Infrastructure and the Economy by Chris Trayhorn, Publisher of mThink Blue Book, January 1, 2009 With utility infrastructure aging rapidly, reliability of service is threatened. Yet the economy is hurting, unemployment is accelerating, environmental mandates are rising, and the investment portfolios of both seniors and soon-to-retire boomers have fallen dramatically. Everyone agrees change is needed. The question is: how? In every one of these respects, state regulators have the power to effect change. In fact, the policy-setting authority of the states is not only an essential complement to federal energy policy, it is a critical building block for economic recovery. There is no question we need infrastructure development. Almost 26 percent of the distribution infrastructure owned and operated by the electric industry is at or past the end of its service life. For transmission, the number is approximately 15 percent, and for generation, about 23 percent. And that’s before considering the rising demand for electricity needed to drive our digital economy. The new administration plans to spend hundreds of billions of dollars on infrastructure projects. However, most of the money will go towards roads, transportation, water projects and waste water systems, with lesser amounts designated for renewable energy. It appears that only a small portion of the funds will be designated for traditional central station generation, transmission and distribution. And where such funds are available, they appear to be in the form of loan guarantees, especially in the transmission sector. The U.S. transmission system is in need of between $50 billion and $100 billion of new investment over the next 10 years, and approximately $300 billion by 2030. These investments are required to connect renewable energy sources, make the grid smarter, improve electricity market efficiency, reduce transmission-related energy losses, and replace assets that are too old. In the next three years alone, the investor-owned utility sector will need to spend about $30 billion on transmission lines. Spending on distribution over the next decade could approximate $200 billion, rising to $600 billion by 2030. About $60 billion to $70 billion of this will be spent in just the next three years. The need for investment in new generating stations is a bit more difficult to estimate, owing to the uncertainties surrounding the technologies that will prove the most economic under future greenhouse gas regulations and other technology preferences of the Congress and administration. However, it could easily be somewhere between $600 billion and $900 billion by 2030. Of this amount, between $100 billion and $200 billion could be invested over the next three years and as much as $300 billion over the next 10. It will be mostly later in that 10-year period, and beyond, that new nuclear and carbon-compliant coal capacity is expected to come on line in significant amounts. That will raise generating plant investments dramatically. Jobs, and the Job of Regulators All of this construction would maintain or create a significant number of jobs. We estimate that somewhere between 150,000 and 300,000 jobs could be created annually by this build out, including jobs related to construction, post-construction utility operating positions, and general economic "ripple effect" jobs through 2030. These are sustainable levels of employment – jobs every year, not just one-time surges. In addition, others have estimated that the development of the smart grid could add between 150,000 and 280,000 jobs. Clearly, then, utility generation, transmission and distribution investments can provide a substantial boost for the economy, while at the same time improving energy efficiency, interconnecting critical renewable energy sources and making the grid smarter. The beauty is that no federal legislation, no taxpayer money and no complex government grant or loan processes are required. This is virtually all within the control of state regulators. Timely consideration of utility permit applications and rate requests, as well as project pre-approvals by regulators, allowance of construction work in progress in rate base, and other progressive regulatory practices would vastly accelerate the pace at which these investments could be made and financed, and new jobs created. Delays in permitting and approval not only slow economic recovery, but also create financial uncertainty, potentially threatening ratings, reducing earnings and driving up capital costs. Helping Utility Shareholders This brings us to our next point: Regulators can and should help utility shareholders. Although they have a responsibility for controlling utility rates charged to consumers, state regulators also need to provide returns on equity and adopt capital structures that recognize the risks, uncertainties and investor expectations that utilities face in today’s and tomorrow’s very de-leveraged and uncertain financial markets. It is now widely acknowledged that risk has not been properly priced in the recent past. As with virtually all other industries, equity will play a far more critical role in utility project and corporate finance than in the past. For utilities to attract the equity needed for the buildout just described, equity must earn its full, risk-adjusted return. This requires a fresh look at stockholder expectations and requirements. A typical utility stockholder is not some abstract, occasionally demonized, capitalist, but rather a composite of state, city, corporate and other pension funds, educational savings accounts, individual retirement accounts and individual shareholders who are in, or close to, retirement. These shares are held largely by, or for the benefit of, everyday workers of all types, both employed and retired: government employees, first responders, trades and health care workers, teachers, professionals, and other blue and white collar workers throughout the country. These people live across the street from us, around the block, down the road or in the apartments above and below us. They rely on utility investments for stable income and growth to finance their children’s education, future home purchases, retirement and other important quality-of-life activities. They comprise a large segment of the population that has been injured by the economy as much as anyone else. Fair public policy suggests that regulators be mindful of this and that they allow adequate rates of return needed for financial security. It also requires that regulatory commissions be fair and realistic about the risk premiums inherent in the cost of capital allowed in rate cases. The cost of providing adequate returns to shareholders is not particularly high. Ironically, the passion of the debate that surrounds cost of capital determinations in a rate case is far greater than the monetary effect that any given return allowance has on an individual customer’s bill. Typically, the differential return on equity at dispute in a rate case – perhaps between 100 and 300 basis points – represents between 0.5 and 2 percent of a customer’s bill for a "wires only" company. (The impact on the bills of a vertically integrated company would be higher.) Acceptance of the utility’s requested rate of return would no doubt have a relatively small adverse effect on customers’ bills, while making a substantial positive impact on the quality of the stockholders’ holdings. Fair, if not favorable, regulatory treatment also results in improved debt ratings and lower debt costs, which accrue to the benefit of customers through reduced rates. The List Doesn’t Stop There Regulators can also be helpful in addressing other challenges of the future. The lynchpin of cost-effective energy and climate change policy is energy efficiency (EE) and demand side management (DSM). Energy efficiency is truly the low-hanging fruit, capable of providing immediate, relatively inexpensive reductions in emissions and customers bills. However, reductions in customers’ energy use runs contrary to utility financial interests, unless offset by regulatory policy that removes the disincentives. Depending upon the particulars of a given utility, these policies could include revenue decoupling and the authorization of incentive – or at least fully adequate – returns on EE, DSM and smart grid investments, as well as recovery of related expenses. Additional considerations could include accelerated depreciation of EE and DSM investments and the approval of rate mechanisms that recover lost profit margins created by reduced sales. These policies would positively address a host of national priorities in one fell swoop: the promotion of energy efficiency, greenhouse gas reduction, infrastructure investment, technology development, increased employment and, through appropriate rate base and rate of return policy, improved stockholder returns. The Leadership Opportunity Oftentimes, regulatory decision making is narrowly focused on a few key issues in isolation, usually in the context of a particular utility, but sometimes on a statewide generic basis. Rarely is state regulatory policy viewed in a national context. Almost always, issues are litigated individually in high partisan fashion, with little integration as part of a larger whole where utility shareholder interests are usually underrepresented. The time seems appropriate – and propitious – for regulators to lead the way to a major change in this paradigm while addressing the many urgent issues that face our nation. Regulators can make a difference, probably far beyond that for which they presently give themselves credit. Filed under: White Papers Tagged under: Climate Change, Compliance, Distribution, Generation, Regulation, Richard J. Rudden, Transmission, Utilities, White Papers About the Author Chris Trayhorn, Publisher of mThink Blue Book Chris Trayhorn is the Chairman of the Performance Marketing Industry Blue Ribbon Panel and the CEO of mThink.com, a leading online and content marketing agency. He has founded four successful marketing companies in London and San Francisco in the last 15 years, and is currently the founder and publisher of Revenue+Performance magazine, the magazine of the performance marketing industry since 2002.