Gauging Risks: Rising Interest Rates and Industry Restructuring

Fortnightly Magazine - March 1 1995
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How risky are utility investments today? Regulators have always faced this question when setting the return component of rates under traditional rate base/rate of return regulation. With major industry restructuring looming, risk issues have become proportionately more important and complex. California regulators, for example, have increased the return for the state's electric utilities to account for investor worries over the pace of restructuring in the "Blue Book" proceeding. Performance-based regulatory (PBR) reform efforts, new environmental regulations, and swings in interest rate trends have also been cited to support utility risk bonuses. Yet, in many cases, regulators have refused to award bonus adjustments, finding such changes to be well known and reflected in the standard financial models used in setting return on equity (ROE) (see box on page 44).

Nevertheless, regulators have acknowledged that restructuring might increase utilities' cost of capital. While finding that consumers might benefit from restructuring and competition at the retail level, the Connecticut Department of Public Utility Control (DPUC) advised careful consideration of "downside risks." In particular, the DPUC cited the potential for escalating financing costs and an increased risk of financial failure.

The possibility that shareholders might be left to cover high-cost investment stranded as a result of increased competition in the electric market has also figured in the ROE debate. At the same time, the question of whether investors assume the risk of paying for uneconomic utility investments has become a focal point in the policy debate over stranded costs.

Just What California Needed?

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