As the new Duke Energy prepares to begin corporate life this week, after 18 months of regulatory filings and after-hours rulings, winning approval might start to look like the easy part.
In the years ahead, Dukes leaders will have to mesh two corporate cultures into the nations largest utility and trim 1,860 jobs. They will spread $650 million in operating savings among Carolinas customers while raising rates. Theyll decide the fate of a crippled nuclear reactor in Florida and try to settle the huge cost overruns of a new plant in Indiana.
The $32 billion merger with Progress Energy will give Duke the financial heft and political muscle that make hard problems a little easier to solve. It culminates decades of growth through mergers and acquisitions for both companies. North Carolina regulators approved the deal Friday; South Carolinas utilities commission meets on the final piece Monday.
Wall Street is bullish on the deal, which diversifies Dukes earnings and power sources. Dukes stock price has surged 30 percent, and Progress stock 35 percent, since the merger was announced in January 2011.
For Dukes 7.1 million customers, its a mixed bag. Theyll see a power company thats leaner and, Duke hopes, more efficient. It will be able to borrow money at lower rates, saving money for customers.
But customers pay for what utilities build, and Duke is on a construction binge. After decades of little change, power bills are going up.
Old coal plants, some dating to the 1920s, will be shut down rather than upgraded to meet new environmental standards. Duke and Progress are building new natural-gas plants to take advantage of cheaper, cleaner fuel. Both want to build nuclear plants price tags estimated in the $10 billion range but may share new ones with other utilities.
All of that is going to drive our prices up, Duke CEO Jim Rogers told the Observer. The reason you do a merger is to make you stronger financially, but also because anything that offsets a rise in price is a good thing.
Before the merger, Duke already had invested more than $3 billion in three new power plants. It won a 7 percent North Carolina rate hike in January to pay for them, raising typical customer bills $7, and will ask for another this summer. This fall, Progress, which has nearly $2 billion in new plants to pay for, will seek its first base-rate increase since 1988.
For most Carolinas customers, the $650 million in fuel savings Duke will share with them over five to six years will come to about $1 a month.
The new Duke Energy will be the worlds second-largest private utility, the company says. If it were a nation, its generating capacity would rank 14th-largest globally, just behind South Korea. Rogers jokes that hes ruled out applying for membership in the United Nations.
The combined political action committees of Duke and Progress would be the states largest, based on past spending, the watchdog group Democracy North Carolina has reported. Duke is likely to be interested in nuclear plant financing, environmental rules and carbon legislation.
Environmentalists insist that, with its new clout, Duke takes on a larger obligation to replace its coal plants with renewable energy.
Duke has so much power that if they went in a new direction, it could change everything, said Jim Warren, director of Dukes most dogged merger opponent, the N.C. Waste Awareness and Reduction Network.
Dukes to-do list
While the old Duke prided itself on its engineering savvy, power plants on the northern and southern ends of its new range show how wrong construction projects can go.
In Indiana, the Edwardsport coal-fired power plant has leading-edge technology that will produce low emissions but is more than $1 billion over budget. Dukes former No. 2 executive and Indianas top utility regulator lost their jobs after chatting by email about it.
In Florida, Progress Crystal River nuclear plant needed large new replacement parts called steam generators. Progress punched a hole through the reactors thick concrete containment structure to replace the components. Now the concrete is failing.
Repairing the damage is estimated to cost up to $1.3 billion. Progress is negotiating with insurers but could end up retiring the reactor.
Crystal River loomed as Dukes directors considered the Progress deal. The merger agreement gave Duke the option of walking away if costs rose enough to affect about 15 percent or more of the combined companys value.
We dont perceive it as being that big a problem, so we dont perceive our right to walk has been triggered, Rogers said. So the short answer is, this is in the ordinary course of business that this has happened, and well deal with it.
He ranks it No. 1 on the new Dukes to-do list.
Destined for marriage?
The corporate marriage of Duke and Progress seemed inevitable to some of the people who have worked for the companies.
Both were born more than a century ago. Duke built its first hydroelectric plant on the Catawba River near Charlotte. Progress oldest still-operating hydro plant dammed the Pee Dee River, just 65 miles east.
Duke electrified the cotton mills that fueled Charlottes industrial growth. Progress became synonymous with downtown Raleigh, moving only three blocks, from Martin to Fayetteville streets, since 1908.
From its beginnings, Duke prided itself on building its own power plants and running them well. Engineers or linemen could expect to spend their careers there.
The motto was, Do it yourself and do it right, said Cathy Roche, a retired senior vice president who joined Duke in 1983. We looked down on the companies that hired the big construction firms to build nuclear plants, with huge cost overruns.
Duke and Progress have had separate retail territories in the Carolinas but competed for wholesale customers. They also helped each other make repairs after storms in the turbulent Southeast.
Through the decades, both grew by combining with other companies. Now theyre part of a national trend. In 1995, 98 investor-owned U.S. utilities operated. Last year there were 55.
Duke and Progress dabbled in natural gas as deregulation swept through the industry in the 1990s, but both have refocused on electricity.
Progress is considered the more conservative company.
It now owns only regulated businesses that provide service to state-designated territories, a model investors regard as less risky. Nearly one-quarter of Dukes revenue last year came from unregulated commercial businesses, such as its western wind farms and international division in Latin America.
How merger talks began
Progress began talking about potential mergers with two unidentified utilities in 2009, according to securities filings. Duke identified Progress as a potential partner the next year.
An intermediary, Duke financial adviser JPMorgan Securities, put the companies in touch.
Both companies envisioned greater financial strength as a combination, including access to capital needed to build new nuclear plants. The Progress board would get their chief executive, Bill Johnson, as the new Duke CEO, and faster earnings growth. A move toward more regulated businesses appealed to Duke directors.
Rogers, then Dukes CEO, called Johnson in July 2010 to ask for a meeting.
Over the following months, the companies sparred over the number of Duke shares to be swapped for each Progress share and the composition of the board. Negotiations continued until the eve of Jan. 8, 2011, when the merger agreement was signed.
Progress investors will get 2.6125 Duke shares for each of theirs and will own 37 percent of the combined stock. Duke will hold 11 of the 18 board seats and five of the top nine officers under Johnson and Rogers.
Phone calls came from other potential acquirers, to both companies, hours before Duke and Progress signed their deal.
2 cultures must become one
Now the new Duke, with more than 29,000 employees across six states, must make two cultures one.
Its not just about your asset and operational mix, its about how you do business, Rogers said. Theres a difference in the how and we need to work together to find the common how going forward.
Some Duke workers contend the new company will be tilted toward Progress leadership, although executive charts roughly parallel the companies relative size.
There is a general concern over why the Duke board of directors and Jim Rogers are allowing Progress to come in and run so much of the company when ultimately, we are bailing Progress Energy out, one employee emailed the Observer last week.
Johnson, the new Duke CEO, says the utilities are more alike than not.
Theyre not so much cultural (differences) as style, maybe, he said. For example, Duke has a much broader business mix and they tend to think about a lot of issues, and we tend to think only about the utility business. Our scope of focus is a lot narrower, which allows us to really just focus on just one thing.
Thats the difference between the two management teams that the Progress folks are going to have to adjust to, because all of a sudden were a lot broader and bigger.
Johnson says hell work to soothe a workforce thats jumpy after a long merger process that left some unsure whether theyll have jobs.
True impact of mergers
Studies of past utility mergers show that predicted operating savings are often hard to achieve. Combined companies may not find real economies of scale if theyve already slashed costs before merging.
Pretty consistently, you could characterize utilities as putting forward claims that turn out to be optimistic, said Peter Schwarz, a UNC Charlotte economics professor who studies the electricity industry. The difficulties of operating the merged companies have typically been underestimated.
Schwarz, who has researched electricity pricing for Duke, said the ultimate test of the mergers impact is whether the companys costs are lower than they would have been. If they are, he said, consumers as a whole should benefit.
Even then, he added, some customers could pay more.
Duke and Progress will operate separately in the Carolinas for a few years. Dukes North Carolina rates are now lower than Progress, but the rates will have to be roughly the same once the Progress name disappears.
North Carolinas Public Staff, which advocates for retail customers, did its own studies of whether the $650 million in post-merger fuel savings the utilities projected are likely to be accurate. The staff will assess other operating savings when rate cases are filed this year.
Theyve got every incentive in the world to achieve all the savings, said Gisele Rankin, a Public Staff lawyer. And if they dont achieve them, well ding them in the rate cases.
The N.C. Utilities Commission, in approving Dukes 2006 merger with Ohio-based Cinergy, ordered Duke to return 42 percent of its expected savings to customers.
That translated into a one-year, $117.5 million rate cut.
For decades, utilities used mergers to grow. Now they more often see combinations as a way to stay profitable amid slumping demand while building new power plants and upgrading older ones.
The logic has changed from what mergers used to be about, said Pattabi Seshadri, a Dallas partner with The Boston Consulting Group in Dallas. It used to be about bigger scale, growth and access to different markets. Now its more defensive in preserving balance-sheet strength and building financial flexibility.
Utilities that overpay for acquisitions, cede too much to regulators or dont find post-merger efficiencies can fail to add value, studies show.
An analysis by the global management consulting firm found that fewer than half of the utility mergers from 1997 to 2005 met their savings goals. Total shareholder returns typically fell after mergers.
Despite that, the group says merger opportunities await. Five utility mergers were announced in 2011, including the Duke-Progress deal.
Rogers predicts Duke will be in no hurry to make more acquisitions.
But you have to be opportunistic, he added. Thats one of the lessons I learned, that you have to be opportunistic in what may come your way.