Upstarts: Energy Deregulation
A Shock to the System
Where do you buy your electricity? If you don't have a choice now, you will soon
Twenty years ago most Americans got their telephone service from Ma Bell (a.k.a. American Telephone and Telegraph) and their power from the local electric company. Today consumers can pick from among AT&T and roughly a zillion other telecommunications companies -- but most people still buy their electricity from a local utility.
Shocking, really. But that situation isn't going to last much longer. As the telecom industry did in the 1980s, the U.S. electricity industry is now undergoing deregulation. State utility commissions are unplugging their tight control on rates and allowing a range of new energy providers to enter the field.
For consumers the process hasn't been uniformly smooth. This past summer electricity users in San Diego and New York City were stung by price spikes after regulators removed long-standing rate caps as part of the deregulation process. Still, within five years, 90% of U.S. consumers will be able to choose where and how they buy their watts and volts, according to the Yankee Group, a research and consulting firm in Boston.
As you might expect, the Internet is making things interesting by providing brand-new ways for energy providers to reach consumers. And investors have certainly recognized an opportunity: venture-capital funding in energy-related companies rose from $150 million in 1999 to an estimated $300 million in 2000, according to Venture Economics, a research company. Deregulation appears to be sparking a whole new wave of start-ups.
Power to the people
Newly empowered consumers in New York City, for instance, can now buy electricity from SmartEnergy.com, which was founded in 1999 by a team that includes five former energy traders from the New York Mercantile Exchange. "We figured that there was a huge market in electricity and natural gas at the retail level," says SmartEnergy president and CEO Gautam Chandra. Someday, he says, Americans may buy their energy from familiar retailers like Wal-Mart or the Home Depot.
But it's likely that those retailers don't know much about the complex supply chain in the energy market. That's where SmartEnergy comes in. "We think of ourselves as a distributor," Chandra says. That means supplying retailers with the electricity and natural gas that they will in turn sell to consumers. SmartEnergy, based in Woburn, Mass., doesn't actually generate power. Instead, the company buys it directly from independent producers and is banking on its energy-trading expertise to save consumers at least 10%. (The energy is delivered to customers over existing infrastructure maintained by formerly monopolistic utilities.) So far, SmartEnergy isn't selling to retailers like Wal-Mart or the Home Depot, but it has struck up partnerships with newly emerging Internet energy retailers such as Essential.com and Energyguide.com.
Consumers can also buy directly from SmartEnergy, and the company offers features that it hopes will distinguish its product from that of traditional utilities. Call it commodity branding. "Customer service has been fairly nonexistent in the energy space," says chief marketing officer Jon Sorenson. With SmartEnergy, customers can use the Internet to sign up for service, reach customer-service agents, and pay their bills with a credit card. They can choose from different service plans -- such as one that lets them buy power at a fixed rate for 12 months and one that offers a rebate that rewards them for saving energy. They can even earn frequent-flier miles on United Airlines: 500 miles for signing up and one mile for every dollar spent thereafter.
SmartEnergy rolled out in New York in February and aims to be in five more states, including New Jersey and Pennsylvania, by the end of the year. Funded originally by its founders, SmartEnergy has since raised more than $10 million from outside investors. The company expects to be profitable in the third quarter of 2001.
SmartEnergy and other upstart providers still have a long way to go to make a dent in the market. As of June, only 2.2% of residential customers and 4.8% of business customers in New York State had switched from their old utility. And now, as the Yankee Group analyst Karl Jessen points out, SmartEnergy and its ilk are facing serious competition -- namely, from the NewPower Co., a potential Goliath energy provider that is funded by energy giant Enron.
On the plus side, this past summer's price volatility -- which temporarily raised electricity bills in New York City by as much as 30% -- gave SmartEnergy a bit of boost. While traditional utility customers were paying wildly varying market rates, SmartEnergy offered consumers a chance to lock in a favorable rate that would remain in place for a year.
A conduit for savings
For a lot of consumers, having to comparison shop for a commodity they've long taken for granted could prove to be quite a jolt. Or so Harvey Michaels figured when he and two cofounders started Nexus Energy Software Inc., based in Newton, Mass., three years ago. "The company's starting thesis was that consumers of energy don't know what's ahead, and that what's ahead is going to be reasonably complex," says Michaels. "But consumers' decisions are going to have a big impact on household budgets or the bottom line of small businesses." After all, he points out, energy can cost a homeowner $3,000 or more a year. "We're addressing a very large cost that people don't really think about" -- yet.
In his former life as president of energy-consulting firm Xenergy Inc., Michaels helped Fortune 500 companies analyze and reduce their energy consumption and save money. "If you're a homeowner or a small business, you can't afford to hire someone to do this," he says. "We saw software on the Internet as a great enabler, helping consumers to make smart energy choices." The result was Energyguide, which is the name Nexus Energy now goes under. At the company's Web site, homeowners or small-business owners can get an analysis of their energy costs by answering an online questionnaire. Based on their data, they receive suggestions on how to reduce those costs. Consumers can compare the energy providers available in their area, sign up for service, and buy products (ranging from fluorescent lightbulbs to energy-efficient space heaters) from Energyguide partners. The company collects a fee for everything sold through the site.
The company's earliest revenues have come from strategic partners, deregulated utilities that were suddenly in the position of having to court their old customers. For them, Energyguide is a service that they can offer as a goodwill-generating freebie to their customers. About 20 utilities pay the company a licensing fee to put the Energyguide software on their own Web sites or to distribute it on CDs. Energyguide also shares in any revenues it generates for the utilities. That solid partner base helped the company rack up revenues of just under $5 million last year. Recently, Energyguide has also broadened its partnerships to include about 20 nonutilities, such as personal-finance Web site Quicken.com.
Michaels estimates that the retail-energy market on the Internet could total $40 billion to $50 billion within the next five years. Energyguide is aiming for a tiny sliver of that. "We're a long way from nailing down what our share ultimately will be," says Michaels. "Probably in the hundreds of millions." But to get there, Energyguide will have to fight off challenges from rivals in the consumer-information niche, including ChooseEnergy Inc. In March, Energyguide raised $7 million from a group of investors led by GE Equity, primarily to increase sales staff and develop more partnerships with energy providers. "Going forward it's going to be a little more interesting," says Michaels.
Emily Barker is a senior staff writer at Inc.
Energy Goes Cellular
Along with more competition and -- theoretically, at least -- lower prices, energy deregulation is bringing some uncertainty to the nation's power grid. After all, California experienced controlled interruptions of service this past summer because utilities had stopped building power plants in anticipation of deregulation. That instability is especially bad news for any company that does business on the Internet, since it takes uninterrupted power to keep Web servers humming.
That's where Sure Power Corp. comes in. Sure Power uses high-tech fuel cells to turn hydrogen and oxygen into electricity -- a backup power source that the company claims is both environmentally friendly and available 99.9999% of the time. That availability level translates into a 1% chance of power failure over the course of 20 years, says cofounder and executive vice-president Art Mannion. Although fuel cells are similar to batteries in some ways, they never run down as long as enough fuel is present.
Sure Power, based in Danbury, Conn., is betting on a growing need for dependable backup power. Its target market includes data centers, Web-hosting companies, medical facilities, research laboratories, high-tech manufacturers, and any other business that can't afford to have its computers or equipment go down for even an instant. Using cells manufactured by a partner, ONSI Corp., Sure Power will install several dozen fuel cells for each of its customers and offer maintenance services for those setups.
The installations aren't small or cheap: each fuel cell is about the size of a sport-utility vehicle, and according to Mannion, a typical contract could run into the tens of millions of dollars -- hardly a price point that most small businesses or individual homeowners would fall into. But Mannion insists that for a 10-year span, Sure Power's system can cost two-thirds to one-half of what traditional power-backup systems would run.
So far, with seven employees, Sure Power has just one customer -- First National Bank of Omaha, which hired Sure Power in 1998 to provide uninterrupted power for its credit-card-processing operations. Sure Power's revenues for both 1999 and 2000 hover around $2 million, says Mannion, adding that the company is currently negotiating contracts worth up to $50 million each.
In landing the First National contract, says Mannion, it helped that some of the bank's executives were familiar with fuel cells. Unfortunately for Sure Power, however, not every customer is going to be so knowledgeable. "Our biggest job is educating the public," he says.
Deregulation can be confusing. To make some sense of the muddle, we spoke with Hugh Holman, a senior analyst at CIBC World Markets who's been tracking energy deregulation since 1997.
Inc.: How did deregulation get started?
Holman: The power industry is really the last remaining large monopoly. We've broken up almost everything else. California opened its market in 1998, and it looks as though the other states will follow.
Inc.: How big is the potential market?
Holman: Huge. The power industry is one of the largest in the United States. Revenues are more than $200 billion a year. Opening it to competition is going to have pretty dramatic ramifications throughout the economy.
Inc.: Is deregulation spawning many new companies?
Holman: There are a lot of newcomers. Some are power marketers who don't generate any power themselves. They just buy power and resell it. A lot of them are selling on the Internet, which is a natural because the wires for providing electricity are already in place. These companies don't need to build warehouses and so forth, like Webvan or Amazon.com, because the power can be delivered over the existing infrastructure.
Inc.: But how can they make money in what's historically been a low-margin business?
Holman: You have to customize your product, differentiate what you're selling. Green Mountain Energy, of South Burlington, Vt., has done that by offering environmentally friendly power, branding it, and selling the environmental attributes of the energy it's providing. In some cases it's going to be reliability that sells. Users like Amazon.com, eBay, and all of the other Internet service providers can't be out of power. So they require highly reliable service, and they are willing to pay for it.
Inc.: Are consumers ready for deregulation?
Holman: I think the proof of the pudding will be whether people switch suppliers. In Pennsylvania they've had a very successful program to educate consumers. As much as a third of all the electricity consumed in Pennsylvania is now being purchased from an alternative supplier. So in that sense deregulation seems to work: people do seem to switch suppliers when given a choice.
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