Valuation of the Utilities Industry

Weekly Corporate Growth Report, Jan 26, 2004 by Dolbeck, Andrew

The utilities industry covers companies engaged in the generation, transmission, or distribution of electricity or gas or steam. It also includes water delivery and irrigation systems, and sanitary systems engaged in the collection and disposal of garbage, sewage, and other wastes. The industry is covered by major SIC code group 49.

Rising Prices

The cost of utilities to the consumer has been on the rise. Unusually cold winter weather, especially on the east coast, has increased energy consumption. The increased demand has not been matched with an increased supply. Commercial inventories of crude, the raw material for heating oil, are at the lowest level since 1982 when the government began tracking them, according to the Energy Department. For the week ending January 9, commercial supplies stood at 264 million barrels, 33.7 million barrels below the five-year average for this time of year. With demand higher than the supply, prices rise.

One reason for the reduced supply is economic: since crude is denominated in dollars in the world markets, the declining value of the dollar gives foreign producers less incentive to increase their output. The demand for oil has also been increased by the high price of natural gas. Many utilities providers and industrial users that normally rely on natural gas have the ability to switch fuels when gas becomes too expensive.

Consumers are responding to the increased prices by trying to limit their consumption. Setting the thermostat lower, investing in improved home insulation, and buying energy-efficient appliances are all ways in which consumers are trying to reduce their energy bills. Utilities providers often support such conservation, especially while their own resources are limited. During record cold days on the east coast this January, electricity suppliers sought voluntary cutbacks to ensure they had enough natural gas to run their generators so their equipment wouldn't go offline due to overuse.

Politics and Utilities

As controlled monopolies providing a necessary service to the public, utilities are subject to a fair amount of governmental interference. Utilities must deal with politics on the federal, state, and local levels.

The Bush administration recently introduced a proposal to block several corporate tax shelters. The proposal takes aim at leaseback deals in which investors buy public works like sewer systems from cities and then lease them back. The investors take advantage of the tax write-offs that result from the deprecation of the property. The federal government is trying to recover lost tax revenue that results from leaseback deals. Defenders of the deals claim that they provide revenue to cities and states that might not otherwise have the resources to maintain and operate aging sewers and other systems.

In November 2003, the Senate adopted an amendment to reduce energy providers from manipulating market prices. The amendment is part of a larger bill that authorizes spending for the US Department of Agriculture. Under the terms of the amendment, the Federal Energy Regulatory Commission could not approve contracts that had been manipulated. Opponents of the amendment claim it repeats restrictions that exist in other parts of federal law. Several public energy providers, including the Northwest Public Power Association, have openly supported the amendment.

In January 2004, the US Supreme Court declined to hear an appeal from Alliant Energy against an appeals court ruling made against it last year. Alliant had been contesting the constitutionality of the Wisconsin Utility Holding Company Act, a state law that limits the ability of utilities companies to invest outside of their core business. Alliant claims the law interferes with its ability to grow at the rate expected by its shareholders.

Consumer groups praised the decision, saying the Wisconsin law and others like it are appropriate because electric utilities are local monopolies. According to David Benforado, executive director of Municipal Electric Utilities of Wisconsin and a member of consumer group Customers First, "If you're going to have a regulated utility that has a captive audience and gets to charge regulated rates, the state has a huge interest in making sure the mother holding company is in sound financial shape."

Another area where utilities providers run up against legal restrictions is environmental regulation. Puget Sound Energy, for example, has shut down its White River Hydroelectric Project after 92 years of operation. The White River is home to both chinook salmon and bull trout, both of which are protected under the endangered species act. While hydropower on the open market cost around $40 a megawatt at the time the project was shut down, the company estimated that generating power while complying with environmental protection measures would have cost $100 per megawatt. The project generated enough electricity to light about 35,000 homes.

The Great Blackout of 2003

On August 14, 2003, a power blackout hit 50 million people in eight US states and parts of Canada. It was the largest blackout in US history. A combined US and Canadian task force determined that the blackout was started when overgrown trees shorted out three major transmission lines owned by FirstEnergy Corporation. The blackout spread when FirstEnergy computers monitoring the power grid malfunctioned and operators did not immediately recognize the severity of the situation.