American electric utilities are currently faced with a need to make significant investments in an ageing grid, prepare for electric vehicle power demand, and transition to renewable energy sources while addressing increasing pressure from consumer advocates relating to residential electricity affordability.
It’s supposed to be relatively straightforward. Typically, regulated utilities determine what they will need to charge customers in order to meet their anticipated continuing service obligations and projected capital requirements. Then go to the appropriate regulatory agency to justify the desired rate increase. Continuing service costs, capital requirements, the appropriate return on capital, industrial and residential rates and sources of capital are all part of a negotiation between the utility and the commissioners. At the end of the day, the electric utility business is a cost-plus enterprise with the nation’s regulatory commissions tasked with determining reasonableness.
It should be clear that the electric utility industry, with historic capital budget requirements, is going to need a lot of money. Investors should recognize that negotiations between utilities and their regulators are likely to be unusually difficult. Rising interest rates, accelerating construction costs and the sheer magnitude of the expected investment requirements will make it difficult to avoid burdensome rate increases. Moreover, rapidly rising energy costs are going to have a significant and immediate adverse impact on utility bills.
All comments and suggestions are welcome.
Walter J. Kirchberger, CFA