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2007 Finance Roundtable: Pricing Regulatory Risk
Despite a favorable outlook for utility finance, cost pressures are straining rate structures.
capital. To the extent regulators treat utilities fairly, they will have good access to that capital. The reverse could be true in other places.
Fortnightly: What’s the outlook for regulatory risk, as utilities open rate cases to finance large construction plans? How are capital markets pricing regulatory risk?
Sauvage: If you look at the regulated utilities, medium PE multiples are at 14.5x. That’s down from where they were, because most utility stock prices are about 10 percent off their 12-month highs. But it’s still a robust multiple on a historic basis.
At those equity value levels, I think the markets are assuming constructive ongoing regulatory relations.
Maloney: We’re seeing a trend toward more sophistication in regulatory policy. The current credit crisis is encouraging regulators to back off from micromanaging and to look at things from more of a macro perspective.
Young: Regulatory lag for a wires-only business is very significant, with capital expenses being such a significant multiple of depreciation. Regulatory lag will cause lower overall creditworthiness.
Utilities will be borrowing for years to come, and borrowing at the right price is good for customers. Regulatory processes that aren’t in synch with that reality will have to get caught up.
When regulators see the same issues time and again, they will come to the realization that utilities need forward-looking rate relief. It’s an evolution, and won’t happen overnight.
Rogers: In our state [Nevada], we have an integrated resource planning (IRP) process that occurs on a triennial basis, with amendments as needed. Through that IRP process, the regulators deem an investment to be prudent on a prospective basis. We rely on that, but just because it’s deemed prudent doesn’t mean we can spend at will. We have to perform on our execution of the spending program.
There could be backlash in states where they have a huge stair-step move in rates, and no pre-prudency process. It’s important for commissions to smooth out the rate impact to customers.
Hempstead: For states that really need certain infrastructure, the regulators and politicians are working in a constructive manner with utility companies to help them get these investments made. Generally speaking, we’ve seen some legislation—in South Carolina, for example—that is very favorable toward utility capital investments.
But it’s the tail-end risks we’re trying to address. With some large-scale projects, the risks are so far out, who knows what will happen? When the costs hit rates, there will be a different political environment, rate environment, and fuel-cost environment.
Hyman: The first risk is that a lot of utilities and regulators haven’t done a lot of rate cases in a long time. You have a lot of people wandering around, feeling their way.
Next you have the risk of going in for all these things at once, and you have a lot of infrastructure spending that wasn’t planned. For large capital expenditures you have uncertainty about how regulators will deal with it. It’s back to rate base exposure, without enough thought about the problems of rate base exposure. The risk is there and I don’t know why anyone