Challenges in Financing for Electric Utilities

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Challenges in Financing for Electric Utilities

• MID-AMERICAN REGULATORY CONFERENCE
• TRAVERSE CITY, MICHIGAN
• JUNE 15, 2009

ROBERT W. GEE PRESIDENT GEE STRATEGIES GROUP LLC
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Disclaimers, etc.

• I am not a financial analyst, nor do I play one
  on television. . .
• I am a former regulator whose forte is listening
  to what others say, usually in jargon . . .
• Then explaining what is said into plain English
  and, if necessary, into regulatory speak to
  regulators

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Overview

• The recent crisis in the financial markets over
  the last several months and how that has affected
  electric utilities
• Policy Implications
• The options utility regulators face

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How The Financial Crisis Has Changed Things

• Volume of capital available for borrowing has
  shrunk significantly
• Fewer traditional lenders of capital after
  bankruptcies and government interventions
• Bank Mergers facilitated but. .
• One plus One Two
• One plus One One
• Currently, capability of banks to lend is down 20
  percent, or approx. 10 trillion less than before
  the crisis
• Result Existing borrowers chasing less available
  capital

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Electric Utilities Are Uniquely Affected

• They are capital Intensive enterprises
• They rely more on bank-provided liquidity to meet
  needs than other industrial sectors one half on
  average versus 76 percent
• Previously, credit of majority (79 ) of
  utilities was rated AA or better in the 1970s,
  but most today (69 ) rated BBB less room for
  error to avoid falling below investment grade
• This exposes them to additional risks at a time
  of economic stress
• Their balance sheets are contracting under this
  stress

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Losses in Equity Markets Mirrored in Utility
Sector

• Losses in public equity markets gt34 trillion
• US electric utilities 40 equity value loss
  from Dec. 2007 level (vs. 53 for S P 500) as
  of April 2009
• Losses have lessened lately, and markets have
  recovered slightly, but stock price volatility
  remains

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Consequences to Consider

• What all this means Competition for available
  capital will be fierce, and cost of capital will
  be higher as reflected in cost of debt
• Example bonds for BBB rated utility seeing
  estimated 346 basis point spread (over10-year
  Treasuries) versus 108 bps in July 2007
• Higher debt cost results in higher cost of equity
• Bad news for a capital intensive industry such as
  electric utility sector
• One unnamed investment banker These are the
  most extraordinary and scary times I have seen in
  my 27 years as a banker.

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Will There Be Sufficient Capital to Meet All
Obligations?

• Crisis arrives at worst time since sector in need
  of capital to finance build out and modernization
  of power delivery infrastructure
• Between 1.5 and 2.0 trillion estimated for
  infrastructure investment between 2010 and 2030
  (Brattle Group)
• Needs for smart grid investments, environmental
  compliance, including carbon mitigation for some
• One estimate for 2009 and 2010, utilities will
  have a funding gap of at least 50 billion
  (calculated as capital expenditures plus
  dividends subtracted from funds from operations)
  -- JP Morgan
• Utilities will need to rely greater on internally
  generated funds and/ or seek assistance from
  nontraditional sources of capital

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Impacts on Regulators

• Quality of utility regulation will be key to
  maintaining sectors competitiveness with other
  sectors
• Investors even more sensitive now to regulatory
  policies
• Investors looking to see if regulators sensitized
  to utilities current cash and liquidity
  conditions and whether their responses are timely
  and certain
• If market perceives quality of regulation to be
  not supportive, capital will migrate elsewhere

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What Do We Mean By Not Supportive Regulation ?
From an Investor Perspective

• Regulatory policy not comprehending that the
  paradigm has been significantly altered, and that
  financial markets have undergone structural
  change
• Persistence of regulatory lag and timely recovery
  of costs impeded
• Authorizing equity rates of return not reflective
  of actual or current market conditions
• Unreasonably restraining rate levels to
  accommodate public constituencies

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Recommended Actions for Regulators

• Open and maintain an ongoing dialogue with your
  utilities
• Understand the financial circumstances they
  operate in
• Build trust if not there
• Collaborate with utilities in partnership to seek
  solutions

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Additional Measures Bolstering Utility
Competitiveness In Capital Markets

• Consistent with state law, utilize tools to
  accelerate cost recovery and reduce risk of under
  recovery
• CWIP in rate base
• Regulatory predeterminations of prudence
• Pass-through of targeted costs or capital
  expenditures
• Forward looking test year
• More frequent rate cases
• Be realistic about return on equity -- dont
  be slave to formulaic outcomes that have
  unrealistic effects
• Be mindful of earned return versus allowed
  return avoid giving with one hand and taking
  away with another

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Lesson for Regulators Exhibit a Profile in
Courage

• Regulators forced to make decisions that are
  unpopular, particularly if public perceives rates
  are rising in this economically distressed
  environment
• Avoid the easy way out this only passes the
  buck to successors
• Spend time consensus building with all of your
  stakeholders and the public
• Repeatedly explain your decisions to the public
  designate knowledgeable staff to assist
• Educate the public to understand the difficult
  choices you need to make
• In the end, the public may not like the
  decisions, but will understand their wisdom
  most likely after you are gone!

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Robert W. Gee President Gee Strategies Group
LLC 7609 Brittany Parc Court Falls Church, VA
22304 U.S.A. 703.593.0116 703.698.2033
(fax) rwgee_at_geestrategies.com www.geestrategies.co
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