[BETA] Fortnightly

Utilities today enjoy the lowest all-in financing costs in recent memory. In August 2012, for example, Georgia Power sold $400 million in three-year senior secured notes with a 0.75-percent coupon. At that rate, investors buying those bonds will lose more to inflation than they’ll earn from the bonds—and yet demand for Georgia Power’s paper was so strong the company issued $50 million more debt than it had initially planned.

Indeed, Wall Street for the past couple of years has been throwing a party in honor of power and utility companies. The celebration includes utility stocks, which for a large portion of the past two years have outperformed the broader markets. Few utilities have issued new equity recently, but for those who have, Wall Street rolled out the red carpet.

Some signs, however, indicate the party might be winding down.

Figure 1 - 10-Year Bonds

For one thing, regulatory commissions in many states are asking tough questions about returns on equity (ROE). The average allowed ROE has been declining for some years, but it’s still in the 10-percent range—even as utility stocks are trading higher than many have for the past decade. Low financing costs combined with high ROEs make for some uncomfortable conversations when utilities appear before regulators to seek rate recovery for capital expenditures.

That discomfort will increase when natural gas prices start rising off today’s rock-bottom $3/MMBtu. Low commodity prices effectively have shielded customers from the effects of rate increases, but the current prices are widely considered unsustainable.

At the same time, utilities face the end of bonus-depreciation policies that have made capital expenditures more affordable for the past two years. As part of the American Recovery and Reinvestment Act of 2009, bonus depreciation provided a 100-percent deduction for property acquired until the end of 2011, and 50 percent in 2012. That allowed utilities to finance a large portion of their capex directly from cash flow, rather than taking on debt or issuing new equity. The end of bonus depreciation might drive many utilities to issue new stock, which will dilute share values.

That’s always a necessary evil, but it comes at an inopportune time. Specifically, dividend tax rates are set to rise dramatically next year, if Congress doesn’t renew the tax cuts it implemented in the early years of the George W. Bush administration. Higher dividend taxes could translate into lower market valuations for utility stocks—compounding the dilutive effect of issuing new equity.

But even if dividend taxes don’t spike—or if a tax hike ultimately has a minor effect on utilities, as some analysts suggest it would (see Frontlines, p.4) —other factors in the market might signal an end to the current cheap-money Bacchanal. Namely, the new Basel III international banking standards are pressuring banks to rein-in loan tenors and increase fees. The European monetary crisis continues to loom over the global economic outlook. And so does the possibility that the U.S. Congress