Despite higher taxable income and pressure on balance sheets, capital spending by regulated utilities will remain elevated—and much of it will be dedicated to replacing aging infrastructure, hardening or efficiency-boosting measures, and on renewables and environmental projects, said Moody’s Investors Service in a recent sectoral briefing.
The credit ratings agency for the first time this June downgraded the regulated utility sector from stable to negative, pointing to a surge in financial risks as more individual companies funnel funds to debt. In a Dec. 14 briefing, Moody’s said utilities will claim less in depreciation expenses and have higher taxable income under the 2017 Tax Cuts and Jobs Act, and most are starting to pay cash taxes as early as 2019 or 2020.
However, several utilities are still involved in extensive improvement projects, it said, warning: “This could put pressure on balance sheets depending on how much debt is used in the financing plans.”
An Unexpected Surge in Captial Spending
Capital spending for a group of 31 utility holding companies that the agency examined was expected surge to $100 billion in 2018, compared to $90 billion in 2017, Moody’s noted. In 2019, that group’s capital spending was expected to fall to $90 billion, and to $80 billion 2020. “We originally expected that capital spending would peak in 2013 and 2014, and then fall back as utilities completed major generation and environmental projects. However, capital spending programs actually accelerated in 2016 and 2017 as companies anticipated the end of bonus depreciation. Now, even though this tax benefit has ended, utility company forecasts are still showing that capital spending will exceed historical levels into 2020, much of it for transmission,” Moody’s said.
Utilities are pouring investments in the transmission grid to improve reliability by reducing congestion and system losses, to better integrate renewables, and to support the installation of distributed energy resources and accommodate flexible power flows and support services, the agency said.
AEP, for example, will designate 75% of its total capital investments on transmission and distribution (T&D) projects between 2019 and 2023, mostly on grid modernization. Duke Energy Corp. will also allocate about 40% of its capital investments to expand its electric and gas T&D business in 2018 and 2019. Meanwhile, Southern Co. plans to sink between 30% and 40% of its total spending on T&D–related projects, but it also allocates an average 14% of total investments in environmentally related projects between 2018 and 2022.
Also notable is that FirstEnergy Corp. will spend $4.7 billion between 2018 and 2021—in addition to $4.4 billion spent between 2014 and 2017—to institute smart grid technologies in the PJM region to quickly identify outages and fulfill “expected load growth from shale gas activity, and reinforcing the system in the wake of coal plant closures.” In ERCOT, Oncor Electric Delivery Co. plans to spend $1.2 billion to upgrade aging infrastructure and build new lines, investments aimed to support large increases in electricity use associated with oil and natural gas extraction in the Permian Basin.
Federal, State Backing for Capital Spending
Capital spending in T&D has been largely backed by state regulators and legislatures, as well as by the Federal Energy Regulatory Commission’s (FERC’s) return-on-equity (ROE) incentives. Recently, however, “some commissioners have voiced resistance to the continuation of ROE incentives, arguing that the transmission companies are not sufficiently independent to justify them. In several cases, the ROE adder has already been reduced to 25 basis points,” Moody’s said. Moreover, “ROEs have been the subject of complaints by some public power utilities, which have considered them too high for current risk and conditions,” it said. However, despite increasing pressure to reduce ROEs, incentives still remain in place of investments in transmission, it said.
In 2018, utilities used a greater part of its external equity from capital markets in 2018—compared to a mix of debt and equity they raised over the last three years. However, owing to the tax reform, Moody’s expects cash flow from operations before changes in working capital to debt ratio to decline 150 to 250 basis points for most utilities going forward.
Most utilities are “attempting to manage any negative financial implications stemming from tax reform through regulatory channels,” Moody’s noted. Some have made proposals to regulators for additional investments aimed to benefit customers or accelerate recovery of regulatory assets, and regulators at FERC and in individual states remain largely supportive of cost recovery mechanisms for the additional capital expenditures, it said.
—Sonal Patel is a POWER associate editor (@sonalcpatel, @POWERmagazine)