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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 industrypublic 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 waterpowered 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 nations 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 nonutility 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 statesall of
which retain jurisdiction over the operations of the industry.
Porters 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. Porters 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.
Suppliersspecifically those of fuelhave 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 Porters 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, Porters
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 companys 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.

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9.

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.
Ibid. p29.
Gale, Ed. Lynn Pearce (2005). Encyclopedia of American Industries.
Vol. 2. p508.
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.
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.
Op. Cit. EEI (2005) p.3
MN Legislative Reference Library (2005) Resources on Minnesota IssuesRestructuring the Electric Industry. Retrieved from
http://www.house.leg.state.mn.us/hrd/pubs/restructure.pdf on Oct. 5, 2006.
Xcel Energy Inc. (2006). Xcel Energy 2005 Annual Report. p25.
Ibid. p5.

10.

Hoovers Inc. (2006). Hoovers Company Records-Xcel Energy Inc. Retrieved


from http://web.lexis-nexis.com.floyd.lib.umn.edu/universe/xcelenergy/ on Sept.
19, 2006.