Three new studies–by the US Energy Information Administration (EIA), and the consultancies Deloitte and IHS Energy–further confirm that significant size and scale, as well as location, will be the key factors that determine which utilities will be the best long-term investments.

As we have reported over the past year, utilities are grappling with the challenges posed by new technologies and changing market dynamics at a time when electricity use is at an all-time low.

Indeed, the wave of mergers and acquisitions announced in the sector over the past few months illustrates a new strategy where large utilities in low-growth service territories have been buying smaller, higher-growth utilities.

These mergers are being motivated by a belief that the transmission and distribution infrastructure will become increasingly valuable as the grid accommodates more distributed technologies and new high-tech systems are adopted to manage these resources. In fact, the latter could be a future source of revenue that offsets declines in usage.

To a great extent, the analysis in the aforementioned studies supports this contention. And the inevitable conclusion is that only the utilities with the financial strength to invest in their wires businesses will be able to capitalize on this opportunity.

Of course, a firm that acquires a smaller, high-growth utility can buy itself some time, but in the end that may not be enough to overcome declining growth in its own service territory.

And such a strategy is limited by the number of high-growth service territories that can be acquired through a merger.

Chart A: Average Annual Growth Rates for Service Territories

Source: Energy Information Administration 

That’s why we could see more so-called “mergers of equals,” where large utilities merge with other large firms to achieve even greater economies of scale. As a utilities investment banker at a recent industry conference I attended put it, “The trend is toward oligopolies.”

And the reason this will become necessary is pretty straightforward. Demand for electricity is in decline, and this trend is expected to continue. At the same time, the price of electricity is expected to rise as a result of a decline in fuel diversity.

Only a few businesses have the economies of scale and the balance sheets to adapt to these changes. This is essentially the path most mature industries take when they are beset by disruptive technologies. And the three studies confirm that the utilities industry is about to undergo a dramatic transformation.

Future Shock: Less Usage, Limited Growth

Of the three studies on the utilities industry, one documents how consumers are using less energy, which is believed to be a permanent trend. Another describes how the trend toward less diversity in energy (i.e., higher reliance on natural gas and renewables) means electricity will cost more. Finally, the third shows what a low-growth environment would mean.

In Deloitte’s recent study, “Informed and In Charge,” the firm’s survey of electricity consumers gets to the heart of the problem for utilities when it comes to the decline in usage.

“On the consumer side, an attitude of ‘resourcefulness’ [has] become entrenched, and consumers, by and large, indicated they did not intend to revert back to their prerecession electricity consumption patterns. A sustained movement toward thoughtful, deliberate energy consumption [is] underway.”

Businesses also reported reducing their electricity consumption by 12 percent on average in 2013, following reductions of 8 percent and 9 percent in 2011 and 2012, respectively. While cost-cutting is still the primary driver, Deloitte says companies increasingly see energy management as a way to lower risk and spur growth.

Chart B: This Era’s Decline in Electricity Use Is Unprecedented

Source: Energy Information Administration

This view is reflected in the growing number of businesses that are incorporating energy management into their overall corporate strategies, and at a more granular level, into their supply requirements and operations planning.

Deloitte found companies are also seeking greater control of components of the energy value chain, “with more than four-in-ten (44 percent) … reporting they generate some portion of their electricity supply on site.”

On the fuel-source front, IHS Energy’s recent report, “The Value of US Power Supply Diversity,” warned:

“ … the relative unpopularity of coal, oil, nuclear, and hydroelectric power plants (compared to renewables), combined with the missing money problem, tightening environmental regulations, and a lack of public awareness of the value of fuel diversity create the potential for the United States to move down a path toward a significant reduction in power supply diversity.”

In modeling what a less diverse energy resource mix would look like, the consultants found, “The power price increases associated with the reduced diversity case would profoundly affect the US economy. The reduced diversity case shows a 75 percent increase in average wholesale power prices compared to the base case.”

Your correspondent fully believes less fuel diversity is likely to become the reality, as it is a nearly impossible task to site nuclear and coal plants in an era of heightened environmental consciousness.

And the impact would be quite clear on consumption. IHS Energy predicts that in the event of a less diverse energy mix, consumers would bear the brunt of the effect through higher power prices.

The higher price of electricity would erode power demand over a period of 10 or more years by around 10 percent. The IHS study also noted that not only will consumers face higher electric bills, but some portion of the increase in manufacturers’ production costs will ultimately be passed on to consumers through higher prices for goods and services.

Moreover, the third report, by the EIA, modeled what a low electricity demand future might look like. The reason one might surmise the government believes such a scenario is part of the new normal, or at least worthy of inquiry, is because the EIA observed that year-to-year demand for electricity has decreased in five of the last six years, while prior to 2008, demand declined only twice in 58 years.

While all these studies, with the exception of the survey, are forecasts and predictions, investors would be wise to identify those utilities that have the best chance of weathering the changes that have been outlined above. In our opinion, that means investing in firms that boast strong balance sheets, robust infrastructure, and have devoted significant investment in upgrading and modernizing their transmission and distribution systems.