Cheap power may be good for businesses trying to cut costs, but it hasn’t been so good for Edison International.

The Rosemead energy company has been hit hard over the past year by cheap prices that utilities and other customers pay to its power generation subsidiary, Edison Mission Group. This drop in power revenue, due in large part to sliding natural gas prices, was a major factor in Edison’s weaker-than-expected year-end earnings and lower guidance for this year.

“Edison Mission Group faces weak power market fundamentals in the year ahead,” Edison Chief Executive Theodore Craver said when earnings were released late last month. “But we see positive value in the business as power market fundamentals improve.”

Edison Mission Group operates 40 power plants in 13 states, mostly in the Midwest, and lower energy costs were the biggest factor in the unexpectedly large 82 percent drop in EMG’s fourth quarter net income to 3 cents per share from 17 cents per share the year earlier.

Supplies of natural gas have increased dramatically over the last two or three years, driving down prices. Supplies rose as massive shale deposits have been tapped and the use of hydrofracking has spread. (In hydrofracking, pressurized water is injected into rock formations in order release gas.)

“The decline in natural gas prices was the major story of 2010,” James Dobson, analyst with Memphis-based Wunderlich Securities Inc., said in a utility industry overview. “Since wholesale power prices, which were already under pressure in early 2010, are driven at the margin by natural gas prices, wholesale power prices were pressured lower through 2010.”

Edison Mission Group was hit hard in the fourth quarter by the expiration of three-year contracts – known as hedges – that the subsidiary had signed with utility companies to provide power. Edison Mission spokesman Douglas McFarlan said some of those contracts were signed in 2007 when power prices were at a peak and no one expected they were coming down.

Utilities had locked in prices in anticipation of continued hikes, but that turned out to be a bad bet for them when prices went down. Edison Mission did well until the contracts began expiring and the new electricity sales yielded less money for Edison Mission.

It may get worse. McFarlan said the bulk of the contract expirations came at the end of 2010, which means that this year, replacement contracts will lead to even lower revenue for Edison Mission.

“This is a cyclical downturn,” McFarlan said. “We’ve been through these before and they will happen again.”

McFarlan said Edison Mission has dealt with lower revenue by cutting costs. In 2009, as the downturn in power prices began, the subsidiary cut 15 percent of its management staff.

Companywide net income fell 22 percent in the fourth quarter to $166 million. A prior-year tax settlement and other one-time charges were other factors in the earnings decline. The earnings drop at Edison Mission offset a relatively strong performance by utility subsidiary Southern California Edison.

Shareholders seemed to take the earnings in stride. The stock rose in the days following the earnings report.

Lower revenue and falling profits aren’t the only challenge the company is facing.

Edison Mission also has to retrofit its power plants to meet environmental regulations. Among the actions the company is taking are installation of scrubbers and conversion to cleaner-burning fuels. The company is expecting to spend $150 million to retrofit its six plants in Illinois to meet state environmental standards that take effect next year. But the subsidiary may also have to spend another $1.2 billion to upgrade those same plants to meet even tougher emission limits that go into effect in 2018.

“Our primary strategy is looking for the most cost-effective solutions for environmental retrofitting,” McFarlan said.

Grid costs

Meanwhile, Southern California Edison plans to spend more than $4 billion a year for each of the next three years to maintain its aging power transmission grid.

SCE is also spending hundreds of millions of dollars building new transmission lines to carry electricity generated by solar, wind and geothermal projects in remote locations to the grid.

Russ Worden, a director at the utility, said the grid expenditures are the major cost factor behind SCE’s bid for a $1.6 billion rate increase over the next three years. That bid, known as the general rate case, is now before the state’s Public Utilities Commission.

Consumer advocate organizations have new clout: Gov. Jerry Brown recently appointed a consumer advocate, attorney Mike Florio, and another consumer ally, law professor Catherine Sandoval, to the five-member PUC.

Worden said Edison hopes the PUC will issue its approval before the end of this year.

But the uncertainty surrounding the rate case has been cited by several industry investment analysts as a risk factor for 2011 and 2012.

On the other hand, Edison hopes to reduce ratepayer costs in the solar rooftop panel program. Last month, SCE asked the Utilities Commission to allow Edison to contract out large scale solar panel installations to third parties.

SCE said the utility could save about $300 million through competitive bids from third party installers and pass on the cost reduction to ratepayers.