But the lower returns on equity don't necessarily result from gen selloffs or moves toward stand-alone distribution.

A survey of utility rate decisions affecting authorized rates of return on common equity (ROE), as issued by state public utility commissions (PUCs) during the period Sept. 30, 1998 to Sept. 30, 1999, indicates a small but discernible trend toward lower returns. There is no clear evidence, however, that PUCs are rethinking their assessment of utility investment risk to reflect divestitures of generation assets or a retrenchment of utility functions toward the model of a stand-alone wires or distribution company.

CONVENTIONAL WISDOM SAYS that power generation entails greater risk than the remaining distribution and transmission service components in the electric industry. Some parties have argued, however, that stripped of its generation and transmission monopolies, a distribution-only company loses strength and faces greater risk in meeting the threat of competition from distributed generation and other forms of system bypass.

Others have argued that generation divestitures can add risk in at least one sense, as utilities must then recover the cost of power purchased from third parties in assembling a resource portfolio to serve standard-offer customers who choose to remain with the utility and not to take generation service from competitive suppliers.

YET, IN ITS MOST RECENT MAJOR ROE CASE, the California PUC set ROE rates for the stand-alone distribution operations of the major utilities operating in the state, but found "no need" for either a discount or premium adjustment to ROE. The commission described the competitive threat to utility distribution as "exaggerated," explaining that:

"Distribution competition is limited relative to generation competition because generation can be transported wherever there are wires, but distribution competition is localized. ¼ Distributed generation and other forms of bypass have potential, but are in their formative stage. ¼ There is less variability in distribution costs relative to generation. And at present any loss or revenue because of price and procurement risks appears minuscule when compared to total revenue."

The commission also noted that financial rating agencies currently advise clients that distribution companies have less risk than generation companies.

Moreover, the California PUC acknowledged the maxim that markets set the rate. It said it believed investors are quick to react to market changes and that such reaction already was reflected in stock prices and yields. If the financial models work as designed, said the PUC, then no premium should be required.

"We have every reason to believe that the financial community has factored into its activities its expectations regarding restructuring." Decision 99-06-057, June 10, 1999 (Cal.P.U.C.).

The survey was conducted by contacting PUCs and major energy utilities and analyzing decisions issued by PUCs affecting rates, cost of service and earnings sharing regimes under plans for performance-based ratemaking. In some cases, the PUC entered an explicit finding on ROE. In others, the ROE figure was derived from an approved stipulation or settlement agreement.

Here, ROE represents the theoretical amount of "profit" allowed to holders of utility common stock by regulators that they factor into the process in setting rates. Thus, the ROE figures reported here do not describe actual earnings realized or recognized by utilities.

Compiled by Phillip S. Cross, contributing legal editor at Public Utilities Fortnightly. The last survey of electric utility ROEs appeared in the Fortnightly in December 1998, p. 14. Before that, the electric utility ROE survey had run yearly for more than a decade, starting Sept. 1, 1983 (but usually appearing in June) and running through June 1, 1995, p. 63. A series of annual surveys on gas ROEs began Dec. 8, 1983, p. 58, and continued (usually in October) through the issue of Oct. 1, 1994, p. 72.

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