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2007 Finance Roundtable: Pricing Regulatory Risk

Despite a favorable outlook for utility finance, cost pressures are straining rate structures.

Fortnightly Magazine - October 2007

Make sure you understand the difference between liquidity facilities and permanent capital.

Nastro: The old axiom about financing when the markets are open is critically important. Those who get in early with long-dated paper will be the winners at the end of the day.

Sauvage: Being ready to issue is of great value. This means having regulatory filings, board authorizations, and security filings current, so the issuer can move quickly to take advantage of market opportunities.

The utility sector is entering a heavy investment cycle, and we expect net assets will more than double in the foreseeable future. Utilities will be in the market very frequently, and depending on market conditions and issuance volume in the sector, first-movers often have an advantage in securing financing.

 

Constructive Regulation

Fortnightly: How do the industry’s cap-ex plans affect the overall financial picture for utilities? How will the buildout affect share values and creditworthiness?

Sauvage: Many companies will be investing more money than they have in net-asset value currently. The sector likely will be cash-flow negative, before dividends, and obviously more negative after dividends.

Also, you have a combination of robust commodity prices, increased infrastructure investments, and somewhat higher borrowing costs. That means pressure on utility rates.

Rogers: We certainly agree the industry is likely to be negative free cash flow. Capital expenditures will exceed cash flow, so we will be depending on the markets for capital formation.

I think it means raising capital sooner rather than later is prudent, because if you run the risk of just-in-time capital formation, or if you get behind, you may need to accept very expensive capital, whether equity or debt.

Nastro: Utilities are being a lot more creative in funding their capital-expenditure plans. Given their significant capital needs, they are positioning themselves to lower their cost of capital and mitigate regulatory risk.

A lot of companies in the sector are asking whether they should go it alone with a large project in a single jurisdiction, or whether they should consider partnering with others to diversify the risk. In the same vein, some companies are considering ways to take projects off balance sheet and off credit. They’re asking whether there’s a way to use a financial partner or private-equity investor to reduce overall cost of capital. We’ve seen several new joint ventures form, such as RBS and Sempra, Constellation and EdF, and DTE and GE.

Petrosino: Capital investments in a regulated business are a good thing from the point of view of all stakeholders. The important question is how it will be financed. If the capital spend is financed in concert with current capitalization, it should benefit all stakeholders—even regulators who don’t want to see over-earnings from an over-levered balance sheet. But if it stresses the balance sheet, credit ratings could come under pressure.

Cortright: The weaker your credit, the more susceptible you are to bumps in the economy. And the implications of a non-supportive rate decision will have more impact than they would otherwise.

Young: The infrastructure of this country, whether ports, highways, or railroads, are competing for