Can utilities simultaneously manage rising costs and pressing capital investment needs?
Johannes Pfeifenberger is a principal at the Brattle Group. Contact him at www.brattle.com. The author would like to thank Larry Kolbe, Peter Fox-Penner, Bin Zhou, Adam Schumacher, and Difan Liu for helpful discussion and research.
Does the utility industry have the financial strength sufficient to meet the combined challenges of: (1) sharply increasing and highly volatile fuel and purchased-power costs; (2) significant capital investment requirements; and (3) rising interest rates?1
The industry has recovered fairly well since the financial meltdown associated with the Western power crisis and the Enron bankruptcy, but recent data also show a downward trend in utility earned returns on equity (ROEs), a decline in operating cash flows, and credit quality that has trended downward over the last five years. These findings suggest that reasonable rate relief and investment-recovery policies will be needed to maintain a financially strong utility industry sufficiently capable of attracting the required capital and meeting its responsibilities in a stable, cost-effective manner. Regulation that does not provide for the full and timely cost recovery of prudent costs will weaken utilities financially, thereby raising investment-related costs and discouraging investments that would yield long-term benefits.