I want a shiny new black Mercedes SUV ML 63 AMG. For the corporation’s use only, of course. Just to get me to and from conferences, meetings and workshops. But, how do I raise the $90,000 to pay for the vehicle? If I was a California investor-owned utility, my answer would be to sell stock and/or tap into cash on hand. Using that “equity” is appealing because it would give my shareholders a profit. I might even give them a ride in my swanky vehicle’s comfy leather seats with individual temperature controls. If I was a California utility instead of a media maven, I would get a rate of return over 11 percent from ratepayers on that $90,000 investment in my new company vehicle. On top of that, the taxes would be covered. So, ratepayers would pay out of pocket 20 percent for the cost of my new car. I could also pay for that shiny new Mercedes by using Wall Street bond financing. This utility debt is the equivalent of a credit card. That $90,000 would also garner our corporation some payback from ratepayers, but at a lower rate of return. It is also one that can’t flow through to shareholders because of state regulations. Here’s the rub: I could only finance about half of my shiny black Mercedes with equity. (For discussion purposes, when I write about equity let’s keep it to stock sold to generate revenue for capital expenditures.) I would pay for the other half with debt financing. That’s because regulators control the amount of funds that can be raised by equity as well as debt. What got me thinking about financing specifics was a key but little-noticed ruling at the California Public Utilities Commission. Three major influences are in play--billions of dollars in investments, the new CPUC ruling easing rate changes in utility returns, and the legacy of deregulation. Vector 1: California’s investor-owned utilities plan to borrow and invest about $44 billion in the next few years. They plan to spend that money on new transmission lines, distribution lines, smart meters, and new power plants. The way utilities obtain those funds impacts ratepayers’ wallets and shareholders’ revenue. Vector 2: In late May, the CPUC voted to pull utilities’ rates of return out of their usual three-to-five-year general rate cases. Regulators decided to put utility investment returns instead into an automatic mechanism. This regulatory hands-off concept allows utilities’ rates of return to rise with the bond market instead of the commission deciding the returns in each utility’s general rate case. Under the automatic mechanism, rates of return on investments backed by shareholder funds would be about 11 percent plus taxes. With taxes it’s about a 20 percent charge to ratepayers, according to the CPUC. However, equity financing--be it for a fancy Mercedes or a 500 kV transmission line--can apply to only about 50 percent of the investments. The rest of the financing comes from the equivalent of a utility credit card--debt raised from financiers. Those funds are allowed about 6-7 percent or so in payback from ratepayers. That is passed through as a charge to customers with no profit for shareholders, according to a CPUC analyst. Assuming half of the $44 billion in new projects is financed with equity, the potential profits from investment soar. I calculate about $2.4 billion in shareholder profits. Vector 3: Utilities huge investment plans have been spiked by deregulation, as well as by regulators. Utilities have been making up for lost infrastructure investment for the last 15 years. Deregulation in the mid-1990s discouraged utilities from maintaining current assets and improving infrastructure. Any money spent on maintenance and improvements became a profit liability because it would not be passed through to ratepayers. Utility investment also has what I term a “nuclear” angle. Back in the 1960s, utilities decided to toss their piddle little $100 million investments in traditional power plants and go for the nuclear option. It works this way--they could either invest $100 million in a regular power plant, at say then, a 10 percent rate of return, or $4-5 billion in a nuclear plant at the same rate of return. So, the amount of investment became a tremendous difference in profits. In other words, if half $100 million garners $5 million in profit, half of $5 billion got utility shareholders $250 million. It’s 12 years after deregulation. As a reporter, I probably covered California’s deregulation closer than anyone. I never once heard mentioned that prices could go up as well as down. The theory held by regulators and legislators is that competition could only drive prices down. Oops. Now, with this new rate of return mechanism, utilities return on investments could go down, but that’s unlikely as interest rates are so low at this point. The way it works is that if the bond index moves more than 1 percent up or down, utilities’ rates of return are adjusted by 50 percent of that difference, according to Moody’s analyst A.J. Sabatelle. Thus, if the index increases by 1.1 percent, utilities would get an increase in returns by one-half percent. Moody’s was chosen by the CPUC to be the financial ratings service for these cases. Sabatelle said he didn’t know why. Financial analysts say Moody’s is probably more conservative than other services like Standard & Poor’s or Fitch. The return on utilities’ investment could go down, but that’s unlikely as there is not much downward room for interest rates in this economy. So, it may go above the 11 percent if the bond market perks up over 1 percent. As of press time, the bond market is, indeed, rising, after being bottomed out in April-May. I’m not saying the new mechanism is a bad thing. It appears to be economic insulation, so it appeases Wall Street. When Wall Street is appeased, it lends money at lower rates. It also reduces the amount of time and money going for lawyers battling out rates of return at the CPUC. Probably that’s only a few million dollars. And, that’s probably about what it will cost utilities to engage the services of Moody’s to create ratings to watch the trigger. Moody’s index might be free, according to Sabatelle. Is ratings service is not cheap. Regulators and legislators need to watch for side deals. So, while the incentive mechanism may clean up part of utilities’ rate cases, in the minutiae of the astounding detail of CPUC proceedings, special deals may lurk. For instance, Pacific Gas & Electric made a deal with regulators for a performance mechanism back in 1988. The compact avoided what promised to be a long and contentious fight over the $5.5 billion nuclear plant. But, it also resulted in such huge returns for the utility (about $30 billion) that in 1994 the state, PG&E, and consumer groups decided on a new settlement. At the time, it was expected to save consumers over $2 billion rather than keeping the old side settlement but it cost far more than a normal rate of return--even on $5.5 billion. If I was financially clever enough, I’d lease my new Mercedes to Halliburton to use half a week; get some income from ‘em and dump it when gas gets to $5/gallon. Planned Utility Investments The three investor-owned utilities projected infrastructure investments for the next few years are as follows: -Southern California Edison--$19.9 billion over five years. Its rate of return on equity is 11.8 percent. -Pacific Gas & Electric--$13 billion over three years. Its equity rate of return is set at 11.35 percent. -Sempra--$11 billion over five years. Sempra’s two utilities, San Diego Gas & Electric and SoCal Gas, are being allotted 61 percent of that amount . The return on equity is 11.1 percent. Sempra’s spokespersons, however, declined to provide Circuit a breakdown of the two public utilities planned infrastructure investments. Note: The information is from the state regulators and utilities.
