Ratemaking Special Report
Return on Equity:
Fixing an appropriate rate of return on equity (ROE) for electric utility investors marks a fundamental...
Targeted Debt: Give the Stockholders What They Want
Too much leverage can be risky, but sometimes it's just what the doctor ordered.
One of the reasons that stockholders in Columbia Gas survived a Chapter XI proceeding more nearly intact than owners of other bankrupt utility enterprises was that the parent holding company was a secured creditor of its operating subsidiaries at the time of the filing. This status gave priority to Columbia Gas stockholders over the unsecured creditors of the operating companies, including the "take or pay" gas suppliers who represented the major problem that provoked the bankruptcy filing. Although in retrospect the filing proved costly and troublesome for Columbia Gas, the creation of a secured position helped the Columbia stockholders once the company found itself in bankruptcy. The stock held steady throughout the proceedings, once the initial shock had passed and analysts understood the basic legal and economic implications of Chapter XI.
In fact, electric utilities learn from the fortuitous example of Columbia Gas.
Symptom: Growing Risk, Falling Stock Price
Today, risk can be seen on the upswing in the electric utility industry. Nevertheless, this growth in risk remains difficult to quantify, because we cannot yet say that we fully understand the true competitive positions of many vertically integrated electric utilities. Where are the real transmission constraints? What cost structures would utility managers accept if they were really obliged to deal with all-out competition? What are the true costs of nuclear power? What is the real political resistance to forcing retail customers to pay higher rates in order to give those with bargaining power the rates they can bargain for?
We can only guess.
Nevertheless, we can assume with a fair degree of confidence that, as the traditional, integrated electric utility comes face to face with competition, its common stock will begin trading below book. while the common stock dividend may be cut or even eliminated. Moreover, the utility's bank creditors would demand assurance that they remain protected.
The reasons will sound familiar enough: too much nuclear or old fossil plants; high labor costs; an unsupportive state public utility commission (PUC); a PUC determined to force deregulation at a rapid pace; slow-to-nonexistent economic growth in the service territory; good transmission ties to lower-cost sources of supply. Some or all of these reasons may apply.
The bond indenture and charter provisions and state and federal law will also come into play. These structures, based on accounting concepts from the '30's and '40's or even earlier, assumed that "cost of service" ratemaking would last forever. They never anticipated the current talk of deregulation, price cap models, or incentive-based regulation.
Along the way, bondholder and trustee fears will grow with the perceived difference between book value of assets and fair market value, where fair market assumes deregulation of generation and continued regulation of transmission and distribution (T&D). These fears relate to nuclear generation, but also to older fossil plants, and in an indirect way to labor costs compared with staffing levels and nonunion labor at independent power producers with modern, gas-fired, combined-cycle generation.