Profits for utility companies range widely from country to country and region to region. In part, due to barriers to entry and other legislative restrictions on competition, both laterally and horizontally. In 2019, the average net profit margin in the utility sector was 9% based on data from CSI Market. For the second quarter of 2020, the average trailing 12 months (TTM) net profit margin was 9.5%.
As far as other margins, the utility sector had an average gross margin of 60% for 2019 and earnings before interest, taxes, deprecation, and amortization (EBTIDA) margin of 22.7%. The sector's gross margin for the TTM as of Q2 2020 was 67%, and EBITDA margin was 22.3%.
To gain a perspective on the range in profit margins across the sector, we can compare the most recent profit margins of two different electric utilities operating in different parts of the world. Spark Infrastructure Group and Duke Energy (DUK). Spark Infrastructure Group supplies electric power and infrastructure across Australia and reported a net profit margin of 29% for 2019. In contrast, Duke Energy runs generation projects in the U.S. and Canada and had a net profit margin of 15%.
- The average net profit margin in the sector was 9% in 2019 and for the trailing 12 months (TTM) as of Q2 2020 was 9.5%.
- The average gross margin was 60% in 2019 and the average earnings before interest, taxes, depreciation, and amortization (EBITDA) margin was 22.7%.
- The average profits for utilities can vary based on where the company operates, given regulatory differences.
- Regulations and the high cost of entry into the industry make it difficult for competitors to enter profitable areas in the utility sector.
- However, rate-making does restrict the profit margins of utilities.
Public Utilities and the Ratemaking Process
Despite wide ranges among different countries, the utility sector experiences relatively high-profit margins in the U.S. Utility companies run de facto monopolies in the regions where they operate, making it difficult for competitors to move into profitable areas and apply competition for energy revenue. Part of this is due to the extremely high levels of capital investment necessary to supply energy, but most of it is from local and federal government restrictions on new projects.
State governments in the U.S. use utility rate-making to fix the prices that utility companies can charge to customers. This also necessarily restricts utility companies’ profit margins. The legal mandate for these providers to go through the rate-making process is another reason why utility companies tend to become natural monopolies.
Public utilities required to go through the rate-making process in the U.S. typically include telecommunications providers, natural gas providers, electricity companies, and railroads.
Typically, profits act as a signal to other companies or entrepreneurs that a valuable service is being provided above-cost in a given region. This attracts competitors and, eventually, works to reduce profits and improve products. However, given regulations and high startup costs, this doesn't necessarily hold true for the utility sector.
The rate-making process for public utility providers has five goals:
- Attract capital to the sector
- Control prices
- Incentivize efficiency in production and distribution of utilities
- Control demand for utilities or ration them to consumers
- Redistribute wealth from consumers to utility owners and between classes of consumers
Traditionally, regulators use the following rate-making formula to determine a utility provider’s revenue needs:
- R = O + (V – D)r
- R = the utility’s rate level or revenue requirement
- O = the utility company’s operating expenses
- V = the value of the utility’s intangible or tangible property
- D = the provider’s accrued depreciation
- r = the rate of return that the utility company is allowed to receive on its capital investment
Because it allows the utility company to receive a rate of return on its capital investments, the traditional model encourages utility providers to invest more capital into their operations—the more capital the utility company and its investors put in, the bigger the returns.