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UTILITY PROFITS: How Much is Too Much?Posted on by admin
How much is too much?
My main responsibility as a member of the Louisiana Public Service Commission is to ensure that the people and businesses of Louisiana have safe, reliable utility service at the lowest possible cost. Giving that assurance requires me to balance the revenue needs of utility companies with the impact of utility bills on customers. The LPSC grants investor-owned utilities in Louisiana an opportunity to earn a profit on their investments at a rate set by the commission. That rate of profit is built into the charges we pay for electricity, natural gas, telephones, and water and wastewater services. I have become concerned that utility bills in Louisiana may be inflated because the profit rates established for electric and gas utilities are too high. How much profit is too much? I have touched a nerve with utility companies by suggesting that their profit allowances may be too high, and asking the commission to investigate.
What prompted my concern was the decline in interest rates on borrowed money, a key factor in deciding utility rate of return. As anyone who has refinanced a house, bought a car or shopped for a decent return on a certificate of deposit knows, interest rates are at rock-bottom levels. Other factors are at work that should drive authorized returns down, including reduced risk to utilities from recent regulatory developments. The LPSC sets utility rates and profit allowances because the regulated electric and gas companies are monopolies — they have defined territories with no competition.
Most Louisiana residents and businesses get their electricity and natural gas from investor-owned companies like SWEPCO, Entergy and CenterPoint Energy Arkla. Roughly 75 percent of the U.S. population is served by investor-owned utilities. These are private companies subject to state regulation. They are financed by a combination of equity funds (stock) raised from their stockholders and debt. The cost of their debt can be determined based on interest rates that utilities pay for short- and long-term borrowing.
The U.S. Prime Interest Rate in mid-2003, my first year on the LPSC, was 4 percent. Since then it has been as high as 8.25 percent, in June of 2006, but never lower than what it is now: 3.25 percent. That means low borrowing cost for utilities. The return on equity (or profit allowed) is more difficult to determine, and it can be one of the most controversial issues facing a utility regulator. In concept, the allowed return on equity is the return that utilities must offer to attract investors. In recent years most regulatory commissions have allowed a return on equity of about 10 percent. It has been as low as 6 percent in some cases and as high as 16 percent in others.
Economic theory holds that the return on equity should be about five percent higher than the long-term “risk-free” rate of return. That five percent is known as the “risk premium” – the compensation that investors receive for assuming the risk of a given investment. A recent survey of U.S. risk premium concluded that the market average was 5.5 percent. The long-term risk-free rate (U.S. Treasury 30-year bonds) is about 2.9 percent. Add those two numbers and you get a general target return for all U.S. stock investment of 8.4 percent. Regulated utilities, shielded from competition, should be able to attract investment dollars with anticipated returns of less than the 8.4 percent for the average stock. Compare that 8.4 percent with rates of return on equity for selected electric companies regulated by the LPSC, as quoted by our staff last month:
• Entergy Gulf States Louisiana – 11.11 percent
• Entergy Louisiana – 11.07 percent
• SWEPCO – 10.01 percent
• CLECO – 11.7 percent
Here are the same numbers for the large gas-distribution companies serving Louisiana:
• CenterPoint Energy Arkla – 10.25 percent
• CenterPoint Energy Entex – 10.5 percent
• Atmos Louisiana Gas Service – 10.4 percent
• Atmos TransLa Gas – 10 percent
I am in business. I certainly believe in profits. But as a regulator I do not support excessive profits for monopoly utilities. How much is too much?
In addition to being protected from competition as monopolies, utilities have seen reduced risk from hurricanes and other acts of Nature thanks to a state-approved program known as “securitization.” Entergy’s losses from Hurricanes Katrina, Rita, Gustav and Ike, calculated by Entergy and verified by the commission, totaled billions of dollars. These costs were assessed to customers as 10-year hurricane surcharges on Entergy bills. Entergy and the LPSC used a state-created program to sell bonds to finance the losses. Interest rates on the bonds varied from three to five percent. This program also financed, at the very low rate of 2 percent, Entergy’s recovery of $200 million lost in its failed effort to convert a gas-fired power plant to petroleum coke.
Government-assured profits of 10 to 11 percent for electric and gas utilities seem high when you consider low interest rates, the average U.S. stock risk premium, and reduced utility risk. If utility profits are excessive, utility bills are excessive. How much is too much? The Public Service Commission owes the people of Louisiana an answer to that question.