Florida Power & Light, which has cut its dividend because it wants cash to finance growth.
Tirello also favors PG&E; because he thinks fears that shareholders will be stuck with a big bill for the Diablo Canyon nuclear plant are overblown.
The telephone precedent is reassuring for utility investors: Stockholders of AT&T; who received shares of seven Baby Bells, plus a share of the new AT&T; in the 1984 breakup, have seen their investment almost quadruple in the intervening decade.
Change, as they say, is constant--but that's not a bad thing.