Growth in any industry is considered a good thing, right? In most cases, that’s true, but the rapid growth of service territories for many U.S. electric transmission and distribution (T&D) investor-owned utilities (IOU) has led to significant credit pressure because of the two-fold dilemma they sometimes face in adding new customers, according to a report from Standard & Poor’s Ratings Services (S&P).
S&P analysts said that when an electric T&D IOU is evaluated, a key consideration is the ability to recover costs. Those with rapid customer growth and large increases in capital costs “could come under significant credit pressure” — especially true if the utility operates in a regulatory environment allowing rate caps or predetermined rate increases.
Normally, noted S&P, companies add customers, increase revenues and recover the capital expense through base rates via rate cases. However, the capital costs associated with adding new T&D customers is significantly higher than the embedded capital costs for serving existing customers, analysts said. Costs vary by region and market, but they may range from 50% to 300% more than the capital costs embedded in the existing customer rates. Also, the difficulties in obtaining permits, construction labor shortages and a general increase in materials costs have driven costs up.
Analysts said that in most cases, the added costs would be included as rate increases in subsequent rate cases, allowing the T&D IOUs to obtain full recovery. “However, the second problem is that regulators for T&D companies in many states have imposed price caps, or are under political pressure to keep rates low. Therefore, it becomes more difficult to pass these cost increases along to customers.”
The southeastern part of the United States is having the most problems, said S&P, where customer growth is as much as 5% a year. “For example, if we assume that customer growth increases at 5% a year over five years, we would expect revenues to grow by about 27% compared with the base year revenues. However, if we assume that new construction is built at a cost of 300% of existing infrastructure, we can see that capital expenses are growing at 15% per year and the asset base will grow by 100% in five years,” leading to a 100% increase in depreciation and interest expenses, and only a 27% revenue increase. “Unless the T&D IOUs receive the required rate increases from regulators, they face the problem of tighter margins as expenses may outpace revenues.”
Noting that electric T&D IOUs are “under an obligation to serve and do not have the option of turning away customers,” analysts said the higher capital costs without corresponding rate increases “presents a real problem.” Many deal with it by reducing costs in other areas, such as using “floating” construction workers who move from utility to utility, rather than hire permanent workers. “However, there is a concern that some utilities may be cutting back on maintenance capital expenditures, which may lead to reduced system reliability.”
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