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Deregulation for Real

High power bills, with the lifting of rate freezes, give pause to politicians.
Fortnightly Magazine - April 2006

In fact, some say the ones to blame for the rate shock are the regulators for not allowing gradual increases in rates, but forcing the entire cost increase on ratepayers all at one time.

This is all spilled milk. Whatever the reasons for the rate shock in various states, or the benefits of electric competition, it just won’t matter in a charged political atmosphere if ratepayers (the voters) are feeling gouged. What politician can forget the lesson of Gov. Gray Davis and the California crisis? A power crisis can get you voted out of office.

Regulatory “Clawback”

Can regulators succeed in turning back the clock? Some say utilities might try to escape attempts at re-regulation by shedding regulatory assets. And this strategy gains credence with reports from some equity research analysts, who are projecting lower financial performance for utilities that operate in a fully regulated environment.

Morgan Stanley’s Kit Konolige and Philson Yim write in one report that utilities might form more stand-alone generation companies if regulators attempt to “clawback” their unregulated earnings.

They write, “Companies as different and at different stages, such as Exelon and PPL, are clearly recognizing that as their unregulated (or pending unregulated) gencos earn strong cash margins in a FERC-protected open market, well above 50 percent and as much as 80 percent of the entity’s equity value is unregulated.”

In particular, Konolige and Yim question whether the regulated wires business, the part left over after generation is privatized, will prove “big enough to ‘stabilize’ cash flows and the balance sheet.”

If not, they say, there would be nothing left but a clawback strategy for those hapless state politicians “who still can’t believe that they passed a law, years ago, that allowed market pricing for the genco—and took the genco out of the politicians’ control.”

Konolige and Yim believe regulators in New Jersey and Illinois (and Connecticut) may use their authority over the state-regulated wires in an attempt to make up for earnings lost from generating units that have fled to greener pastures under federal jurisdiction.

Meanwhile, Lehman Brothers equity research analyst Dan Ford believes the increase in rates will lead to demand destruction, and to flattening or negative top-line growth.

Ford says the historical evidence suggests that a 1 percent increase in retail rates leads to an approximate 0.25 percent decrease in usage rates. “Though this relationship would likely break down over the course of a 50 percent plus rate hike profile, we believe a considerable slackening of demand is possible as the decade progresses.”

Ford expects customers’ bills to increase about 10 percent annually through 2010. On a cumulative basis relative to 2005 rate levels, customers could see a 65 percent rise in their electricity costs. Ford believes that, as a result of these increases, utilities may well face cash deferrals, harsh rate treatment, and the specter of re-regulation.

In its annual ranking of state PUCs from an investor perspective, the bank found that the top five PUCs are Georgia, Indiana, Iowa, Kentucky, and Wyoming. The bottom tier consisted of Arizona, Hawaii, Montana, New Hampshire, and