Challenges in Financing for Challenges in Financing for Electric UtilitiesElectric Utilities

MID-AMERICAN REGULATORY CONFERENCE

TRAVERSE CITY, MICHIGAN

JUNE 15, 2009

ROBERT W. GEEPRESIDENT

GEE STRATEGIES GROUP LLC

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Disclaimers, etc.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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OverviewOverview

• 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 How The Financial Crisis Has Changed ThingsChanged 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

Electric Utilities Are Uniquely AffectedElectric 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 1970’s, 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 Losses in Equity Markets Mirrored in Utility Sector Mirrored in Utility Sector

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• Losses in public equity markets = >$34 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

Consequences to ConsiderConsequences 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 Will There Be Sufficient Capital to Meet All Obligations? 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 RegulatorsImpacts on Regulators

• Quality of utility regulation will be key to maintaining sector’s 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 What Do We Mean By “Not Supportive” Regulation ? *Supportive” Regulation ? *

• 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

*From an Investor Perspective*From an Investor Perspective

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Recommended Actions for RegulatorsRecommended 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 Additional Measures Bolstering Utility Competitiveness In Capital MarketsCompetitiveness 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 -- don’t 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 Lesson for Regulators: Exhibit a “Profile in Courage” “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. GeePresidentGee Strategies Group LLC7609 Brittany Parc CourtFalls Church, VA 22304U.S.A.703.593.0116703.698.2033 (fax)rwgee@geestrategies.comwww.geestrategies.com