Post-Derecho Lessons for Utility Investors

Roger Conrad |

Post-Derecho Lessons for Utility InvestorsThe Great Derecho of 2012 knocked out power to 4.3 million people over 10 Midwest and Middle Atlantic states. The toll in human lives and property damage has yet to be fully counted.

A Derecho is a straight line of fast-moving storms. Hurricanes typically take days to form at sea. That gives first responders, utilities and government agencies in threatened areas time to prepare for damage control.

In contrast, the Great Derecho came with hurricane force winds virtually without warning. Recovery plans had to be made on the fly, in some cases with emergency communications networks out of service. The longer the outage, the greater the cost incurred by utilities (see “When the Lights Go Out”).

The storm’s intensity is a clear warning we’ve entered a period of greater extremes with increased stresses on basic systems, particularly electricity.

Electric utility companies’ performance following storms is increasingly under scrutiny from customers, and by extension regulators.

Utilities are heavily insured for property damage and in many cases against loss of load as well. Instead, the exposure lies in the perceived effectiveness of a company’s response-and how that perception affects relations with regulators who set their rates.

Last autumn, for example, a destructive winter storm triggered outages throughout Northeast Utilities’ (NU) New England territory, nearly derailing its merger with neighboring NSTAR Electric. Connecticut Attorney General George Jepsen is still pushing state regulators to levy huge financial penalties. Meanwhile, National Grid (NGG) lost its contract to manage the Long Island Power Authority system, largely because of its poor storm response.

As I stated in How Utilities Cope with Weather-Related Disasters, public perception of utilities’ performance in the wake of the Great Derecho of 2012 is still forming. In the crosshairs are regional utilities American Electric Power (AEP)Dominion Resources (D), Exelon (EXC), First Energy (FE) and PEPCO Holdings (POM).

So far, Dominion Resources’ response seems to be drawing the best reviews. Not only did the company set and later meet clear goals for restoring power to customers, but it also provided an extraordinary amount of information on its efforts.

Conversely, the press and politicians are already slamming into PEPCO Holdings, which serves the District of Columbia and large parts of Maryland, Delaware and New Jersey. DC Mayor Vincent Gray declared himself “fed up” with PEPCO’s performance.

The company has asked Maryland regulators to delay their decision on its request for a 4 percent rate hike, almost surely because it fears denial in the wake of its criticized storm response. PEPCO also has a 5 percent rate hike on file in the District.

Denying PEPCO these rate hikes-and perhaps tacking on penalties such as a denial of storm cost recovery-would prove politically popular. The problem is, defunding a utility boosts its capital costs and inhibits investment. When that happens, shareholders are the first to suffer. Consequently, it pays for investors to be wary of utilities with tough regulatory environments.

PEPCO, for example, hasn’t raised its dividend since early 2008 and its share price has dropped 33 percent over the past five years. In contrast, neighboring Dominion, which has consistently enjoyed strong relations with Virginia regulators, has boosted its payout five times in five years by a total of almost 50 percent, returning nearly 55 percent over that time.

To grow, utilities must earn a fair return on their system investment from regulators. And nothing affects utility/regulator relations as strongly as a company’s performance during power outages. Investors ignore this reality at their own risk.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
TOF.UN:CA Taylor North American Equity Opportunities Fund 12.16 0.16 1.33 500

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