Regulation plays an important role in determining the cost and quality of utility services. Thus, participating in the regulatory process is an essential strategy for pro-actively managing your company’s electricity and natural gas costs. All regulatory commissions determine:
(1) the utility’s overall revenue requirement or cost of service to provide the utility a reasonable opportunity to earn a reasonable return on investment and recover reasonable and necessary expenses,
(2) how the utility’s costs are allocated and recovered from each customer class (i.e., residential, commercial, industrial, lighting) served by the utility, and
(3) the rates, terms and conditions applicable to each service.
Other than following the three ratemaking steps, the specific processes and applications are unique to each jurisdiction. Consequently, the practices and precedents established in one regulatory jurisdiction will not carry-over to other jurisdictions, except by coincidence. Thus, it is important to have in-depth knowledge of the regulatory commissions that directly determine your utility rates and costs.
Regulatory Research Associates (RRA), a group within S&P Global Commodity Insights, issued a quarterly evaluation of the regulatory climate for energy (electric and gas) utilities in 53 jurisdictions (50 state commissions, District of Columbia, New Orleans City Council, Texas Railroad Commission). The evaluations are conducted from an investor perspective and indicate the relative regulatory risk associated with the ownership of securities issued by each jurisdiction’s energy utilities. RRA then assigns a ranking ranging from Above Average/1 (highest) to Below Average/3 (lowest) to each jurisdiction.
The current RRA rankings are summarized below.
As can be seen, Alabama has the highest ranking, while Arizona has the lowest ranking. RRA states that it considers several variables in assigning rankings. The variables include:
- Impact of State Leadership (Governor/Mayor): Whether energy issues were a topic of debate along with potential involvement in the regulatory process.
- Commissioner Selection Process/Membership: Elected commissions are viewed more risky than appointed commissions. Commissioner backgrounds are relevant. The selection methods are listed below (courtesy of S&P Global).
- Commission Staff/Consumer Interest: The greater the number of consumer intervenors, the higher the investor uncertainty.
- Settlements vs. Litigation: The ability of the parties to reach agreement (and avoid litigation) is considered constructive.
- Rate Case Timing: RRA considers whether there is a set time frame within which a rate case must be decided, the length of any such time frame and the degree to which the commission adheres to that time frame. Interim rate authority is viewed as constructive.
- Regulatory Policies: For example, whether the Commission uses an historical or future test year, whether construction work in progress is allowed in rate base, how authorized returns on equity (ROEs) compare to the average authorized ROE for energy utilities nationwide, whether the company has been accorded a reasonable opportunity to earn the authorized return in the first year that new rates are in effect, whether alternative (streamlined) regulation (i.e., multi-year rate plans, margin/earnings sharing, formula rates) is allowed.
- Court Actions: Whether appellate judges are appointed or elected.
- Legislation: How proscriptive newly enacted laws are; whether it balances ratepayer and shareholder interests; and whether the laws are clear or open to varied interpretations.
- Corporate Governance: Whether regulators have the ability to intervene in a utility’s financial decision-making process (e.g., pre-approval of all securities issuances, limitations on leverage, dividend payouts, ring fencing, and mergers).
- Regulatory Reform/Industry Restructuring: How standard-offer or default service is procured and how much market-price risk the utility must absorb; how stranded costs were addressed. The status of industry restructuring by regulatory jurisdiction is as follows:
- Securitization: RRA views securitization as an attractive option because it allows regulators to minimize the customer rate impacts related to recovery of a particular utility asset. The carrying charge on the asset is the interest rate applied to a highly rated, usually AAA, corporate bond rather than the utility’s weighted-average cost of capital or even the interest rate on typical utility bonds, which are generally rated BBB and carry higher interest rates. At the same time, securitization reduces the investment risk for the utility by providing the utility up front recovery of its investment in what are usually non-revenue producing assets. The company can then redeploy those investment dollars elsewhere. The states that authorize securitization are shown on the map below (courtesy of Saber Partners). Since publication, securitization legislation has been enacted in Kentucky, Indiana, South Carolina and Virginia.
- Adjustment Clauses: RRA views mechanisms that allow rates to be reset outside of a full rate case as constructive depending on the frequency of such adjustment; whether there is a true-up mechanism (to ensure full cost recovery); and whether adjustments are forward-looking or based on a historical period. Common examples of adjustment clauses include fuel/purchased power, infrastructure, energy efficiency, and revenue (full or partial) decoupling.
- Integrated Resource Planning: RRA generally considers the existence of a resource-planning process to be constructive as it may provide the utility at least some measure of protection from hindsight prudence reviews of its resource acquisition decisions or pre-approval of the ratemaking parameters and/or costs for a new facility.
- Renewable Energy/Emission Requirements: RRA considers whether there is a defined preapproval and/or cost-recovery mechanism for investments in projects designed to comply with these standards and whether there is a mechanism that limits or restricts cost recovery. With the threat of a federal carbon emissions standard, the manner in which potential stranded costs are addressed also poses a risk for investors.
- Rate Structure: RRA looks at whether (1) there are economic development or load retention rates are in placed and how any associated revenue shortfall is addressed; (2) there have been steps taken to reduce/eliminate interclass rate subsidies (i.e., to equalize rates of return across customer classes); and (3) the commission has adopted or moved toward a straight-fixed-variable rate design.
Taking these criteria into account, RRA recently lowered the rankings of Maryland (citing recent the recent Gubernatorial change and increased consumer opposition) and Virginia (citing recent legislation affecting cost recovery and on-going conflicts between the Governor and legislators), and it raised the rankings of Nevada (citing a stable regulatory climate) and West Virginia (citing the expanded securitization framework). RRA is closely monitoring Connecticut (recent disappointing rate case decision), Florida (ongoing investigations into corruption, bribery and campaign violation allegations against Florida Power & Light), Georgia (controversy surrounding the 2022 commissioner elections and the election process), Kentucky and Massachusetts (Commissioner turnover), and New Hampshire (ongoing investigations regarding utility rate adjustments, energy procurement and net metering).