Must-know: Regulated versus unregulated players

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Sep. 11 2014, Updated 9:00 a.m. ET

Regulated versus unregulated players

The electric utility industry is partially unregulated. Only a few states don’t regulate electricity generation. Most of the sector is still regulated. Companies usually operate with a combination of regulated and unregulated activities.

Unregulated plants are riskier than regulated plants. They don’t offer firms any protection against price fluctuations. However, they capitalize when the demand is high. This attracts higher margins. Recently, there have been a lot of merger and acquisition (or M&A) activities in the industry. Companies want to focus on their strengths instead of diversifying their assets based on regulated and unregulated entities. Duke Energy (DUK) sold its unregulated business to Dynegy (DYN) this month. DUK wants to focus on its regulated business. The regulated business forms the majority of its operations. For Dynegy, this deal increases its unregulated generating capacity to 26,000 megawatts (or MW).

In March, NRG Energy (NRG) bought Dominion Resources’ (D) unregulated retail marketing business. Both companies want to strengthen their core business. NRG and D are part of the Utilities Select Sector SPDR (XLU).

The earnings and profitability of the unregulated entities are volatile. They depend on weather and energy demand. Changing temperatures increases the demand for electricity. This results in higher prices. Low swings in weather conditions causes the price of electricity to decrease.

Regulated companies are immune to the weather. Their pricing is based on a markup to cost set by the regulators.

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