THE POWER PLANTS OF AT LEAST FIVE UTILITIES IN NEW England and California get swapped this year for more than $5.3 billion. And happily, those holding bonds on the plants will be given cash for...
Credit Parameters in Flux: When Assets are Liabilities
The question I am asked most frequently is "Who will emerge as the 'winners' and 'losers' among today's electric utility companies?" The short answer is painfully simple. The winners will offer the best prices (a.k.a., the low-cost producers). The losers will be unable to cut prices to meet the market (a.k.a., the high-cost producers).
Unfortunately, real-world answers rarely come in black and white. The electric utility industry enjoys less pricing flexibility than one might imagine. An analysis of industry cost options reveals that "production costs" do not vary significantly enough to create major differences in credit ratings between companies. Today, capital investment, as reflected in both the "Assets" and "Liabilities & Capital" sides of the balance sheet, is the single most critical variable driving costs. This fact raises serious questions about the ability of many companies to hold asset values at currently stated levels. For some, at least, assets have indeed become liabilities.
The Cost vs. Rate Debate
In the United States, we have seen electric rates set historically on a cost-plus basis, yielding a high correlation between "costs" and customer rates. Where rates are high, costs typically are also high. If this were not so, some utilities would be earning attractive returns (em but that's clearly not the case. In 1994, for instance, it appears that the average return on common equity (ROE) for the industry will come in at just under 10 percent. The single-digit nature of the aggregate ROE suggests that prices and costs track each other closely. But further examination of electric utilities and their flexible and inflexible production costs yields some interesting observations.
When fuel costs are compared exclusively, the long-held precept that nuclear is cheaper than most other fuels (primarily coal, oil, and gas) holds true. But this fuel-specific cost advantage quickly vanishes when other production costs and load factors are taken into account (please hold capital in abeyance for the moment). When all is said and done, the production-cost analysis usually reveals a startling find: The operating cost of producing electricity as a commodity does not vary significantly from company to company. In fact, whenever large variances in production costs do appear, they are often explained by items that are characteristically regional (em
specifically, local taxes. That's the hidden story behind electric generating "costs." The differentiating factor is not at the "production cost" level but the "capital cost" level (em a finding that gains even more credence when depreciation (an asset-related cost) is factored out of the production equation.
The Capital Dilemma
I can still remember my first day of accounting class back in college. The professor, who had practiced as a CPA, told us. "You will have no problems understanding accounting if you never forget this one thing: "Assets always equal liabilities plus capital." I never forgot that rule of thumb. (Fortunately, I passed my accounting courses.)
Let's apply that rule to electric utilities. Who's high cost and who's low cost? Production costs do not vary much when you add in nonfuel factors. So the key must lie on the balance sheet. Since rates