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SCIENTECH IssueAlert, September 26, 2000
The Wires Business as a Cash (Strapped) Cow
By: Jon T. Brock, Director, Strategic and Competitive Intelligence
===============================================================

Victoria's  Office of the Regulator-General in Australia ruled last Thursday
that the state's five electricity distribution companies must reduce average
network charges by between 12 and 22 percent starting January 2001.


ANALYSIS:  There used to be a time not long ago when utilities were 
strategically
addressing electric deregulation by diversifying into new "growth" businesses,
and in most cases many still are. Concerned about the impact competition
will have on the industry, utilities have conducted studies and research
to try and make themselves more appealing to consumers. The result is a
flurry of activity to diversify. Some companies diversify their services
in an attempt to be a "one-stop shopping" utility. Utilities across the
U.S. are offering home security systems, mobile phones and other 
telecommunications
services.

Then there are the "rational" utilities who decide to stay in the business
that they know best ) the wires business.  This is due to the fact that
the wires business still remains regulated at a decent return for the typical
shareholder of what was the regulated utility and will become the regulated
wires company.  Let's take a look at some other countries that have 
deregulated
before the U.S. and see how their wires companies have fared.

First, after the massive U.S. takeover of the British utilities (RECs)
in 1996-1997, the British government enacted a new law in July 1997 that
imposed a one-time windfall tax on the revised privatization value which
originally had been computed in 1990 on privatized utilities. OK, so this
is an anomaly.  It is not usually a cost of doing business in the wires-only
environment.

Second, in December of 1999, the Office of Gas and Electricity Markets
(OFGEM), the U.K. gas and electric regulatory body, published final proposals
for new rates in the distribution business and for price caps in the supply
business.  The final proposals reduced distribution rates beginning on
April 1 of 2000 (and it was not an April's Fool joke).

Third, Australia's state of Victoria appears to be helping set the trend
of making the wires business more efficient by mandating a reduction in
their rates.  They also ruled to set targets for different companies within
the state to improve reliability by between 15 and 37 percent.

It appears this "regulated" wires business is getting measured by a 
"competitive"
business standard.  In any sense, lets bring it home.  California has become
the summer poster child for examples in the electric industry.  They have
an unregulated wholesale market that is spiking while the retail market
in one territory is open to feel the pain (price) of electricity while
the other areas are "protected", at least at the end consumer level.  But
who eats the difference?  The retailer of course.  Well, the retailer in
California just happens to be the wires company (incumbent service provider).
So while PG&E is trying to figure out how to recover these astronomical
gaps in what they pay for wholesale electricity and what they retail it
for, they may end up eating it.  This actually qualifies for that anomaly
argument that the U.K. experienced because it should not be the norm.


In a true deregulated market, wires should take care of getting electrons
to customers while retailers should handle the commodity and value-added
services.  I know of only one state in the U.S. that is proposing this
model for their opening date ) Texas.

Can wires survive on their own?  You bet.  But I believe there are trends
forming that will have to be addressed by any company focusing on a wires
strategy.  The new wires companies will come under regulatory scrutiny
to become more efficient.  Their rates will be reduced and they will be
expected to increase reliability.  In other words, do more with less.
This will mean two things:  One, size is important.  Scale always produces
efficiency in one form or another.  Second, these new companies will seek
efficiencies in cost savings.  This is one reason for the explosive growth
in the supply chain and exchange areas of the utility industry. Do not
expect your local regulator to stick to the cost-plus method of calculating
rates for wires.

This does raise an interesting question that I will save for another day.
How does the wires company successfully raise investment capital for improving
its distribution system with such low rates of return?
==============================================================

Today's related article entitiled, "Lines of Argument: Can a "Wires-Only"
Company Succeed in a Competitive Market" (January 2000), can be found in
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Sincerely,

Jon T. Brock
Director, Strategic and Competitive Intelligence
jbrock@scientech.com

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