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Restoring Financial Balance

With looming mandates and aging infrastructure, utilities need regulatory support.

Fortnightly Magazine - November 2011

customers. This move permitted customers to enjoy lower utility rates for several decades, because the utility industry needed much less capital over that period due to slower growth, excess capacity, and limited infrastructure replacement. Looking ahead, substantial new capital investment is required to replace infrastructure for both gas and electric utilities, including replacement of gas distribution facilities, building new transmission lines to deliver renewable resources and other power supplies to markets, updating environmental controls on existing power plants, and adding new capacity to replace retiring units and to meet current and expected load growth. This daunting to-do list doesn’t even include the cost of developing carbon capture and control systems or other new environmental requirements.

The amount of new capital investment needed by utilities over the next few decades will require that utilities, regulators and other stakeholders find a way to restore balance in the regulatory compact if utilities are going to continue to provide safe, reliable and economically priced power to fuel the economic engine of the U.S. This means the case for a fairly balanced regulatory compact is all the more compelling for the future than it has been for the last 20 years. The question for regulators and utilities is how to find that right balance in the current economic climate. With today’s white-hot public policy debates concerning energy and the environment spilling over onto utility regulation, finding a solution will be a very challenging task.

The significant increase in government debt at all levels, the growing debt abroad, and the issues surrounding investor liquidity make access to capital generally much more difficult today. This is particularly true for utilities with lower credit ratings that have less financial flexibility. Further improvement in financial metrics will be complicated by such issues as the adoption of International Financial Reporting Standards that might be less flexible for utilities than are current reporting standards. Part of the key to improving financial metrics must include improved cash flow from operations and increased retained earnings to support greater equity in the capital structure of utilities.

The competition for capital will be difficult unless the balancing of the regulatory compact recognizes that improved financial metrics must be a key element of a properly structured framework.

In the current economic environment, utilities, regulators, and other policy makers must play a role in rebalancing their relationship. Utilities must meet the obligation to efficiently and effectively manage the costs that are within their control. By adopting best-practice concepts in their operation and maintenance activities, utilities can contribute to better use of assets, longer life, and lower costs.

Utilities also must work to assure that additions to rate base are made prudently and efficiently. Thus, the processes used from planning through bidding, construction, testing, and placing new assets in service should be complete and thorough. It’s critical that the utility follow processes that are transparent and involve stakeholders so that the resulting rate base additions satisfy the used-and-useful mandate as well as the prudence requirements that are critical to a balanced regulatory approach. Importantly, the process for approving capital additions