another perspective: WHAT WE NEED TO ATTRACT CAPITAL

Electric Perspectives, Jul/Aug 2005 by McMahon, Richard

WHAT WE NEED TO ATTRACT CAPITAL

When everything is said and done, the reason the electric utility industry wants regulatory stability and effective energy and environmental legislation is simple. Between now and 2025, electricity demand will grow by nearly 2 percent annually, according to the U.S. Energy Information Administration. Reserve margins-the difference between demand and capacity on hand-were at almost 28 percent in 2003, but margins in some regions will disappear completely by as early as 2007.

That means U.S. utilities will need to spend more than $100 billion during the next 20 years on a new generation of capital-intensive powerplants-those that run continuously to meet a utility's or a region's minimum (baseload) demand. Those big plants will run on coal or nuclear; in some cases, natural gas and hydropower. Also, they will need more transmission capacity to deliver the electricity they generate.

Given the long lead times necessary to build this infrastructure, investment decisions must take account of long-term uncertainties such as regulatory risk and energy and environmental legislation. Utilities need to attract investors who consider the same uncertainties-they want investors to be confident about what they fund.

It's time to build-and we need the certainty and the legislation.

A Solid Base

Chief among the industry's tasks is to have access to capital at reasonable rates. To that end, electric utilities have emphasized dividends, reduced debt, and focused on core operations. To strengthen investor confidence even more, utilities have opened up dialogues among the financial community, regulators, credit rating agencies, and utility chief financial officers to listen, explain, and educate.

These efforts are paying off. Electric utility stocks produced a 22.8-percent return in 2004, beating the broader stock indices. [See the related article on page 68.] In the six-year period ending in 2004, Edison Electric Institute Index investors earned a 42.1-percent return, outperforming both the Dow Jones Industrial Average and the Standard & Poor's 500.

Mitigating Regulatory Risk

But to build a large, capital-intensive powerplant or transmission facility means a large capital outlay. Before committing, builders and investors need certainty that they recover their costs and earn a fair return on their investment for the risk they assume.

In the past few years, tension has arisen between the Federal Energy Regulatory Commission (FERC), which governs both the rates and the transmission of electricity in interstate commerce, and the states, which oversee the retail sale of electricity and the adequacy of generation capacity. That tension creates uncertainty for investors.

The industry fully supports FERC's goals in the development of wholesale power markets; at the same time, it wants to reinforce the states' needs for generation and transmission adequacy. When it comes to the competitive procurement of power, achieving the right regulatory balance is crucial.

Another procurement area that would benefit from increased certainty is in building capital-intensive plants to serve customers within regional transmission organizations (RTOs). Right now, the market mechanisms that indicate when and where new powerplants should go up differ widely among regions. We're working to develop more accurate and consistent forward-pricing mechanisms within RTOs.

Companies building transmission lines look to mitigate risks, as well. The industry is working with FERC to create a regulatory framework that assures investors they can fully recover their investment, along with their cost of capital, through electricity rates. And the industry is working with state regulators to allow full recovery of all prudently incurred costs to design and permit transmission facilities, as well as the avoidance of unrecoverable costs, which arise when federal and state regulatory policies diverge.

Let's Say It Again

Comprehensive national energy legislation and sensible multi-emission legislation are vital for building plants and transmission facilities.

Among the essentials in energy legislation is the need to strengthen the nation's transmission system. We need to accommodate new capital-intensive plants, which can be located far from population centers; and we must enable the country's developing wholesale electricity markets to move large blocks of power between regions.

To stimulate more grid investment, Congress must put transmission on par with other major assets and reduce their depreciable lives from 20 years to 15. Congress also must enact enforceable reliability standards, streamline the federal permitting process for transmission, and grant FERC limited "backstop" authority to help site new transmission lines in congested areas.

Environmental concerns are another issue. Low-cost, reliable electricity results, in part, from the power sector's ability to use a variety of energy sources, including coal. The current approach to air quality regulation, though, has led to persistent litigation. This slows down environmental progress and could lead to higher electricity prices. Congress needs to adopt multi-emission legislation similar to the Clear Skies Act of 2005-that act would result in a 70-percent cut in sulfur dioxide, nitrogen oxide, and mercury by 2018 and impose an emission cap-and-trade system that gives a utility the ability to choose the most appropriate compliance strategy for its circumstances.