Utility 2.0 Adapting to the New Business Reality Workshop

Transcription

1 Utility 2.0 Adapting to the New Business Reality Workshop Denise M. Furey Regent Square Advisors August 12, 2015 Richard Sedano Regulatory Assistance Project

2 Practicing Risk-Aware Regulation Practicing Risk-Aware Electricity Regulation: What Every State Regulator Needs to Know, How State Regulatory Policies Can Recognize and Address the Risk in Electric Utility Resource Selection Ceres April 2012 Update November 2014 Authors: Binz, Mullen, Sedano, Furey

3 1. Stressors on the Utility Financial Norm Customer energy empowerment Distributed generation and emerging technologies Environmental imperatives and the Clean Power Plan Consistent reliability and service expectations 3

4 New Technology Investment by Utilities Value not necessarily valued by customers Prospect of Revenue Erosion Shaved by energy efficiency Bigger bites from distributed generation Changing net demand Siting challenges Sprawl, new preferences, increased cost for like for like replacement, deferred maintenance Environmental Compliance Opportunity for someone, but for whom? 4

5 Large Customer Demands Stable (reduced) rates Clean power 5

6 On the Other Hand: Electrification Transportation Thermal Erratic progress Upward Trend seems consistent Hard to forecast 6

7 Is Regulation a Stressor Also? Some say revenue recovery under normal rules is not assured Does rate base emphasis induce attraction to large (inherently costly, risky) assets? Should less of the return be based on rate base and more on achieving outcomes? 7

8 2. Trends: Industry Investments Current Infrastructure Needs (aging system) Repairs Transmission New (Smart) Technology Retiring Coal Plants New Renewable Facilities New Natural Gas Facilities

9 Natural Gas Facilities Depressed natural gas prices Improving technologies for gas extraction Need for more transport Firm demand Costs Siting Same regulators

10 2. Investment, Depreciation, Rate Trends Distribution investment changes with DER Some investment due to DER, while other investments are avoided 10

11 2. Investment, Depreciation, Rate Trends Rate Pressure Rates are going up Sales growth no longer offsetting costs Revenue adequacy Decoupling Some utilities not confident in decoupling 11

12 III. From the Investor s Perspective Concerns and Opportunities

13 Credit Issues - Ratings Uncertainty Financial flexibility is weaker than during the last construction phase. Industry average ratings are in the BBB range. Down from A levels a decade ago. In context with other infrastructure improvement needs Recovery of stranded assets Non-regulated assets Diversity of operations Financial flexibility Vertically integrated utilities Constructive regulatory bodies? Regulatory fatigue

14 US Electric IOUs Rating History S&P Credit Ratings Distribution, U.S. Shareholder-Owned Electric Utilities 22% 46% 27% AAA AA+, AA, AA- A+, A, A- BBB+, BBB BBB- BB+, BB, BB-, B+, B, B-, CCC+ Source: Standard & Poor s, Macquarie Capital

15 Credit Issues Ratings (cont.) The Rating Process The Numbers Ratios etc Fuel mix Geographic diversity Customer base Hedges in place Age of assets

16 Credit Issues Ratings (cont.) The Rating Process The Mitigants or the Stressors Event risk Condition of assets Regulators Management Politics Other

17 Fixed Income Investors Retail Buy and hold Highly illiquid Investment grade bonds Institutional High Yield Investment grade bonds Conservative Pensions, High grade bond funds

18 Equity Investors Retail and Conservative Changes landscape of ownership Seeking Yield Seeking new products

19 Equity New and Newer Products MLPs Natural gas, oil and coal related assets REITs Real estate, limits on activities and distributions Yieldcos Newest Tax complexity Mostly HY

20 3. Changing Financial Attitudes and Behavior Credit rating agencies may lack imagination about new answers they just want to see the ratios that address repayment Utilities could have the inapt investors for the business they will be in and may need to accept that 20

21 MLPs GP GP GP Units LP Units LP Distributions MLP Distributions

22 Attractions & Concerns Concerns Typically not Investment Grade Interest rate sensitive Risk relating to the tax credits Project/Asset structure (valuations) Political and regulatory risks Attractions Strong yields Asset heavy Tax benefits

23 Attractions & Concerns Concerns Typically not Investment Grade Interest rate sensitive Risk relating to the tax credits Project/Asset structure (valuations) Political and regulatory risks Attractions Strong yields Asset heavy Tax benefits

24 Attractions & Concerns - Yieldcos Concerns Typically not Investment Grade Interest rate sensitive Risk relating to the tax credits Project/Asset structure (valuations) Political and regulatory risks Attractions Strong yields Asset heavy Tax benefits

25 Case Study - Structure NRG Yield Sponsor NRG Energy Inc. Pool of assets v. single asset Wind, solar PV, gas-fired, district heating Project and Sponsor both rated HY Rated higher than Sponsor US assets Large pool of assets at NRG some of which could be added to the NRG Yields portfolio

26 NRG Yield Inc. (NYLD) Structure at inception 2013 NRG Energy Inc. $395MM Class A Units NYLD Class A Common $468MM Public Issuance Owners $79MM for Class A Units Class B Units for 2/3s interest NRG Yield LLC NRG Yield Operating LLC GenConn 49.9% Marsh Landing 100% Avenal 49.9% CVSR 48.9% South Trent 100% Other Thermal 100% Misc. 100%

27 IV. Assessing and Managing Risk What to do?

28 Risks in Perspective Cost-related Time-related Cost of and access to capital Capex overruns Variable cost estimates Management Regulatory fatigue Market prices for output Construction delays Auxiliary assets Technological changes Changes in market dynamics Contingencies

29 Sources of Risk in the Risk-Aware Report Construction Operating Costs Regulation Carbon Water Capital Planning 29

30 Variable Costs Natural Gas Hedging Long term contracts Finding one of any duration Counterparty risk Exchange traded Tenors Greatly reduced counterparty risk Basis risk Instruments

31 Variable Costs Other Uranium and Coal Longest term contracts one can find Best counterparty one can find Environment related credits SO2, NOx, RPSs, Carbon? Contracts Markets Products Maintenance Good management

32 Prices for Output Vertically Integrated Regulators!? Wholesale generation activities Contracts PPA Hedges Markets Exchanges RTOs Products

33 4. Monetizing Risk Planning generates insight that allows risk to be recognized and managed, and that transparent utility planning allows the regulator to be involved Customers can be involved in risk management 33

34 5. Affirmative Risk Management Strategies Affirmative risk management strategies start with planning and energy efficiency to understand and then to reduce all knowable risks, with diversification, while avoiding large assets until they are necessary (but not hiding from them either if they are) Engaging and educating regulators is an important risk management tactic 34

35 6. Practicing Risk Aware Regulation Diversifying supply portfolios Robust Planning Transparent Ratemaking Financial and physical hedges Holding Utilities Accountable Active Regulation Regulatory Reform and Reinvention 35

36 6. Practicing Risk Aware Regulation Planning and clear-eyed assessment of risks Regulatory reform elements Multi-year revenue with forecasted test year Decoupling Outcome-based regulation Built to assure capital and reasonable cost Attitude of collaboration 36

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39 6. Practicing Risk-Aware Regulation Is there a capital bias? Where might it come from? Executives preferences or fears Chronic gauze-eyed view of risk Or a presumption that customers will bail out bad investments, which may be less of a viable assumption Rate base for all of nearly all earnings Peers OEM pressure DERs are coming, executives that do not understand them are exposed 39

40 6. Practicing Risk-Aware Regulation Large assets Plan A: avoid Plan B: See them coming for a long time Discuss them Delay them Gather critical mass of support for them 40

41 Organizing Idea: Efficient Capital Maximizing performance of invested capital An animating idea in NY REV For example, steers us away from addressing peak with more (inefficient) capital and toward reducing peak Earnings more important than growth 41

42 7. Converging Interests Utility, Investor, Consumer Consumers need respect For what they spend that they can t avoid And confidence that performance is good or better That performance includes their experience For what they can bring to the grid For being able to express some preferences To be protected when that is necessary 42

43 Challenges for Management Not just change, but timing of change Regulatory fatigue at the the state level Regulatory uncertainty at the federal level Infrastructure improvement costs Financial flexibility Changing the regulator/regulated dynamic Managing costs!

44 Challenges for Investors Who, When and Where What instruments are the safest What instruments have the greatest upside How to price risk? Uncertainty!!! Timing of change Devil is in the details

45 Convergence happens through more engagement and transparency Helps if all systems work together 45

46 8. Building Continued and Future Financial Health of Utilities 46

47 8. Why do we need or want utilities? Starting from preserving the utility is the wrong place and confuses some people We need to start with what society needs Utilities are likely to be the best ways to get key needs met, so that is why Delivery, connection, back-up, technical support, billing, metering, enabling (as with NY REV DSP) 47

48 Utility Value Proposition Remaking regulation to assure continued capital flow to support society s needs (for which utility will likely be important) Empower customers with infrastructure PLUS Adapt as needed Invest in customers Communicate, including through rates, scorecards, and planning narratives Need staff who get customers 48

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52 About RAP The Regulatory Assistance Project (RAP) is a global, non-profit team of experts that focuses on the long-term economic and environmental sustainability of the power and natural gas sectors. RAP has deep expertise in regulatory and market policies that: Promote economic efficiency Protect the environment Ensure system reliability Allocate system benefits fairly among all consumers Learn more about RAP at rsedano@raponline.org