Stock Performance Q FINANCIAL UPDATE QUARTERLY REPORT OF THE U.S. SHAREHOLDER-OWNED ELECTRIC UTILITY INDUSTRY

Transcription

1 Stock Performance Q FINANCIAL UPDATE QUARTERLY REPORT OF THE U.S. SHAREHOLDER-OWNED ELECTRIC UTILITY INDUSTRY

2 About EEI The Edison Electric Institute (EEI) is the association that represents all U.S. investor-owned electric companies. Our members provide electricity for 220 million Americans, operate in all 50 states and the District of Columbia, and directly employ more than 500,000 workers. With $90 billion in annual capital expenditures, the electric power industry is responsible for millions of additional jobs. Reliable, affordable, and sustainable electricity powers the economy and enhances the lives of all Americans. EEI has 70 international electric companies as Affiliate Members, and 270 industry suppliers and related organizations as Associate Members. Organized in 1933, EEI provides public policy leadership, strategic business intelligence, and essential conferences and forums. About EEI s Quarterly Financial Updates EEI s quarterly financial updates present industry trend analyses and financial data covering 54 U.S. shareholder-owned electric utility companies. These 54 companies include 48 electric utility holding companies whose stocks are traded on major U.S. stock exchanges and six electric utilities who are subsidiaries of nonutility or foreign companies. Financial updates are published for the following topics: Dividends Stock Performance Credit Ratings Construction Rate Case Summary SEC Financial Statements (Holding Companies) FERC Financial Statements (Regulated Utilities) Fuel EEI Finance Department material can be found online at: For EEI Member Companies The EEI Finance and Accounting Division is developing current year and historical data sets that cover a wide range of industry financial and operating metrics. We look forward to serving as a resource for member companies who wish to produce customized industry financial data and trend analyses for use in: We Welcome Your Feedback EEI is interested in ensuring that our financial publications and industry data sets best address the needs of member companies and the financial community. We welcome your comments, suggestions and inquiries. Contact: Mark Agnew Director, Financial Analysis (202) , MAgnew@eei.org Aaron Trent Manager, Financial Analysis (202) , ATrent@eei.org Bill Pfister Senior Financial Analyst (202) , BPfister@eei.org Future EEI Finance Meetings EEI Wall Street Briefing February 11, 2015 University Club New York, New York 50th EEI Financial Conference November 8-11, 2015 Westin Diplomat Hollywood, Florida For more information about EEI Finance Meetings, please contact Debra Henry, (202) , DHenry@eei.org Investor relations studies and presentations Internal company presentations Performance benchmarking Peer group analyses Annual and quarterly reports to shareholders Edison Electric Institute 701 Pennsylvania Avenue, N.W. Washington, D.C

3 The 54 U.S. Shareholder-Owned Electric Utilities The companies listed below all serve a regulated distribution territory. Other utilities, such as transmission provider ITC Holdings, are not shown below because they do not serve a regulated distribution territory. However, their financial information is included in relevant EEI data sets, such as transmission-related construction spending. ALLETE, Inc. (ALE) Alliant Energy Corporation (LNT) Ameren Corporation (AEE) American Electric Power Company, Inc. (AEP) Avista Corporation (AVA) Berkshire Hathaway Energy Black Hills Corporation (BKH) CenterPoint Energy, Inc. (CNP) Cleco Corporation (CNL) CMS Energy Corporation (CMS) Consolidated Edison, Inc. (ED) Dominion Resources, Inc. (D) DPL, Inc. DTE Energy Company (DTE) Duke Energy Corporation (DUK) Edison International (EIX) El Paso Electric Company (EE) Empire District Electric Company (EDE) Energy Future Holdings Corp. (formerly TXU Corp.) Entergy Corporation (ETR) Exelon Corporation (EXC) FirstEnergy Corp. (FE) Great Plains Energy Incorporated (GXP) Hawaiian Electric Industries, Inc. (HE) Iberdrola USA IDACORP, Inc. (IDA) Integrys Energy Group, Inc. (TEG) IPALCO Enterprises, Inc. MDU Resources Group, Inc. (MDU) MGE Energy, Inc. (MGEE) NextEra Energy, Inc. (NEE) NiSource Inc. (NI) Northeast Utilities (NU) NorthWestern Corporation (NWE) OGE Energy Corp. (OGE) Otter Tail Corporation (OTTR) Pepco Holdings, Inc. (POM) PG&E Corporation (PCG) Pinnacle West Capital Corporation (PNW) PNM Resources, Inc. (PNM) Portland General Electric Company (POR) PPL Corporation (PPL) Public Service Enterprise Group Inc. (PEG) Puget Energy, Inc. SCANA Corporation (SCG) Sempra Energy (SRE) Southern Company (SO) TECO Energy, Inc. (TE) UIL Holdings Corporation (UIL) Unitil Corporation (UTL) Vectren Corporation (VVC) Westar Energy, Inc. (WR) Wisconsin Energy Corporation (WEC) Xcel Energy, Inc. (XEL)

4 Companies Listed by Category (as of 12/31/2013) Please refer to the Quarterly Financial Updates webpage for previous years lists. iven the diversity of utility holding company corporate strategies, no single company categorization approach will be G useful for all EEI members and utility industry analysts. Never-theless, we believe the following classification provides an informative framework for tracking financial trends and the capital markets response to business strategies as companies depart from the traditional regulated utility model. Regulated Mostly Regulated Diversified 80%+ of total assets are regulated 50% to 80% of total assets are regulated Less than 50% of total assets are regulated Categorization of the 48 publicly traded utility holding companies is based on year-end business segmentation data presented in 10Ks, supplemented by discussions with company IR departments. Categorization of the six non-publicly traded companies (shown in italics) is based on estimates derived from FERC Form 1 data and information provided by parent company IR departments. The EEI Finance and Accounting Division continues to evaluate our approach to company categorization and business segmentation. In addition, we can produce customized categorization and peer group analyses in response to member company requests. We welcome comments, suggestions and feedback from EEI member companies and the financial community. Regulated (38 of 54) ALLETE, Inc. Alliant Energy Corporation Ameren Corporation American Electric Power Company, Inc. Avista Corporation Black Hills Corporation Cleco Corporation CMS Energy Corporation Consolidated Edison, Inc. DPL, Inc. DTE Energy Company Duke Energy Corporation Edison International El Paso Electric Company Empire District Electric Company Entergy Corporation Great Plains Energy Incorporated Iberdrola USA IDACORP, Inc. Integrys Energy Group IPALCO Enterprises, Inc. Northeast Utilities NorthWestern Energy OGE Energy Corp. Otter Tail Corporation Pepco Holdings, Inc. PG&E Corporation Pinnacle West Capital Corporation PNM Resources, Inc. Portland General Electric Company Puget Energy, Inc. Southern Company TECO Energy, Inc. UIL Holdings Corporation Unitil Corporation Westar Energy, Inc. Wisconsin Energy Corporation Xcel Energy, Inc. Mostly Regulated (13 of 54) Berkshire Hathaway Energy CenterPoint Energy, Inc. Dominion Resources, Inc. Exelon Corporation FirstEnergy Corp. MGE Energy, Inc. NextEra Energy, Inc. NiSource Inc. PPL Corporation Public Service Enterprise Group, Inc. SCANA Corporation Sempra Energy Vectren Corporation Diversified (3 of 54) Energy Future Holdings Hawaiian Electric Industries, Inc. MDU Resources Group, Inc. Note: Based on assets at 12/31/2013

5 Q Stock Performance COMMENTARY HIGHLIGHTS nthe EEI Index returned -4.1% during the third quarter, trailing the major averages 1% to 2% gains. The pullback followed an 18.0% surge in the year s first half powered by declining interest rates and firming natural gas prices. nthe third quarter was marked by price volatility among merchant power stocks and utilities with competitive market exposure. After 25%+ first half gains, these corrected 10% to 15% during July, forcing the broader utility indices down 7% to 8% for the month. npersistently weak power demand and fast-improving economies of scale for rooftop solar have sown doubt about long-term rate base growth predictions, but analysts continue to forecast mid-single-digit earnings gains for the industry in the years ahead as needed investment in distribution systems, transmission infrastructure and renewable generation remains considerable. nmulti-year predictions of rising rates continue to be confounded by falling yields. Utilities tend to underperform in rising rate environments, yet if long-rates stay flat when the Fed finally tightens, this time may be different. The EEI Index returned -4.1% during the third quarter, trailing the major averages positive 1% to 2% returns. Analysts cited profit taking as a primary reason for pullback; the EEI Index gained a strong 18.0% during 2014 s first half versus the Dow Jones 2.7%, the S&P 500 s 7.1% and the Nasdaq s 5.6% returns. Another reason offered was renewed weakness in natural gas prices and power prices after a firming earlier in the year sparked gains among merchant power 1 I. Index Comparison (% Return) Index EEI Index Dow Jones Inds S&P Nasdaq Comp.^ Calendar year returns shown for all periods, except where noted. * Through September 30 ^Price gain/loss only. Other indices show total return. Source: EEI Finance Department II. Category Comparison (% Return) U.S. Shareholder-Owned Electric Utilities Index All Companies Regulated Mostly Regulated Diversified Calendar year returns shown for all periods except where noted. * Through September 30 Returns shown here are unweighted averages of constituent company returns. The EEI Index return shown in Table I above is cap-weighted. Source: EEI Finance Department, SNL Financial and company annual reports III. Total Return Comparison Value of $100 invested at close on 12/31/2009 EEI Index S&P 500 Index DJI * Note: Year end, except where noted. * Through September 30 Source: EEI Finance Department, SNL Financial 2014* *

6 2 STOCK PERFORMANCE 16% 12% 8% 4% 0% IV. 10-Year Treasury Yield Monthly Average Monthly Yield, 1/1/80 through 9/30/14 VIII. Returns by Quarter U.S. Shareholder-Owned Electric Utilities Index Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 EEI Index Dow Jones Industrials S&P Nasdaq Comp.^ Source: U.S. Federal Reserve 5% 4% 3% 2% 1% 0% Source: U.S. Federal Reserve $/mmbtu Source: SNL Financial V. 10-Year Treasury Yield Daily Daily Yield, 1/1/08 through 9/30/14 VI. Natural Gas Spot Prices 1/1/05 through 9/30/14, Henry Hub VII. NYMEX Natural Gas Futures 9/30/ /31/2013 $/mmbtu 12/31/2012 6/30/ Nov 2014 May 2015 Nov 2015 May 2016 Nov 2016 Source: SNL Financial August 2014 through December 2016, Henry Hub Category* Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 All Companies Regulated Mostly Regulated Diversified * Returns shown here are unweighted averages of constituent company returns. The EEI Index return shown above is cap-weighted. Source: EEI Finance Department, SNL Financial and company annual reports. IX. Sector Comparison, Trailing 12 mo. Total Return For the twelve-month period ending 9/30/14 Sector Total Return Technology 30.0% Healthcare 27.6% Basic Materials 18.8% Financials 16.5% Utilities 16.2% EEI Index 15.8% Consumer Services 14.8% Telecommunications 14.3% Industrials 13.7% Consumer Goods 13.4% Oil & Gas 11.9% Note: Sector Comparison page based on the Dow Jones U.S. Indexes, which are marketcapitalization-weighted indices. Find more information at mdsidx/downloads/fact_info/dow_jones_us_indexes_industry_indexes_fact_sheet.pdf Source: EEI Finance Dept., Dow Jones & Company, Yahoo! Finance X. Sector Comparison, 3 mo Total Return For the three-month period ending 9/30/14 Sector Total Return Healthcare 5.1% Technology 4.4% Telecommunications 2.4% Financials 1.2% Consumer Services 1.1% Consumer Goods -0.1% Basic Materials -1.2% Industrials -2.2% EEI Index -4.1% Utilities -4.6% Oil & Gas -8.7% Note: Sector Comparison page based on the Dow Jones U.S. Indexes, which are marketcapitalization-weighted indices. Find more information at mdsidx/downloads/fact_info/dow_jones_us_indexes_industry_indexes_fact_sheet.pdf Source: EEI Finance Dept., Dow Jones & Company, Yahoo! Finance

7 STOCK PERFORMANCE 3 XI. Market Capitalization at September 30, 2014 (in $ Mil.) U.S. Shareholder-Owned Electric Utilities Company Stock Symbol $ Market Cap % Total Duke Energy Corporation DUK 52, % NextEra Energy, Inc. NEE 40, % Dominion Resources, Inc. D 40, % Southern Company SO 39, % Exelon Corporation EXC 29, % Sempra Energy SRE 25, % American Elec. Power Co. AEP 25, % PPL Corporation PPL 21, % PG&E Corporation PCG 21, % Public Service Enter. Group PEG 18, % Edison International EIX 18, % Consolidated Edison, Inc. ED 16, % Xcel Energy Inc. XEL 15, % FirstEnergy Corp. FE 14, % Northeast Utilities NU 13, % Entergy Corporation ETR 13, % DTE Energy Company DTE 13, % NiSource Inc. NI 12, % CenterPoint Energy, Inc. CNP 10, % Wisconsin Energy Corp. WEC 9, % Ameren Corporation AEE 9, % CMS Energy Corporation CMS 7, % OGE Energy Corp. OGE 7, % SCANA Corporation SCG 7, % Pepco Holdings, Inc. POM 6, % Company Stock Symbol $ Market Cap % Total Alliant Energy Corporation LNT 6, % Pinnacle West Capital Corp. PNW 6, % MDU Resources Group, Inc. MDU 5, % Integrys Energy Group, Inc. TEG 5, % Westar Energy, Inc. WR 4, % TECO Energy, Inc. TE 3, % Great Plains Energy Inc. GXP 3, % Vectren Corporation VVC 3, % Cleco Corporation CNL 2, % Hawaiian Electric Indus., Inc. HE 2, % IDACORP, Inc. IDA 2, % Portland General Electric Co. POR 2, % Black Hills Corporation BKH 2, % UIL Holdings Corporation UIL 2, % PNM Resources, Inc. PNM 1, % ALLETE, Inc. ALE 1, % Avista Corporation AVA 1, % NorthWestern Corporation NWE 1, % El Paso Electric Company EE 1, % MGE Energy, Inc. MGEE 1, % Empire District Electric Co. EDE 1, % Otter Tail Corporation OTTR % Unitil Corporation UTL % Total Industry 557, % Source: EEI Finance Dept., SNL Financial XII. EEI Index Market Capitalization (at Period End) $ Billions U.S. Shareholder-Owned Electric Utilities Note: Change in EEI Index market capitalization reflects the impact of buyout and spin-off activity in addition to stock market performance. Source: EEI Finance Dept., SNL Financial EEI Index Market Cap (in $Millions) Q ,035 Q ,200 Q ,668 Q ,238 Q ,331 Q ,553 Q ,598 Q ,454 Q ,073 Q ,324 Q ,601 Q ,193 Q ,460 Q ,305 Q ,663 Q ,989 Q ,727 Q ,825 Q ,899 Q ,848 Q ,281 Q ,858 Q ,088 Q ,565 Q ,946 Q ,486 Q ,711 Q ,024 Q ,472 Q ,921 Q ,070 Q ,844 Q ,185 Q ,672 Q ,281 Q ,044 Q ,014 Q ,275 Q ,164 Q ,236 Q ,352 Q ,635 Q ,597 Q ,083 Q ,540 Q ,916 Q ,163 Q ,091 Q ,776 Q ,365 Q ,006 Q ,735 Q ,472

8 4 STOCK PERFORMANCE XIII. Comparative Category Total Annual Returns U.S. Shareholder-Owned Electric Utilities, Value of $100 invested at close on 12/31/ /31/ /31/ /31/ /31/2013 9/30/2014 EEI Index Regulated Mostly Regulated Diversified EEI Index Annual Return (%) EEI Index Cumulative Return ($) Regulated EEI Index Annual Return Regulated EEI Index Cumulative Return Mostly Regulated EEI Index Annual Return Mostly Regulated EEI Index Cumulative Return Diversified EEI Index Annual Return (5.16) Diversified EEI Index Cumulative Return /30/ (0.92) Calendar year returns shown, except where noted. Returns are unweighted averages of constituent company returns. stocks and utilities with competitive operations. These have been mired in a multi-year bear market caused by the impact of abundant shale gas on competitive power markets. Indeed, the quarter was marked by considerable price volatility as merchant power stocks and utilities with competitive market exposure fell anywhere from 10% to 15% during July, forcing the broader utility indices down 7% to 8%. Relatively cool summer weather was also cited as a factor influencing market sentiment. While one summer cooling season has no impact on longer-term business fundamentals, it cooled the bullish spirits that had crept into the outlook for merchant power. Despite the summer correction, the EEI Index recovered ground in August and September and remained solidly ahead of the major averages through 2014 s first nine months with a 13% gain. Rising Rates? Not so Fast There was little change in prevailing interest rate levels or the rate outlook during the quarter. The 10-year Treasury traded narrowly in a 2.4% to 2.6% range as investors scoured economic data and Federal Reserve statements for insights into when the central bank would begin to reverse the extraordi- XIV. EEI Index Top Ten Performers (Year to Date) For the 9-month period ending 9/30/2014 Company % Return Category Pepco Holdings, Inc R Exelon Corporation 27.8 MR NiSource Inc MR Entergy Corporation 26.3 R Edison International 23.1 R Integrys Energy Group, Inc R Sempra Energy 19.7 MR Public Service Enter. Group Inc MR DTE Energy Company 17.7 R Vectren Corporation 15.4 MR Note: Return figures include capital gains and dividends. R = Regulated, MR = Mostly Regulated, D = Diversified Source: EEI Finance Department

9 STOCK PERFORMANCE 5 nary monetary ease in place since the 2008/2009 financial crisis. The primary macro trend that contributed to utility share strength in 2014 s first half was falling interest rates a surprising development since fears of rising rates were so pervasive last year. Federal Reserve talk of tapering its aggressive bond buying program sent 10-year Treasury yields from 1.7% in May 2013 to nearly 3.0% by September Yet the event of tapering, which began last December and reduced Fed purchases from a peak of $85 billion per month to a projected conclusion this October, hardly produced the rising rates investors feared. Instead, rates fell to under 2.5% by the middle of Q2, due in part to renewed economic weakness blamed on severely cold winter weather. Natural Gas Price Rally Stalls On the strength of rising natural gas prices, several of the EEI Index s top gainers in 2014 s first half were utilities with competitive operations, led by Exelon (+36%), Public Service Enterprise Group (+30%), Entergy (+30%) and NextEra Energy (+20%). The trend was also visible in pure merchant power stocks such as NRG (+30%) and Calpine (+24%). However, the trend reversed during the third quarter as Henry Hub spot prices drifted down from $4.40 in early July to under $4 through August and September. The event confirmed analyst skepticism voiced in Q2 about the durability of the rally, given abundant domestic supplies of shale gas and strong supply growth. Nevertheless, the first half s price action helped stoke perceptions that these stocks, after a brutal multi-year bear market, are attractively priced for patient investors given EPA-mandated coal plant retirements in the years ahead and a prospective tightening of power market supply. The third quarter sell-off only improved entry prices for the bulls. M&A Underpins Valuations Merger and acquisition (M&A) activity in the broad market has been driven to the highest levels in years by interest rates at 60-year lows, investors thirst for yield of any kind and abundantly available financing. Market-wide deal volume year-to-date exceeded $1.1 trillion through late August, on par with 2013 s full-year level; if trends hold, 2014 s total may exceed 2007 s record $1.2 trillion. Shares of smaller, regulated utilities were in some cases underpinned by M&A speculation and two deals have taken place this year. On April 20, Exelon made an all-cash offer for Washington, D.C.-based east coast utility Pepco Holdings for $27.25 per share, a 25% percent premium to the pre-offer price, citing the compelling strategic rationale given geographical proximity of territories and similar business models. Exelon also indicated the goal of having its corporate dividend fully supported by regulated earnings by 2015 was a motivation for the deal. Pepco was the EEI Index s leading stock over the first six months of the year, with a 47% return. The year s other deal was Wisconsin Energy s June 23 offer to buy Integrys in a cash and stock transaction that represented a 17% premium to Integrys pre-announcement price. Integrys posted the EEI Index s fourth-strongest gain for the first half, returning 34%. The proposed merger emphasizes the combination of regulated utilities with complementary geographical footprints in the upper Midwest and offers the prospect of faster earnings growth for the combined company through rate base growth. Wisconsin Energy described the proposed deal as earnings-accretive in the first calendar year after closing, largely credit neutral and able to produce a growth rate at least equal to Wisconsin Energy's stand-alone growth rate. Both proposed deals showcase a theme in utility M&A over the past few years: consolidation driven by the desire to take advantage of regulated rate base growth opportunities, often in nearby service territories, and in some cases where the acquiring company has a stronger ability to fund capex than does the acquired utility. Synergies from the combination as a source of earnings growth have also been cited as an M&A rationale, given a backdrop of low-demand-growth across much of the nation. Louisiana regulated utility Cleco also jumped on deal talk, up 28% through mid-year. While not party to an announced deal by the end of Q3, Cleco had reported on June 23 that it had received buyout inquiries and retained financial advisors to review proposals. On October 20, Cleco announced an agreement to be acquired by a group of investors led by Macquarie Infrastructure and Real Assets (MIRA) and British Columbia Investment Management Corporation (bcimc). The investor group will acquire all outstanding shares of CNL for $55.37, a 15% premium to the October 17 closing price of $ Anemic Demand Raises Capex Questions A trend that presents a contrasting theme to M&A optimism about rate base growth opportunities is the multi-year stagnation in power demand. Driven by cold winter weather, power demand actually jumped about 2% nationwide for the first nine months of However, demand was flat in 2013 as U.S. electric output increased only 0.1% over 2012 s 3,991,409 GWh and weather-normalized demand actually declined 0.6%. Nationwide demand has essentially been flat for five years. In-roads made by energy efficiency and demand-side management programs into the patterns of power usage are driving structural changes in demand, which has lost its historical link to broad economic growth as the economy moves farther from an emphasis on industrial and manufacturing activity and toward services.

10 6 STOCK PERFORMANCE Weak demand has caused speculation that industry rate base growth prospects are less solid than consensus thinking predicts, although the longer-term need for improvements to the nation s transmission and distribution infrastructure, new renewable capacity to meet state renewable portfolio standards and future carbon standards offers a convincing counterargument. Industry watchers make credible cases on both sides of the debate, while the ambiguity inherent in predicting events that far in the future lessens any impact on stock prices today. Nevertheless, the industry s near-term capital spending outlook has softened. EEI s latest projections show estimated industry-wide capex reaching a record $103 billion in 2014 (more than double 2004 s cyclical low of $41 billion) but then falling to $96 billion in 2015 and $91 billion in These figures are, of course, subject to revision as companies evolve their strategic plans and release new capex outlooks, but the general trend hints that the speed of rate base growth may slow from the fast pace of recent years. If this does happen it has yet to significantly erode analyst growth estimates for the industry. The outlook continues to be that of mid-single-digit earnings gains for many regulated companies over the next several years as current capex plans are implemented. As of mid October 2014, a survey of analyst estimates for EEI Index companies showed a projected aggregate earnings growth rate of 5.1% for the next five years (an arithmetical average of individual company estimates). Distributed Solar: The Next Game Changer? While it did not emerge entirely out of left field, the rooftop solar trend is garnering more attention as a potential threat to utility business models. A Wall Street firm released a report earlier this year suggesting proliferation of rooftop solar and battery storage, due to rapidly improving economies of scale, could erode industry revenues on the margin and threaten some companies credit strength over a longterm horizon. Other analysts point out that rooftop solar could substitute in many regions for peak demand and obviate need for rate base growth that supplies peak load. However, they also observe that state commissions may make rate designs less accommodative to self-generation (which typically relies on grid-supplied back-up power) as current rate structures don t contemplate such selective and restrictive use of infrastructure designed to be supported by all rate payers. Moreover, other technical innovations such as electric vehicles could, in theory, offer a new source of demand for electricity and possibly integrate in a constructive way with utility-directed load management. Utilities may even have an opportunity to get into the rooftop solar business, depending on regulatory treatment and regulatory policy goals. Technological innovation is never a completely dormant force in any industry, even in one as staid as regulated electric power, but the uncertainties are considerable from today s vantage point and it s very hard to come up with a certain enough view of the future to over-ride current projections for industry fundamentals in a way that influences stock prices. It may happen, but it s not in sight as of today. EPA Proposes Carbon Regs In June, the Environmental Protection Agency (EPA) released proposed guidelines for regulating carbon emissions from existing fossil fuel power plants under the Clean Air Act, advancing a process that started in 2007 with the Supreme Court s ruling that EPA has authority and obligation to regulate greenhouse gases if it finds they endanger human health or welfare. Given the seven years that have passed since the court s decision, the deliberative nature of guideline development and the very long-term horizon over which final rules will be implemented, the proposed regulatory structure hardly came as a surprise and had little impact on industry stock prices. The EPA s proposal calls for a 30% reduction in power plant CO 2 emissions by 2030 from 2005 levels, a number the industry is already well on the way to meeting through growing natural gas generation, coal plant retirements under EPA mercury regulations and growth of renewable generation. While 30% is a nationwide figure, states have the right and obligation to formulate compliance plans, which they must propose during 2017 and Such a long-term horizon leaves ample room for other forces to impact utility share prices long before CO 2 rules do, and regional differences in generation mix and power market structure mean impact of carbon regulation will vary from region to region and company to company. Compliance may result in rate base growth opportunities for some regulated utilities and required investment with uncertain payoff for competitive coal generators. The long-run impact on business strategies and share prices will likely be determined by state regulatory treatment of these legally mandated capital investments. NextEra Launches Yield Co. Likely the most innovative financial development in the industry over the past year or so is the advent of so-called yield companies (YieldCos) publicly traded spin-offs from parent companies that hold portfolios of generation assets with long-term contracts, providing dividend yield with dividend growth potential as assets are added to the portfolio, or dropped down in the parlance of the concept. The yieldco pays out as much as 90% of distributable cash flow and targets long-term dividend growth through drop-downs according to analysts of 8% to 15%, well in excess of the mid-single-digit growth rate prevalent across the broader industry. Such a vehicle purports to unlock value associated

11 STOCK PERFORMANCE 7 with contracted assets in a holding company structure, where commodity cycle risk and other risks may dilute investor s recognition of contracted assets cash flow stability and earnings power. The yieldco is very much a creature of the current market environment, in which more than five years of zero interest rate policy by the Federal Reserve and interest rates at 60-year lows have left investors prizing nearly any sort of income, especially above-average dividend growth potential with below-average risk. Merchant power giant NRG launched the first yieldco in July 2013 with plans to grow a portfolio of contracted wind, solar and natural gas generation assets. The offering s success has riveted industry attention, climbing from an initial price of $22 to over $54 by late August 2014, before correcting to the mid-$40s into October on concern over the prospect of rising interest rates from imminent tightening of monetary policy by the Fed. In July 2014, EEI Index member NextEra Energy formed NextEra Energy Partners, a yieldco subsidiary that will own, operate and acquire contracted clean energy projects with stable, long-term cash flows. A handful of yieldcos have come public but are generally renewable developers unrelated to utility holding companies. That may change if utilities with contracted generation are persuaded yieldcos offer a way to boost value for shareholders more than simply selling the assets. Although the entire concept seems premised on a continuation of investors aggressive hunt for yield and willingness to pay up to get it. The Eternal Threat of Rising Interest Rates Independent of the vagaries of broad macroeconomic forces, the utility industry s business fundamentals have been fairly steady in recent years. Rising capital spending has funded rate base growth and with it earnings and dividend growth. This has occurred within a context of very low interest rates and abundant capital (which has made financing cheap and reduced interest expense), state regulatory relations that most analysts characterize is constructive and well managed, and low natural gas prices that have held down the fuel component of rates and made rate cases somewhat easier than they might have been (the other side of the coin of pain inflicted on merchant power by low natural gas prices). For the past five years, the prospect of rising interest rates has been cited as a primary threat to utility stock valuations. Now, with economic growth seemingly consistent enough to allow the Fed to end five years of unprecedented monetary accommodation, analysts are citing probable Fed rate hikes as a headwind to utility shares, as economic growth with rising inflation and rising rates has historically been a challenging backdrop for utility stocks. This is especially the case given the industry s migration back to regulated businesses with dividend yield as the primary appeal to investors. A contrasting thesis emerged during the summer that, as Fed tightening raises short rates, longer-term rates may remain stable, flattening the yield curve. In this case, the impact on utility shares may be more neutral than historical experience suggests. This time may be different. Such speculation is natural but ultimately fruitless. When rates will rise is anyone s guess, and plenty have guessed in recent years only to be confounded by declines to ever lower levels. For the time being, utilities generally sound balance sheets, modest but healthy earnings growth, sturdy dividends, constructive regulatory backdrop and the paucity of income available almost everywhere in the markets make an attractive combination for income-seekers. Future threats, whether from rising rates, rooftop solar or rising fuel costs that impact rate cases seem distant threats.