Large Capital Projects: What are the Risks and Who Should Bear Them?
Mark Agnew, Edison Electric Institute
NARUC Accounting/Finance MeetingLexington, KY October 13, 2008
Table of Contents
Regulatory Compact – The Key Players Industry’s Soaring Capital Expenditures Risks Facing the Industry
Demand Financing, Credit Regulatory Execution, Inflation Specific businesses (Transmission, Generation)
EEI’s Outreach Activities
Who Shares the Risks? Management
Duty to manage utility/projects prudently Shareholders
Receive an adequate return on investment for risks taken on behalf of ratepayers
Ratepayers Receive reliable service at just and reasonable rates Not responsible for mismanagement by utilities
Good regulation tries to achieve a fair balance of all interests
Soaring Capital Expenditures
Increasing Electricity Demand
Industry Capex Continues to Rise
43.041.840.740.2 41.142.0
43.645.3
48.451.9
55.1
58.5 59.962.4
64.366.2
69.171.4
74.5
35.0
40.0
45.0
50.0
55.0
60.0
65.0
70.0
75.0
80.0
2003 Q4
2004 Q1
2004 Q2
2004 Q3
2004 Q4
2005 Q1
2005 Q2
2005 Q3
2005 Q4
2006 Q1
2006 Q2
2006 Q3
2006 Q4
2007 Q1
2007 Q2
2007 Q3
2007 Q4
2008 Q1
2008 Q2
Capital Spending-Trailing 12 MonthsU.S. Shareholder-Owned Electric Utilities (in $ Billions)
Capex Projected to Top $86 Billion in 2008
P = projected
Industry Capital ExpendituresIndustry Capital Expenditures Industry committed to reliability
and making needed investments in generation, transmission, distribution and the environment Capex
2006 totaled $59.9 billion (+24%) 2007 totaled $69.1 billion (+16%) 2008 projected $86.5 billion (+25%)
Dollar growth in all categories from last year
2008 (+16%) and 2009 (+12%) projections revised sharply upward from last year’s study
Increased spending expected to continue Total capex for 2010-2030 ~ $1.5 trillion*
U.S. Shareholder-Owned Electric Utilities
* The Brattle Group, preliminary findings from The Edison Foundation presentation titled Transforming America’s Power Industry. Represents the entire Power sector.
Overall Infrastructure Investment Needs $1.5 trillion will be required over the 2010 – 2030
period doubling existing net plant in service Distribution - $675 billion Transmission - $233 billion Generation - $560 billion
Represents the entire power industry IOUs, Cooperatives, Municipals, IPPs
Carbon Legislation would enhance overall projection
Source: Transforming America’s Power Industry: The Investment Challenge (Preliminary Findings), The Brattle Group, April 2008
About 2/3 of Industry is State Regulated
Demand Risk
Demand Risk Energy Efficiency
Decoupling and other EE measures How much will this impact future revenues?
Brattle’s latest projections on this impact Required generation could fall by 17% from 2010-2030,
under a reasonable EE scenario Price Elasticity
Consumer reaction to rising gas prices (‘08 v ‘07) Risk – Management/SH – EE & price elas.
Ratepayers - energy efficiency
Financing and Credit Risks
Financing Risk Financing decisions that don’t impair:
Financial strength, Credit Rating Tighter Credit Markets
Overall trend, magnified by recent financial crisis Eventual Rise in Interest Rates?
Rates still at historical lows Strong correlation to awarded ROEs
Dividends – frozen or cut? borrowing to pay? Risk – Ratepayers - Int rates & gen cap trends
Management/SH – all the above
Credit Ratings Risk Taking on too much debt without timely cost
recovery impairs credit metrics may lead to downgrades Increases financing costs Capex plans & related debt mentioned in most
ratings actions/outlooks in 2007-08.
Risk – Management/Shareholders
Industry Leverage Beginning to Rise
Credit Quality Starting to Slide in ‘08
Downgrades outpacing upgrades in 2008 First time since 2004
Average Credit Rating Has DeclinedS&P Bond Ranking for Regulated and Mostly Regulated Electric Utilities
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Year
Below BBB- BBB- BBB BBB+ A- or Higher
Regulatory Risk
Regulatory Risk Timely recovery of large capex is crucial
CWIP Large capex cycles tend to put downward
pressure on realized ROEs Regulatory lag
Risk – Management/Shareholders
Ratepayers Quality of cost recovery affects all.
Regulatory Lag is Returning
($7,500)
($2,500)
$2,500
$7,500
$12,500
$17,500
$22,5001973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
-4.0%
-3.5%
-3.0%
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
Pre-Div FCF Actual less Allowed ROE
Note: Figures reflect Lehman Brothers utility coverage scaled up by a factor of 1.11x to reflect companies not in the Lehman Brothers coverage universe
Source: FactSet and Lehman Brothers estimates
10
Rate Cases on the Rise
Execution and Inflation Risks
Execution Risk
Delays in completing the project Cost overruns Other delays (licensing, environmental
opposition, etc.)
Risk – Management/Shareholders
Construction material costs have soared in recent years.
Labor also on the rise Inflation clauses required by builders
Risk – Ratepayers, Management/Shareholders
Cost Inflation Risk
Raw Materials Price Indexes
Risks by Business Activity
Transmission - Risk Largely regulated, less financing risk Political (siting) challenges
Communities, landowners, environmentalists Enormous long-term planning
Generation Planning risk – when will transmission be in place?
Risk – Management/Shareholders
Generation - Risk General Risks
Project management, fuel choice
Regulated Cost Risk - Management/Shareholders
Ratepayers Overruns (retroactive disallowance) – Mgmt/SH
Merchant Risk – Management/Shareholders
31
Margins Projected to Fall Below Minimum Target Levels
TRE (ERCOT)2009/2016+
New England 2009/2009
RFC (MISO)*2008/2008
AZ/NM/SNV2009/2011
California2009/2012
Rocky Mtn2008/2011
SPP2015/2016+
MRO2009/2009
(US)
New York2011/2016+
RFC (PJM)2012/2014
*Excludes MISO resources outside the RFC boundary
Source: NERC 2007 Long Term Reliability Assessment
Coal-Fired Generation - Risk
Most companies delaying construction starts Proposed capacity fell 11% from Feb to Aug ’08 Large capital outlays, long build time
Carbon regulation How expensive will coal generation be? What model used?......Price of CO2 allowances?
Environmental opposition
Natural Gas-Fired Generation – Risk
Lower capital costs - less financing risk Shorter construction time - less project
management risk. “Bridge” fuel pending nuclear and clean coal
Proposed capacity rose 20% from Feb to Aug ’08
Least risky for continuous power
Nuclear Generation - Risk Financing risk is largest risk
Capturing financing cost in rates is key Considerable project management risks
No nuclear built in decades Majority of in-service dates targeting 2015-2020 Proposed capacity rose 70% from Feb to Aug ’08
Fuel disposal? Risk – Management/Shareholders
Ratepayers (built in rate base)
Renewables - Risk Financing risks are less
Government incentives ….but higher KW hour costs than fossil fuels
Intermittent, RPS driven Low political risk
Political and cultural popularity “Transmission access” risk associated with prime
wind and solar areas Proposed Wind capacity +69% from Feb to Aug ’08 Majority of proposed build by IPPs and foreign utils.
EEI’s Outreach Activities
Opinion Leader Outreach
“Get Energy Smart – Get Energy Active” Internet campaign to help educate consumers about the key issues facing the electric power industry today
1.8 million visits to Web site since launch
Keeping the Lights On—Our National Challenge: Conference in New York focused on industry’s infrastructure needs and the role of energy efficiency
State Capital Road Shows
38
April 16-17, 2008 Fargo and Bismarck, ND
October 22, 2007 Santa Fe, NM March 17-18, 2008 Topeka, KS
June 11, 2008 Albany, NYMay 13-14, 2008 Sioux Falls-Rapid City, SD
Wall Street Outreach EEI’s State-of-the-Industry address to Wall Street EEI Leadership Wall Street Visit Wall Street-Regulator Dialogues
Nearly 20 dialogues to date Wall Street-Utility Leadership Forums
2 forums on climate issues Pre-NARUC Convention Discussion of Market
Conditions (November ‘08) Energy Policy Leadership Forum (Dec. '08)
EEI Financial Publications
Contact Information
Mark Agnew
Manager, Financial Analysis
Edison Electric Institute
(202)508-5049