Insight: David Nish on ScottishPower - Best laid plans
Markets are like the world's weather systems these days: increasingly diverse, extreme and unpredictable.
Markets are like the world's weather systems these days: increasingly diverse, extreme and unpredictable.
And weather is an important preoccupation for David Nish, ScottishPower’s youthful, softly-spoken finance director. Not so much Glasgow’s steady drizzle, but the early summer and long dry periods of America’s north-west.
Fourteen months after ScottishPower’s acquisition of the US power company and Nish is reflecting on atmospherics – both financial and weather-related.
PacifiCorp, targeted by ScottishPower’s management as a resource rich but underperforming operation, has been adversely hit by both.
In fact, PacifiCorp has in the last year-and-a-half faced some of the most difficult market conditions imaginable. The company has been scorched by the driest winter of the last 70 years, power shortages, sharp rises in demand plus Californian politicians prohibiting utilities from passing on price rises to the consumer.
As if that were not enough, ScottishPower’s management was getting ready to implement a post-deal integration plan. It was pursuing a leaner, fitter, more efficient PacifiCorp with 1,600 fewer employees, duplication eradicated and costs cut.
It could be read as salutary tale for executive boards in search of greater market share and capitalisation. Why should a UK utility expect to integrate a North American one, cut costs and survive the vagaries of this highly regulated market? A Chicago Tribune study last month suggested many of the US’s biggest mergers of the last decade have failed to deliver. Some 70% of merged companies trailed their competitors up to two years after the deals were completed.
Looking at the low success rate of UK to US mergers and looking at the poor financial forecasts for the US in general and the vagaries of the power market in particular – and you might wonder in retrospect if ScottishPower had picked an endurance test too far.
The ScottishPower team may not have forecast this combination of circumstances, but it has nonetheless benefited from its policy of early and thorough planning.
‘The main thing that has happened to us in the last 14 months after the PacifiCorp deal is the unpredictability of the Californian power market, which no one anticipated. We’re now having to deal with it,’ Nish says.
‘I think however what it does demonstrate and has demonstrated to us – notwithstanding how thorough we were in terms of understanding the marketplace, understanding the company we were getting involved in, and ultimately coming up with a plan that is the most detailed piece of work we’ve ever done in terms of a post-integration plan – that you have to take a perverse view of market conditions.
‘Because what can be viewed as the extreme can actually happen.’ As Nish narrates the tale of the last 14 months, he peppers his description with highly coloured words: market conditions were ‘perverse’, ‘extreme’ and ‘dramatic’. The financial modelling that the merger team carried out took into consideration ‘what ifs?’ and possibilities that allowed for a hike in the price of power from $40 per mega watt hour to around $100. In the event the turbulence was such that prices at one point hit a rate of $300.
‘The beginning of the year actually started down at $40 per mwh. And then about May time it spiked all of a sudden up to several hundred. But then it started to come back down again. And most people talked about some anomalies there to do with gas – there was a shortage of gas in the US, constraints on shipping and so on – and viewed that as a temporary blip.’
This wasn’t the end of the story. What occurred then was a combination of factors never experienced: gas prices were high; the early summer meant low availability of hydro power; and there was an increase in demand.
Growth in the states of California, Arizona, Nevada and Utah was 5% plus.
‘So you ended up with a range of factors that put price pressure back up.’ For the management team to have consoled itself with the idea that things couldn’t get any worse at this point would have been to reckon without the peculiarly involved and interventionist nature of US state politics, however.
‘The final extreme event was the reaction of the politicians in California. Against this background of increasing demand, shortfall in supply (because there hadn’t been enough focus early in the years post Californian deregulation to build generation) the politicians basically said as prices went up: “the customer should not pay for this”.’
‘Now what you have to do to get economic balance is you have to get demand going back down again. You have to send a message to the consumer, because that happens in any other form of competitive business.
And that wasn’t the end of the story. In November last year, PacifiCorp was hit by the failure of one of it generators. That factor alone hit the company with #450m in unforecast costs. Although he doesn’t duck away from the harsh reality of these market conditions, Nish is surprisingly matter of fact.
Because in spite of it all, some of these factors have worked in their favour.
‘We had a major plant failure at a time when the price was at the peak, so power became very expensive. However, although we have probably consumed an additional $450m of excess power costs we didn’t forecast, I probably can look at PacifiCorp and say it’s potentially more valuable than it was 12 months ago,’ he says.
‘Now why do I say that? We’ve already written off that $450m and we’re currently going through rate increases in all our states to recover that cost. So therefore we have got a good expectation of getting back a reasonable proportion of the money we’ve expended.
We have also commenced construction of additional new generation – there’s 750 megawatts coming on this year.
Importantly, the high power rates mean that PacifiCorp as a producer enjoys a position of strength when it comes to operating in the unregulated wholesale market. ‘Because the prices have remained high, the value of that generation has gone exceedingly high. So we’ve got the potential to lock in value. Now it will be interesting to see if the market hadn’t spiked last year, would we have made certain steps to put in place that generation.’
‘We’ve had a situation where, for example, on selling power to California, we stopped selling because of the credit risk. So we’ve next to no exposure to California. Some of the very large traders in the US have got several hundred million dollars in unpaid bills. One Sunday afternoon, we were actually swopping power and we did it on a barter basis – I’ll give you one mw, you give me two back, it was at so much of a premium. We actually got a call from a Californian utility to say “I would rather pay $2,000 per mwh, because I cannot find the power.” So we said: “sorry, we’re not going to sell you for cash”.’
‘And that was the extremes it had gotten to in terms of the brokenness of the marketplace. They basically let the economic balance of supply and demand get totally out of kilter. And it’s going to take a period of time to get back into kilter but during that time, we have to have had the opportunity to take advantage and that’s what we’re going to try and do.’
‘Certainly there’s a lot in the last 12 to 14 months that we would not have appreciated in terms of our pre-planning. It’s basically believing that anything is possible.
‘I think what people probably don’t appreciate for something like electricity, which used to be taken for granted, there are different economic circumstances underlying that mean there’s a lot of volatility coming through. Business cycles are a lot shorter and there’s greater volatility,’ he says.
It’s been a roller coaster ride, but not even the threat of recession is all bad news. ‘It’s actually quite perverse. Against the background of the power market in the west, we would actually benefit from an economic slowdown, because it would take the heat out of the load growth and so flatten the price curve. And therefore in some ways, an economic slowdown would take away risk. And also because PacifiCorp is a business that is under-earning and under-performing that wouldn’t actually hurt us.’
‘Now where the economic slowdown would hurt a utility would be if it went into extreme recession. And certainly I would not see that as being talked about that widely in the US.’
If the last year vindicates ScottishPower’s emphasis on planning, it also makes Nish aware that for the future they will have to raise their game when it comes to strategy.
‘All I’m trying to demonstrate is that the best laid plans have somehow to be stress tested – you have to believe the impossible can happen. Now we’ve probably got through 12 of the most difficult months we’ve had, although we probably believe we did the best job we could, we now have to set the standards to a far higher level of stress testing.’
For investor and company information go to www.pacificorp.com or the company’s website at www.scottishpower.plc.uk.
To see an interview with David Nish just after the merger a year ago visit www.accountancyage.com/Business/104868
WHEN POWER IS EVERYTHING
PacifiCorp, acquired for #2.5bn in 1999, makes up 45% of ScottishPower’s business and accounts for 40% of its employees. It operates throughout six states in north-west America: Utah, Wyoming, Oregan, California, Idaho and Washington. Each state is subject to its own regulatory regime and its own local market conditions. This can give the cross-border utility considerable management headaches. For instance, building a coal plant needs consent from six authorities.
That’s easy to achieve in coal-rich Utah but more difficult in environmentally-friendly Oregan. ‘The US is a very political place. One of our concerns when working on the PacifiCorp merger was the failure rate of UK to US mergers. Part of it is about how you work within the cultural/political/economic framework,’ Nish says.
ScottishPower wants to solve this by breaking the company into six retail utilities and a power generation company contracting power to the other states. ‘It gives these states choice. Oregan is environmentally friendly.
It likes hydro and wind, it hates coal. Utah is rich in coal reserves and it loves coal. So you end up saying to Utah, “you effectively have your own slice of resources. Do you want to build a coal plant?” ‘Because a coal plant brings with it a mine, jobs in construction and so on. We can turn to Oregan and say, “You like wind. We’ve just contracted for the biggest wind farm in the world to be built in Oregan.” It shows in an environment thought of as regulated and bureaucratic, we’re developing strategies to work with the circumstances of different states.’ If living with the US situation requires constant vigilance, reporting back to the City needs continuous communication. ‘From a City perspective, it’s been our most challenging time. The majority of the institutions and analysts that cover us are UK-based. If I go to investor meetings in the UK I get asked about US regulation. If I go to the US I get asked about what’s happening in the UK. We’ve had a fair amount of uncertainty built into our share price in the last 12 months. But we’re in an education process. Winning the argument will come over the next six to nine months.’