By John H. Herbert

Traditionally, when Wall Street is stuck in a bear market, utility stocks enjoy relatively strong performance. But will utilities maintain their defensive posture when talk of a recession turns into reality? The answer may be no, because the most pressing current economic problems—specifically a declining housing market, cratering credit markets and rising commodity prices—all create special problems for maintaining utility profits.

Utility companies’ current and future net income increases roughly in proportion with floor space. In other words, new homes and additions to existing homes create more demand for electricity and natural gas—not just this year but in future years.

Annualized sales of new single family houses fell to only 604,000 units in December 2007. Compare this to the record level of nearly 1.4 million homes in July 2005. During that same period, large additions were being built onto existing homes across the country. Accordingly, the Dow Jones Utilities Index during this period was posting gains 16 times greater than the Dow Jones Industrial Average.

In December 2007 floor space additions from new homes were so low that they probably didn’t cover the decline in floor space from physical depreciation of existing homes. This declining trend is not likely to reverse anytime soon, based on the large and growing stock of unsold homes.

Furthermore, much of the recent decline in housing activity is associated with credit problems in the mortgage market, and these problems have spread to other credit markets. For example, credit card interest rates and fees for many utility customers have increased. These costs have risen along with inflation in prices for gasoline and other basic commodities that utility customers purchase.

These pressures may affect utilities’ collection rates and bad-debt expenses, as utility customers put off the timely payment of utility bills. They know they can do this because most will continue receiving service even if their payments are overdue. Others will not pay their utility bills at all, because they will abandon houses they can no longer afford. Increasingly late payments and uncollectible bills will reduce utility cash flow, increase short term borrowing requirements and trim income.

The Federal Reserve has lowered the federal funds rate over the last six months primarily to shore up financial markets. Yet utility costs of capital have remained relatively steady, as financial institutions have built a larger spread into loans to balance perceived market risks and offset mortgage-market losses. Moreover, the Fed may need to increase rates in the second half of the year if prices for energy and other basic commodities remain elevated, and if core inflation stays above the Fed’s target level. This could boost utility borrowing costs and reduce utility income. Interest rate hikes appear increasingly likely as economists at the Fed and elsewhere focus more on stagflation, which has re-emerged as an economic bugaboo.

Thus until credit markets, housing markets and inflation stabilize, investors should not count on utility stocks remaining defensive.

Editor’s note: Certainly rising interest rates would put pressure on the utility industry’s cost structure. By itself, that wouldn’t end utilities’ role as a defensive investment. Rather, capital costs are only one factor in a complex set of forces driving up overall costs and complicating utility rate cases—and therefore utilities’ value proposition. To the degree the U.S. economy contracts, regulators will be increasingly reluctant to grant favorable rate treatment for expected capital expenditure plans. Shareholders may need to wait several months longer to ride the wave of a growing rate base. -MTB

Posted: March 11th, 2008 under Current News, utility stocks.
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By Courtney Barry

Environmental advocates in Texas are crying “bird kill!” over potential damage to a fragile ecosystem caused by proposed wind turbines. But is that really the issue driving opposition?

Aligned as “Coastal Habitat Alliance,” environmentalists, Audubon Societies, and the 825,000 acre King Ranch in South Texas seek to halt progress on two planned wind projects. The wind farms would put more than 600 turbines on 60,000 acres of land located near Corpus Christi. Last December the Alliance filed suit in both federal and state court, naming several defendants, including the PUC, the Texas General Land Office (which oversees wind farm development), and the projects’ developers and investors. David Newstead, of the Coastal Audubon Society, a member of the Alliance, says the projects could affect as many as two to three hundred bird species. Now ranchers and landowners are showing up at hearings, challenging the wind facilities on environmental grounds.

Jack Hunt, CEO of King Ranch, claims the sited area is “full of wetlands, endangered species, threatened species, migrating birds, and over wintering birds…We recognize the value of wildlife.” But reviewing the case history, before the talk of an environmental assessment, and before a public relations firm started fronting media questions for the Alliance, a long economic thread becomes evident. Early challenges to the wind projects raised concerns about hunting revenue loss, and tax abatements. Environmental concerns were raised too, but Hunt also acknowledged biodiversity is why King Ranch is world renowned as a hunting destination favored by presidents, foreign dignitaries, and CEOs. Indeed, hunting at the ranch bring in five times as much revenue per acre as cattle-raising does. That ability to command a hunting premium will be affected by the turbines, Hunt said. He also opposes hefty tax abatements for project developer PPM, claiming they will cost the county millions in tax revenue.

And from the King Ranch’s point of view, it doesn’t help that the neighboring Kenedy Ranch, where the turbines will be situated, stands to garner all the profits—between $1,200 and $5,000 per turbine each year, according to sources.

Still, ecology is the binding factor for the Alliance, and many people say the siting is just plain wrong. Ned Ross of FPL, which has scouted regions for wind, and has significant wind development in Texas (Panhandle region), says FPL was not interested in developing the area around the Gulf Coast, for various reasons including avian activity. Ross, aware of all the dissention created by the lawsuits, says “The courts are going to have to make a call on that.”

A hearing on the merits in the state case is set for March 5, focusing on the original transmission line order handed down from the PUC, and whether the Alliance can intervene, says Doug Fraser, assistant attorney general handling the case for defendant PUC. In the federal case defendants have filed a motion to dismiss, but the court has not yet scheduled a hearing date.

In related news …
Hunting & Fishing Groups Call for GHG Regulation

Posted: February 18th, 2008 under Current News.
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A recent consumer backlash against demand-response programs in California seems to have caught the industry off guard. The blogosphere (and some traditional media) erupted in a rhetorical bacchanalia after the California Energy Commission proposed including programmable thermostats in the state’s new building codes.

This episode shows just how badly informed consumers are about electricity — and more specifically, about the value of smart meters, time-of-use rates and demand-response programs. It should serve as a wake-up call to the utility industry and its policy makers, who have given almost no attention to public-perception questions in the effort to advance the smart grid.

The fact this occurred in California is all the more revealing. One of the country’s greenest-thinking and most tech-savvy states — the state that commercialized windpower and gave us Menlo Park and Silicon Valley — rightfully should welcome smart meters with open arms. Instead, an inherent distrust of public institutions — and probably a lingering hangover from the California energy crisis — set the state’s demand-management proponents back on their heels.

It seems many California consumers don’t accept anything the industry says at face value — particularly when higher electricity rates are at stake. Claims of environmental benefit seemed only to raise the level of suspicion — invoking images from George Orwell’s 1984, and the more obscure (and much funnier) Brazil, a film directed by Terry Gilliam.

The backlash also might have been fueled by the concerns of civil libertarians and medical marijuana advocates in California, who fear utilities will give time-of-use metering data to drug-enforcement agencies seeking marijuana growing operations. Some Canadian jurisdictions already do this as a matter of course, while others focus on power theft rather than metered use of electricity related to clandestine activities.

Few consumers would argue with using the smart grid to detect power theft. But the industry must walk a fine line. If consumers perceive the smart grid as a truncheon in the hands of the green police — whether that green is the color of cannabis or the environment — they’ll disregard the technology’s conservation and efficiency benefits faster than you can say “doubleplus ungood.”

If the industry finds itself playing defense like the California Energy Commission did in January, then the smart grid revolution could be over before it even begins.

Posted: February 1st, 2008 under Current News.
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