Florida regulators to Florida utilities: "Say good-bye to reliable returns that ensure a low cost of capital." Florida utilities to Florida regulators: "Fine, but don’t expect any new investment."
Utility-regulator relations were frequently hostile in the 1970s and ’80s, when companies brought the current fleet of nuclear power plants into service. By that time, commodity price inflation, higher interest rates and unanticipated safety costs after the Three Mile Island accident had pushed up construction costs to multiples of previous estimates. Rate-increase requests filed one-by-one by the utilities were similarly elevated.
Spurred by angry constituents, regulators were having none of it. With the exception of a handful of states such as Wisconsin, officials across the country disallowed billions in nuclear plant construction costs as “imprudent.” The result was billions in asset writeoffs, a wave of share price-crippling dividend cuts, slashed credit ratings and a handful of utility bankruptcies, with even more near-bankruptcies.
Not surprisingly, what followed was a period of extreme underinvestment in the nation’s energy grid. Weakened finances dramatically pushed up utilities’ cost of capital from where it was in the ’50 and ’60s.
The completion of the giant nukes meant that companies could dramatically curtail capital spending afterward. But for nearly two decades, management was leery of making any major investment in regulated infrastructure. The result was the power shortages of the late ’90s and grossly outdated transmission and distribution infrastructure, which has only recently begun to be addressed.
Are we heading back to the bad old days? This week’s decisions by the Florida Public Service Commission (PSC) are certainly a worrisome sign.
Florida has historically been one of the most reliable regulatory climates for utilities. The state’s electrical grid has faced immense challenges, mainly a dense and growing population and extreme weather, including numerous hurricanes.
Bereft of fossil fuel resources that provide more than 70% of America’s electricity, it’s had to rely instead on imported fuels and technology such as nuclear energy and renewables, which are more expensive. Then there are the environmental concerns, which have prevented widespread use of coal in many regions.
Offsetting these challenges has been an exceptionally experienced PSC, which has pursued a cooperative relationship with operating companies, regardless of the political party running the state. As a result, utilities FPL Group (FPL-OLD), Progress Energy (NYSE:PGN), TECO Energy (NYSE:TE) and Southern Company (NYSE:SO)--which services the Panhandle--have been able to work with regulators to do long-term planning. That’s kept their cost of capital among the lowest on Wall Street, holding down the expense of projects to meet demand.
That doesn’t appear to be the case anymore. The catalyst was the recession, which has apparently hit Florida harder than most states due in part to the collapse of the homebuilding industry. One victim of the unrest was Governor Charlie Crist, who despite only recently succeeding Jeb Bush as governor has set his sights on the US Senate.
Once the favorite and still enjoying the backing of numerous national party leaders, Crist is now locked in a tight battle with state Speaker of the Florida State House Marco Rubio for the right to run on the Republican ticket in November.
Crist, however, isn’t going down without a fight. And his planned road to redemption is an old one followed by many politicians over the years: bashing the state’s utilities.
All three major Florida utes came to the PSC last year requesting rate increases to finance future capital spending. Crist immediately politicized the issue, first openly opposing the rate increases and criticizing the PSC as bought and paid for by utilities. He eventually sacked the entire PSC, replacing two of the commissioners with a retired editorial writer and the owner of a bar.
The new PSC has definitely gotten the message: Don’t worry about such highfalutin concepts as cost of capital and the long-term needs of the state. Forget about the fact that rate increases requested by FPL and Progress Energy--even if granted in full--would have resulted in lower rates for consumers, thanks to their management of fuel costs.
And honestly, who cares what the PSC staff has to say, even though they had already cut the proposed rate increases by more than half?
The result: This week, after a delay of several months, the Florida PSC denied 100% of Progress Energy’s request for a $500 million boost. It also slashed the ute’s allowed return on equity (ROE) to 10.5% and voted unanimously to raid its depreciation reserve.
For FPL, the PSC granted a miniscule $75 million of a planned $1 billion proposal this year that was to be followed by $247 million next. ROE was taken down to just 10%, actually the midpoint of a range from 9% to 11% and among the lowest in the country. In contrast, the PSC staff had proposed a $357 million boost.
The bottom line at the new Florida Public Service Commission--clear from both the decision and commissioners’ self-congratulatory comments afterward--is that no rate increase is justified for whatever reason. The decision has already landed the utilities on credit watch at all major rating agencies.
Unfortunately, this train wreck may be very hard to reverse, especially given the lack of experience (to be charitable) the new commissioners have.
Ironically, the worst victims of these decisions are sure to be those they were supposed to help--consumers. Hostile regulators have never been good news for utilities. And there’s a chance the Florida PSC could try to go after utility assets that are outside its power of review.
Already we’ve heard charges that FPL was funneling capital to its NextEra Energy unit--the nation’s largest producer of wind and solar power--at the expense of Florida ratepayers. And we’re likely to hear a lot more of that going forward.
FPL definitely has a few more cards in its hand than the utilities of the late ’70s and ’80s, which completed nuclear plants and just had to take whatever rate relief regulators offered. For one thing, FPL has no major regulatory asset for which it needs to recover costs now. Instead, much of the increase was meant to gradually finance future projects to avoid future rate shock.
The company has already announced it’s halting $10 billion in capital projects planned over the next 10 years. These include expansion of the Turkey Point nuclear reactor and numerous infrastructure investments to improve reliability that the company claims would have created 20,000 construction jobs over the next several years. It also pledged to assess the cost structure of its other operations, holding out the possibility of more job cuts.
Instead of investing in its regulated Florida assets at meager rates of return, FPL has far more profitable opportunities elsewhere in the US to expand its fleet of renewable energy power plants under its NextEra unit. Utes in most states are still woefully behind renewable energy targets, and NextEra has had no problem landing new business.
Progress, meanwhile, has plenty of customers in the Carolinas who are in need of infrastructure spending. And neither faces any competition in Florida, which remains entirely regulated.
The bottom line for investors here, however, is caution. It’s still possible that Florida’s utilities and regulators will pull back from the brink. And these utilities obviously aren’t the sitting ducks nuke builders were in the ’70s and ’80s.
But it’s equally possible that FPL’s mass cancellation of projects will provoke a further hostile reaction from regulators. That means more bad publicity, legal squabbles and, almost certainly, problems for the stock.
In the final analysis, no one wins from utility-vs.-regulator confrontations, at least not until they’re defused. That’s food for thought for anyone considering loading up on Florida utilities now, particularly when utilities in most states are not plagued by regulators and others playing politics with this increasingly vital industry.
Disclosure: No Positions