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Financial News

Fortnightly Magazine - January 15 1997

cost of generation investment accounts for another 7.7 percent. The degree of regulatory restructuring in the state served by the utility was associated with an additional 3.7 percent of total variance (see Table 2). All four variables are statistically significant in their relationship to M/B ratios at the .01 level, meaning that the association would be likely to occur by chance only 1 time out of 100.

As expected, ROE, as a standard measure of profitability, is positively associated with M/B ratio, with a higher ROE indicating a higher M/B ratio.

Again, as expected, because industrial price is a reflection of a utility's ability to supply a commodity to its most vulnerable market segment in a less-regulated market, a higher industrial price has a negative association, indicating a lower M/B ratio. This variable captures some of the essence of the more complex-to-calculate S&P "reasonable" and "severe" cases and, therefore, should be considered as an easily available surrogate to the S&P estimates.

An easily accessible surrogate variable for the Moody's stranded cost calculation is generation capacity cost ($/kW installed less accumulated depreciation), reflecting a utility's embedded generation cost and to some considerable extent the fixed costs that would need to be covered by revenues generated from sales of electricity at market-clearing prices. As expected, the relationship is negative, with higher generation capacity costs indicating a lower M/B ratio.

We found it more difficult to attach an "expected" explanation to the relationship to M/B ratio indicated by the regulatory restructuring variable. As noted above, our data came from Regulatory Research Associates (RRA), which categorized states into five tiers based on their relative progress toward industry restructuring. Tier 1 indicated that a restructuring plan had been adopted, while Tier 5 indicated that no substantive restructuring initiative was underway. The relationship discovered by this analysis is positive, in the sense that the higher the number (em meaning the less that the state has done to restructure regulation (em the higher the M/B ratio. %n9%n At this point, this relationship raises more questions than it answers.

One might view the inverse relationship between restructuring progress and M/B ratio as "expected," but for different reasons. For instance, investors might see state restructuring efforts as leaving utilities less able to collect revenues under the traditional system and therefore less able to meet fixed costs and generate earnings. Or progress in state restructuring might indicate that market pressures in the state are so intense as to motivate regulators and legislators to meet consumer demands for choice. In that case, investor reaction might not be adverse to regulatory restructuring as such but, rather, to the indication that the market in the state is becoming more competitive.

On the other hand, one might see the inverse relationship as "unexpected," since investors should see restructuring as an indication that states are prepared to address such issues as stranded-cost collection. In any case, the modest relationship of regulation to M/B ratios deserves closer review, since we can expect more states to undertake restructuring initiatives in the near future.

Overall, this new model leaves one-fourth