Challenges in Financing for
Electric Utilities
ROBERT W. GEE
PRESIDENT
GEE STRATEGIES GROUP LLC
MID-AMERICAN REGULATORY CONFERENCE
TRAVERSE CITY, MICHIGAN
JUNE 15, 2009
Disclaimers, etc.
• I am not a financial analyst, nor do I play one on
television. . .
• I am a former regulator whose forte is listening to
what others say, usually in jargon . . .
• Then explaining what is said into plain English and,
if necessary, into “regulatory speak” to regulators
2
Overview
• The recent crisis in the financial markets over
the last several months and how that has
affected electric utilities
• Policy Implications
• The options utility regulators face
3
How The Financial Crisis Has
Changed Things
• Volume of capital available for borrowing has shrunk significantly
– Fewer traditional lenders of capital after bankruptcies and government interventions
– Bank Mergers facilitated but. .
• One plus One
• One plus One
Two
One
• Currently, capability of banks to lend is down 20 percent, or
approx. $10 trillion less than before the crisis
• Result: Existing borrowers chasing less available capital
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Electric Utilities Are Uniquely Affected
•
They are capital Intensive enterprises
•
They rely more on bank-provided liquidity to meet needs than other
industrial sectors – one half on average versus 76 percent
•
Previously, credit of majority (79 %) of utilities was rated AA or better in
the 1970’s, but most today (69 %) rated BBB; less room for error to avoid
falling below investment grade
•
This exposes them to additional risks at a time of economic stress
•
Their balance sheets are contracting under this stress
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Losses in Equity Markets
Mirrored in Utility Sector
• Losses in public equity markets = >$34
trillion
• US electric utilities: 40 % equity value
loss from Dec. 2007 level (vs. 53% for S
& P 500) as of April 2009
• Losses have lessened lately, and
markets have recovered slightly, but
stock price volatility remains
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Consequences to Consider
•
What all this means: Competition for available capital will be fierce, and cost of
capital will be higher as reflected in cost of debt
•
Example: bonds for BBB rated utility seeing estimated 346 basis point spread
(over10-year Treasuries) versus 108 bps in July 2007
•
Higher debt cost results in higher cost of equity
•
Bad news for a capital intensive industry such as electric utility sector
•
One unnamed investment banker: “These are the most extraordinary and scary
times I have seen in my 27 years as a banker.”
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Will There Be Sufficient Capital
to Meet All Obligations?
• Crisis arrives at worst time since sector in need of capital to
finance build out and modernization of power delivery
infrastructure
– Between $1.5 and 2.0 trillion estimated for infrastructure investment
between 2010 and 2030 (Brattle Group)
– Needs for smart grid investments, environmental compliance, including
carbon mitigation for some
• One estimate: for 2009 and 2010, utilities will have a funding gap
of at least $50 billion (calculated as capital expenditures plus
dividends subtracted from funds from operations) -- JP Morgan
• Utilities will need to rely greater on internally generated funds and/
or seek assistance from nontraditional sources of capital
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Impacts on Regulators
• Quality of utility regulation will be key to maintaining
sector’s competitiveness with other sectors
• Investors even more sensitive now to regulatory policies
• Investors looking to see if regulators sensitized to
utilities’ current cash and liquidity conditions and
whether their responses are timely and certain
• If market perceives quality of regulation to be not
supportive, capital will migrate elsewhere
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What Do We Mean By “Not
Supportive” Regulation ? *
*From an Investor Perspective
• Regulatory policy not comprehending that the paradigm has
been significantly altered, and that financial markets have
undergone structural change
• Persistence of regulatory lag and timely recovery of costs
impeded
• Authorizing equity rates of return not reflective of actual or
current market conditions
• Unreasonably restraining rate levels to accommodate public
constituencies
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Recommended Actions for Regulators
• Open and maintain an ongoing dialogue with your
utilities
• Understand the financial circumstances they
operate in
• Build trust if not there
• Collaborate with utilities in partnership to seek
solutions
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Additional Measures Bolstering Utility
Competitiveness In Capital Markets
• Consistent with state law, utilize tools to accelerate cost recovery
and reduce risk of under recovery
–
–
–
–
–
CWIP in rate base
Regulatory predeterminations of prudence
Pass-through of targeted costs or capital expenditures
Forward looking test year
More frequent rate cases
• “Be realistic” about return on equity -- don’t be slave to formulaic
outcomes that have unrealistic effects
• Be mindful of “earned return” versus “allowed return” – avoid
giving with one hand and taking away with another
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Lesson for Regulators: Exhibit a
“Profile in Courage”
•
Regulators forced to make decisions that are unpopular, particularly if public
perceives rates are rising in this economically distressed environment
•
Avoid the “easy way out” – this only passes the buck to successors
•
Spend time consensus building with all of your stakeholders and the public
•
Repeatedly explain your decisions to the public – designate knowledgeable staff
to assist
•
Educate the public to understand the difficult choices you need to make
•
In the end, the public may not like the decisions, but will understand their wisdom
– most likely after you are gone!
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Robert W. Gee
President
Gee Strategies Group LLC
7609 Brittany Parc Court
Falls Church, VA 22304
U.S.A.
703.593.0116
703.698.2033 (fax)
[email protected]
www.geestrategies.com
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