[BETA] Fortnightly

Should the power industry adapt its approach to capital markets in this environment? The answer, of course, is yes. Multiple frameworks are necessary to establish a power company’s or project’s current cost of capital, especially under volatile capital market conditions. The analyses reveal that in today’s capital markets, it is critical to balance or combine the alternative approaches to the cost of capital in order to develop a long-term view.

The results of annual survey of rates of return on equity authorized for major electric and natural-gas utilities—based on a sample of the retail rate cases conducted by state public utility commissions—show a vibrant and perhaps growing interest in traditional rate-of-return regulation.

A Survey of Recent PUC Rulings

With most restructuring efforts at a standstill in the energy industry, state public utility commissions (PUCs) have tended to shift their attention back to the art and science of ratemaking. For electric and gas utilities, that has meant a renewed emphasis on the mechanics of setting a maximum allowed rate of return on common equity (ROE).

An alternative measure of performance - not based on dividends, earnings growth or P/E ratios.

How to place a value on a utility company? That is the question.

The traditional models no longer work very well. Dividend discount models will not work well if utilities cut dividends and buy back stock to return capital to the shareholders. Earnings growth offers no reliable performance gauge either, as utilities acquire or divest large amounts of capital. Restructuring charges often become necessary to shift resources to their best use.

One of the iron rules of competition and open markets is that there are winners and losers. Winners tend to win very big; losers tend to lose everything and disappear, through absorption or insolvency. As deregulation takes hold, high-cost producers and less adroit managers may find themselves steamrollered by emerging strongmen and entrepreneurial upstarts. These rivals may usurp segments of their business by bidding the job cheaper and still making money, leaving a rising tide of shareholder suits in their wake.