challenges in financing for electric utilities mid-american regulatory conference traverse city,...
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Challenges in Financing for Challenges in Financing for Electric UtilitiesElectric Utilities
MID-AMERICAN REGULATORY CONFERENCE
TRAVERSE CITY, MICHIGAN
JUNE 15, 2009
ROBERT W. GEEPRESIDENT
GEE STRATEGIES GROUP LLC
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Disclaimers, etc.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
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OverviewOverview
• 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
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How The Financial Crisis Has How The Financial Crisis Has Changed ThingsChanged 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 Two • One plus One 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
Electric Utilities Are Uniquely AffectedElectric 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 Losses in Equity Markets Mirrored in Utility Sector Mirrored in Utility Sector
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• 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
Consequences to ConsiderConsequences 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 Will There Be Sufficient Capital to Meet All Obligations? 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 RegulatorsImpacts 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 What Do We Mean By “Not Supportive” Regulation ? *Supportive” Regulation ? *
• 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
*From an Investor Perspective*From an Investor Perspective
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Recommended Actions for RegulatorsRecommended 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 Additional Measures Bolstering Utility Competitiveness In Capital MarketsCompetitiveness 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 Lesson for Regulators: Exhibit a “Profile in Courage” “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. GeePresidentGee Strategies Group LLC7609 Brittany Parc CourtFalls Church, VA 22304U.S.A.703.593.0116703.698.2033 (fax)[email protected]