When microgrids are optimized in a smart grid, they’ll usher in a new era of utility resilience and flexibility. Get ready for dynamic microgrids.
Volatile markets call for alternative financial models.
private banks, including private-equity firms, actively will participate in this risk-sharing arrangement with the federal government. The flow-through effect of these changes on the power sector notably will affect both utilities and merchants.
Whatever the timing of the market restoration, it’s clear that structural and regulatory shifts will place more onerous guidelines for capital ratios on the banking industry, and restrict the use of securitization structures and off-balance sheet transactions. In the meantime, both utilities and merchants still have a high need for capital to finance large infrastructure projects. Banking and capital market changes likely will cause a permanent upward shift in the long-term cost of capital for the power sector. In this context, the CAPM and DCF models must be recognized for what they are: models that attempt to capture the financial outlook for a firm and determine its cost of money. By applying these models judiciously, perhaps in combination, and in new ways, utilities and merchant companies can determine the best approach and the best timing for the complex task of raising capital when they need it.
1. Even though utilities in some states were less regulated than in other states, they all have reasonably stable cash flows to service their debt obligations as many generate revenues through sales to affiliates.
2. See EEI Publication, 2008 Financial Review.
3. Source: Ibbotson SBBI, 2009 Valuation Yearbook . One explanation of this phenomenon from a trading standpoint is that small firms are not very liquid (have high liquidity betas) and not frequently traded by hedge funds and other financial players, and hence there is an illiquidity premium that should be added to the cost of equity. Another explanation is that smaller firms generally are perceived to be riskier and have fewer resources to fall back on in a crisis than large ones (though large firms often fail as well).
4. Ibbotson SBBI, 2009 Valuation Yearbook.
5. Based on “Estimating the Cost of Risky Debt,” by Cooper and Davydenko, Journal of Applied Corporate Finance , Volume 19, Number 3, Summer 2007.