Navigating Uncharted Waters

By Teresa Hansen, editor in chief

The global financial crisis is dominating the news. While I would like to completely ignore it, I just haven’t been able to do so. I find myself checking throughout the day to see if the Dow Jones is up 400 points or down 700. I also can’t help but be curious about the recent earnings reports, and I find it almost impossible to make it through a day without thinking about my 401K and my kids’ 529 accounts.

To help calm my fears, I’ve tried to learn as much as I can about how we got to this point and what I need to do to manage my investments through these uncharted waters. In addition to learning how this financial dilemma affects me personally, I’ve also tried to educate myself on how it affects our industry. When news of the mortgage-lending and housing-market woes first surfaced, most analysts didn’t think the utility industry would be affected. Even when the problems spread to large financial institutions, many experts still believed utilities would see little impact. Except for utilities with merchant branches such as Constellation (which was recently acquired by Warren Buffet’s MidAmerican Energy Co.), and Reliant Energy (whose strategy is so complicated I stopped trying to figure it out), most utilities have little or no trading risk; therefore, experts still thought they were relatively safe.

Generally, electric utilities are risk-averse and their stocks are still thought of as “widow and orphan” stocks by many investors, so they should be safe, right? Maybe not. Richard Rudden, senior vice president of Black & Veatch’s Enterprise Management Solutions Division, wrote in a recent press release, “The utility industry is not immune to the current financial conditions that government, business and consumers face, even though utility securities are often considered safe havens in times of economic difficulty.” Rudden, who authored “Rudden’s Energy Strategies Report,” noted that utilities have huge capital requirements, and trouble in the credit markets means they will likely have difficulty obtaining money to develop new capital projects and infrastructure. As a result, customers could see less reliable service, he said.

In a recent Energy Insights article, “Impact of the Financial Crisis on Technology Spending in the Utility Industry,” author Rick Nicholson said that many utilities are beginning to conserve cash by limiting or completely freezing external spending for the next three to six months. Nicholson thinks, therefore, that overall IT spending will decrease dramatically in the short term.

He went on to say that although utilities have traditionally been able to raise long-term capital at favorable rates, the cost of such capital, even for utilities with good credit ratings, is likely to be expensive. But he doesn’t think the extra cost of capital will completely quash IT spending in the long term (one to two years). “Despite this expected slowdown in spending for large capital projects, energy demand will continue to grow (albeit at a slower rate) and regulators will continue to enforce renewable energy, CO2 reduction and energy efficiency goals,” Nicholson wrote. “This situation alone will make distributed energy, demand response and energy efficiency technology investments more attractive.”

Commodity prices appear to be easing, mainly because economies are falling into recession and demand is slowing. But, even though construction costs may be leveling out, new capital projects are still expensive. This expense combined with the increasing cost of debt and uncertainties surrounding CO2 regulation and fossil fuel costs will probably derail some large capital projects, at least for the next few years. For many of you who read this magazine, however, that may not be such bad news. A curtailment of power plant and T&D infrastructure projects will almost certainly make energy efficiency and demand response programs more valuable and plentiful.

In addition, the $700 billion bailout package that President George W. Bush signed Oct. 3 included $18 billion for energy-related tax incentives during the next decade, including a change in the depreciation rate for smart meters and smart grid technologies from the current 20-year period to a 10-year period–a small positive.

Although utilities and their equipment and service providers will certainly not make it through the current economic crisis unscathed, there is reason to believe they will make it through with limited injuries.

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