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Utility deals resume after 18 months of austerity.

Fortnightly Magazine - October 2010

quality, and have helped to keep utilities from getting stressed.”

The picture is somewhat different for merchant power companies and also hybrid issuers that earn their revenues from a blend of regulated and unregulated businesses. Unexpected volatility in gas prices, combined with sinking electricity demand and a shifting regulatory landscape, put many wholesale operations in a weak position. As such, while investment-grade utilities have been selling bonds with interest-rate spreads below 200 basis points (see Figure 4) , riskier issuers are paying higher premiums—sometimes substantially higher (see Figure 5) .

“Investors are tending to discount non-regulated growth, because of the perceived volatility in cash flow and earnings,” Nastro says.

Even so, quality issuers across the industry are finding a ready appetite on Wall Street for their paper—as well as their stock. “Even with all the speculation and uncertainty, there’s a lot of capital available, in both the debt and equity markets,” says John Lange, head of power investment banking at Barclays Capital. “This might end up being one of the biggest years ever for equity issuance among utility companies. The high-yield markets also are back, after being closed during some periods in the financial crisis. There’s no problem with access to the capital markets.”

Conditions might not remain this favorable for long, however. Today’s uncertainties eventually become tomorrow’s market realities, driving changes in market risks and investor appetites. And with interest rates as low as they are today, money seems unlikely to get much cheaper—which means the current sweet spot can’t last.

“Utilities may face headwinds going into 2011,” Nastro says. “We see the potential for a rising interest-rate environment, and uncertainty around dividend tax rates coming out of Washington, D.C.”

The expiration of Bush-era tax cuts could spur investors out of their defensive posture and into more risky investments—especially if the economy rebounds faster than expected. Thus, the current seller’s market for utility securities might not last too far into 2011—which in part explains the flurry of bond issues that went to market in late summer and early fall.

Companies are getting ready for change.

Cap-Ex Coming

Even if costs of capital move upward, Wall Street has shown a consistent willingness to finance utility companies’ needs. That’s a good thing, because those needs seem unlikely to decline any time soon; in fact, capital expense budgets are set to increase next year as companies move forward with a variety of construction programs.

Exactly how much capital spending will rise, and when, depends on a slew of economic and policy questions. But a ballpark figure of $1 trillion through 2020 seems plausible, considering the major cap-ex programs already in the works, and the industry’s recent history. In 2009, for example, the investor-owned power and gas industry in the United States spent about $84 billion—a decline from 2008’s $94 billion, according to the September 2010 Fortnightly 40 Report (See “ The 40 Best Energy Companies ,” September 2010 ) .

“We’re beginning a construction cycle that’s bigger than any we’ve seen since the 1970s and 1980s,” Redinger says. “It’s kind of a perfect storm.