Smarter Utility Insights

Back to Blog

The smart utility growth multiplier

07/18/2019

5% growth may be all you need to double your income. The electric utility industry often focuses on low operating costs when trying to reduce the cost of electric rates, but there is a far more effective way to reduce rates: grow off-peak sales! For many utilities, it takes just 5% growth in sales to double the pre-tax income line (or income before “payments in lieu of taxes” in the public power utilities sector).

iStock-960131774 (1)

This high degree of operating leverage is both a blessing and a curse. As many utilities have painfully experienced, just a few percentage point reduction in off-peak sales can wipe out all earnings! However, in this article, we are going to focus on the positive side of operating leverage in an industry with very high fixed costs AND very high contribution margins (defined as revenue minus cost of energy minus cost of capacity).

This is because with flat or declining sales in service territories across the country, the time has come to find smart growth in off-peak hours – especially because the most exciting sources of sales and earnings growth can also significantly reduce carbon emissions in the utility territory.

First - a quick primer. The utility industry has high fixed costs, which means that a large percentage of the yearly bills your utility pays are effectively constant, or change slowly. Think of transmission lines, distribution networks, generating facilities, and even your employees and trucks. These costs do not vary based on the amount of electricity sold. By the same token, the industry is also one that operates with high contribution margins, which means that each new off-peak kilowatt-hour (kWh) sold has very low cost wholesale energy and capacity cost. In essence, the incremental contribution margin growth goes straight to the bottom line. This applies to public power utilities, IOUs, vertically integrated and even in some decoupled utilities (that are not meeting return on equity targets). Nearly all utilities share this characteristic of high operating leverage.

Now - what does that mean for the business of your utility? Simply put, increasing off-peak sales has an disproportional impact on your utility's bottom line. At public power and investor owned utilities (IOU) alike, this could be used to lower rates, or to invest into the utility infrastructure. In the case of IOUs, part of the increased income could be delivered as increased earnings. Have a look at the table below for a fairly average sized public power utility in the northeast. While the example utility below is small, the same concepts apply to all utilities regardless of the size.

chart

 

The second column (titled “5%”) shows that even a small increase of 5% results in a 230% increase in income or (or at some public power utilities, the payment in lieu of taxes (“PILOT”) line). At the extreme end, an increase in sales of 50% could increase the income line by 1,400%. While a 50% increase in sales may seem out of reach, remember that the strategic electrification of transportation (nationwide) and home heating (in the northern half of the US) could actually deliver that level of trans-formative change. Utilities don't need to worry about adding new customers when they are able to grow their sales from existing customers by capturing an increasingly large percentage of the total energy use in their communities.

"But wait!" you say, "what about my capacity costs, or limits on generation? Won't that drive up my fixed costs?"

Increasing sales alone isn't enough, and new kWh sales should be added off-peak as much as possible. Effective EV load management and other load shifting efforts are critical to ensuring that these new sales create more good than harm. We are always happy to take a look at the economics for your utility and provide an initial review at no cost to see if the same kind of growth the utility moneyball can provide in your case as well.

 

Subscribe

Leave a Reply.

Subscribe