Maintaining gross operating margins when electric utility revenues decline

At the start of the latest fiscal operating year, your electric utility could likely cite any number of favorable areas (e.g,, on-track strategy, a full capital project pipeline, and industrial customers operating at maximum capacity). Now the current environment is different and no one knows how long it will last.

What is certain: Declining power sales will directly impact gross operating margins.

It’s time to place full attention on the impact to your utility’s operating income, which generates the cash flows for operations, debt service and capital expenditures.

Cost map for electric utilities

Costs for electric utilities, like any business, are a combination of fixed and variable costs. As illustrated in the image below, fixed costs are the infrastructure to size the electric system and connect customers, while variable costs are the cost of fuel or purchased power and system maintenance.

How are these costs recovered from your customers?

Power cost recovery from utility customers

Electric utility customer charges are a combination of fixed customer charges (monthly or kW charges) and variable customer charges (kWh charges). Traditionally, electric utilities have not fully recovered the fixed charge component of power costs in the customer's fixed monthly or kW demand charges. The remaining fixed costs then are allocated to the kWh energy charge. See the graph below depicting the bill structure for a common residential customer:

Although kWh sales are variable revenues generated by variable costs (e.g., fuel, purchased power), a profit margin for fixed cost recovery is built into the rate for each kWh. Declining kWh sales (as in a customer downturn) will erode the utility's gross profit margin. The electric utility must still pay fixed costs to its power supplier (or if the utility generates its power, the fixed costs are depreciation and debt service). Therefore the utility now has a cash flow squeeze as higher fixed charges paid out to suppliers do not match reduced cash flow coming from customers for those fixed charges.