Profits in utilities range dramatically from country to country and region to region. This is partly due to barriers to entry and other legislative restrictions on competition, both laterally and horizontally. In 2019, the average net profit margin in the utilities sector typically ranged from 4.9%-11% based on statistics from CSI Market.
To gain a perspective on the type of range in profit margins across the sector, compare the December 2019 data between two different electric utilities: Spark Infrastructure Group and the Atlantic Power Corporation. Spark Infrastructure Group supplies electric power and infrastructure across Australia and reported a net profit margin of more than 29%. In contrast, the Atlantic Power Corporation runs generation projects across the Eastern United States and Canada and had a net profit margin of 16.5%.
- The average profits in utilities usually varies dramatically.
- The average net profit margin in this sector ranges from 4.9%-11%.
- It is difficult for competitors to enter profitable areas in the utility sector.
Public Utilities and the Ratemaking Process
Despite these wide ranges, the utility sector as a whole experiences relatively high profit margins. 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 United States use utility ratemaking 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 ratemaking process is another reason why utility companies tend to become natural monopolies. Public utilities required to go through the ratemaking process in the United States typically include telecommunications providers, natural gas providers, electricity companies, and railroads.
A Signal to Companies and Entrepreneurs
Typically, profits act as a signal to other companies or entrepreneurs that a valuable service is being provided at above cost in a given region. This attracts competitors and, eventually, works to reduce profits and improve products. This is difficult in the utilities sector, and history is riddled with politicians across the world alleging that margins among energy giants are too high.
The ratemaking process for public utility providers has five goals: 1) attracting capital to the sector, 2) controlling prices, 3) incentivizing efficiency in production and distribution of utilities, 4) controlling demand for utilities or rationing them to consumers, and 5) redistributing wealth from consumes to utility owners and between classes of consumers.
Traditionally, regulators use the following ratemaking formula to determine a utility provider’s revenue needs: R = O + (V – D)r. R is the utility’s rate level or revenue requirement. O represents the utility company’s operating expenses. V represents the value of the utility’s intangible or tangible property. D represents the provider’s accrued depreciation, and r represents 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.