Bob Frenzel is the CFO at Xcel Energy (XEL), one of the largest and greenest utilities in the US. Tune in to the Buyside podcast to hear Bob breakdown everything you’ve wanted to know about utility investing. Topics discussed include the regulatory process, renewable energy, carbon-free target, replacement cost, and how to value utilities.
In this interview, you’ll hear Bob talk about some of the elements that are required for a utility to be, well, a great utility. You’ll also hear about Xcel’s carbon-free ambitions and what the company will have to do to achieve their targets. And here’s a spoiler, achieving a carbon-free generation portfolio isn’t solely based on wind, solar, and batteries. The solution is actually much more complicated than pundits would like you to believe.
Bob also does a great job of describing just what the regulatory process is like for a utility, how a utility justifies spending money that we, as ratepayers, essentially pay for, and Bob also talks a little about how a utility determines the rates that we as customers must pay. As someone who likes to talk about the future of electric generation and utilities, having Bob on the program is a real treat, but for me, there are two really interesting topics that are discussed.
The first is the fact that regulated utilities don’t generate a ton of free cash flow. That’s because they’re constantly reinvesting into the grid. The second relates to replacement cost or replacement value. I won’t spoil that last one. It’s a doozy, at least for the value investors out there!
If you’re interested in learning more about utilities, you should check out the interviews with Vistra Energy‘s CEO Curt Morgan, NRG Energy‘s CFO Kirk Andrews, Spark Energy‘s CEO Nathan Kroeker, and Pattern Energy Group‘s CEO Mike Garland.
Interview Transcript
Participants
Bob Frenzel, CFO of Xcel Energy (XEL)
Nate Abercrombie, The Stock Podcast
Interview Transcript
Nate: Bob Frenzel, thank you so very much for coming onto the podcast. It’s a pleasure to have you on the program.
Bob: Thanks, Nate. It’s great to be with you, too.
Nate: Welcome to Denver, by the way.
Bob: It’s great to get to Denver periodically. We have substantial operations here.
Nate: I start out all of these interviews just asking about background. If you wouldn’t mind just sharing a little bit about yourself and how you got into the business.
Bob: Sure. Happy to. I can’t actually believe that it’s been three years since I joined Xcel. I came here from Texas where I was the CFO of a generation company, but my education and first job were really in engineering. I was an industrial engineer in college. I was a nuclear engineer in the Navy where I ran nuclear power plants on aircraft carriers. You know, between those two, I spend some time in graduate school getting an MBA and working on Wall Street with Goldman Sachs advising energy and power clients; and ultimately, one of my clients hired me; and even Xcel Energy had been a client before, so it’s great to come back to companies that you know, and work with people that you’ve worked with in different parts of your career.
Nate: That was Luminant?
Bob: Yeah, that was Luminant Energy where I was the CFO; and I also spent some time at the parent company, Energy Future Holdings, where I ran corporate development and strategy for the company for about three years.
Nate: Can you just provide us a little history of Xcel? Anything you’d like to share, but just some background of what Xcel does, where they operate, and just how they came together? Because, as I understand it, there were some mergers and acquisitions in the past that created what is today Xcel Energy, one of the largest utilities in the United States.
Bob: Yeah. Xcel, as we know it today, is really a holding company that operates four regulating utilities, gas and electric, and the combination of Xcel Energy happened over the course of probably two significant mergers in the last 25 years: one that combined our Southwestern Texas and New Mexico businesses with our Colorado business to form a company called New Century Energies; that company merged with Northern States Power, which is our Upper Midwest business, to form Xcel as we know it today. Xcel, broadly speaking, is 100% rate regulated electric and gas utility. We operate across eight states and 15 retail jurisdictions to deliver gas and energy to our customers.
Nate: How much of your business is gas versus electric?
Bob: We have three and a half million electric customers and two million gas customers; but when I think about it from a revenue or an income or an invested capital perspective, we’re about 85% electric and about 15% gas on those metrics.
Nate: Is one business more profitable than the other? Do you get better treatment, rate treatment, for electric versus natural gas? You know, I interviewed Spark Energy, which is a retail electricity company, they operate nationwide, and they described their electric businesses being just less profitable, and customers being less sticky than their natural gas business. Now, I know you’re regulated, so it’s a different dynamic, but is there a big difference in terms of either profitability or just your ability to grow between electric and natural gas?
Bob: I think about electric and natural gas as having similar earnings opportunities. I think the invested capital in our electric business is just so much larger than the capital in our gas business. When you think about how regulated utilities have that income, it’s generally around a return on invested equity; and our invested equity in our electric business … because of the scale of both the generation fleet, the transmission fleet, and the distribution fleet … is such that we have more earnings and more invested capital. The actual return on equity for the gas and the electric business is reasonably equitable.
Nate: Could you just characterize the earnings from transmission, distribution, and generation?
Bob: You know, Nate, the way I think about is where have we invested capital, and where are we earning a return on that capital. When I think about our rate base or net plant, we have about $35 billion in net plant; roughly half of that is transmission and distribution, a third of that is generation, and the rest is either our natural gas system or other invested capital.
Nate: Could you just talk about the different geographies? You mentioned the different states. So, you operate in Minnesota; you operate in Colorado. You have, I think, eight states that you operate in today?
Bob: We serve customers in eight states, in Wisconsin, Minnesota, North and South Dakota, Colorado, Texas, and New Mexico. When I think about the composition of our earnings power, about a third of it is in Minnesota Electric, about a third of it is in Colorado Electric, and a third is in all the other jurisdictions combined. Clearly, our biggest drivers are electric customers in both Minnesota and Colorado.
Nate: You’re the first regulated utility to come under the program, so thanks for that; but could you describe how a really good regulated utility is run? I can tell you that from the outside looking in, you talk to people who are familiar with utilities and they just think, “Oh, well, it’s a pseudo government body,” in the sense that it’s overseen by the commission, and the people that run the business are almost like bureaucrats, but I certainly don’t think that’s the case. I think that good utilities are run by really good management teams, but I would love to hear your thoughts on just how a really good regulated utility is run, and what are those characteristics of a really good regulated utility?
Bob: When I think about great utilities, I think about excellent operations and an excellent safety culture, high reliability, low cost; and increasingly in this day and age, a cleaner more renewable energy supply. When I think about Xcel Energy, we try to hit on all five of those characteristics as we operate our company. We come to work every day with a competitive mindset. We think of our customers as having choice. We want to be their provider of choice, and so we strive to deliver them products and services at an affordable price with an increasingly lower and lower emissions profile.
Nate: Yeah. It’s interesting you mentioned choice. There’s a lot of changes going on right now in the industry with respect to choice, especially on the West Coast. Even here in Colorado you see Boulder trying to carve themselves out so that they can be 100% renewables. I just read an article the other day about Tri-State … which is on the other side of the Rockies, but still in Colorado … where the municipalities and the co-ops would like to have cleaner energy, and so they’re considering other options, and I’m just curious: from your perspective, where are you seeing it? I mean are those pressures, from your perspective, for Xcel, in terms of trying to find some ways to mitigate customers leaving Xcel from a generation perspective? Obviously, if they’re still in your service area, they’re still gonna pay for transmission and distribution; but from a generation perspective, and the choice dynamics that are going on, how is Xcel dealing with those issues today?
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