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Large Capital Projects: What are the Risks and Who Should Bear Them? Mark Agnew, Edison Electric Institute NARUC Accounting/Finance Meeting Lexington, KY October 13, 2008. Table of Contents. Regulatory Compact – The Key Players Industry’s Soaring Capital Expenditures

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Large Capital Projects: What are the Risks and Who Should Bear Them? Mark Agnew, Edison Electric InstituteNARUC Accounting/Finance MeetingLexington, KY October 13, 2008

table of contents
Table of Contents
  • Regulatory Compact – The Key Players
  • Industry’s Soaring Capital Expenditures
  • Risks Facing the Industry
    • Demand
    • Financing, Credit
    • Regulatory
    • Execution, Inflation
    • Specific businesses (Transmission, Generation)
  • EEI’s Outreach Activities
who shares the risks
Who Shares the Risks?
  • Management
    • Duty to manage utility/projects prudently
  • Shareholders
    • Receive an adequate return on investment for risks taken on behalf of ratepayers
  • Ratepayers
    • Receive reliable service at just and reasonable rates
    • Not responsible for mismanagement by utilities
  • Good regulation tries to achieve a fair balance of all interests
industry capital expenditures
Industry Capital Expenditures
  • Industry committed to reliability and making needed investments in generation, transmission,

distribution and the environment

    • Capex
      • 2006 totaled $59.9 billion (+24%)
      • 2007 totaled $69.1 billion (+16%)
      • 2008 projected $86.5 billion (+25%)
    • Dollar growth in all categories from last year
    • 2008 (+16%) and 2009 (+12%) projections revised sharply upward from last year’s study
  • Increased spending expected to continue
    • Total capex for 2010-2030 ~ $1.5 trillion*

U.S. Shareholder-Owned Electric Utilities

* The Brattle Group, preliminary findings from The Edison Foundation presentation titled Transforming America’s Power Industry. Represents the entire Power sector.

overall infrastructure investment needs
Overall Infrastructure Investment Needs

$1.5 trillion will be required over the 2010 – 2030 period doubling existing net plant in service

Distribution - $675 billion

Transmission - $233 billion

Generation - $560 billion

Represents the entire power industry

IOUs, Cooperatives, Municipals, IPPs

Carbon Legislation would enhance overall projection

Source: Transforming America’s Power Industry: The Investment Challenge (Preliminary Findings), The Brattle Group, April 2008

demand risk1
Demand Risk
  • Energy Efficiency
    • Decoupling and other EE measures
    • How much will this impact future revenues?
  • Brattle’s latest projections on this impact
    • Required generation could fall by 17% from 2010-2030, under a reasonable EE scenario
  • Price Elasticity
    • Consumer reaction to rising gas prices (‘08 v ‘07)
  • Risk – Management/SH – EE & price elas.

Ratepayers - energy efficiency

financing risk
Financing Risk
  • Financing decisions that don’t impair:
    • Financial strength, Credit Rating
  • Tighter Credit Markets
    • Overall trend, magnified by recent financial crisis
  • Eventual Rise in Interest Rates?
    • Rates still at historical lows
    • Strong correlation to awarded ROEs
  • Dividends – frozen or cut? borrowing to pay?
  • Risk – Ratepayers - Int rates & gen cap trends

Management/SH – all the above

credit ratings risk
Credit Ratings Risk
  • Taking on too much debt without timely cost recovery impairs credit metrics
    • may lead to downgrades
    • Increases financing costs
    • Capex plans & related debt mentioned in most ratings actions/outlooks in 2007-08.
  • Risk – Management/Shareholders
credit quality starting to slide in 08
Credit Quality Starting to Slide in ‘08
  • Downgrades outpacing upgrades in 2008
    • First time since 2004
regulatory risk1
Regulatory Risk
  • Timely recovery of large capex is crucial
    • CWIP
  • Large capex cycles tend to put downward pressure on realized ROEs
    • Regulatory lag
  • Risk – Management/Shareholders

Ratepayers

    • Quality of cost recovery affects all.
regulatory lag is retu rning
Regulatory Lag is Returning

Note: Figures reflect Lehman Brothers utility coverage scaled up by a factor of 1.11x to reflect companies not in the Lehman Brothers coverage universeSource: FactSet and Lehman Brothers estimates

10

execution risk
Execution Risk
  • Delays in completing the project
    • Cost overruns
    • Other delays (licensing, environmental opposition, etc.)
  • Risk – Management/Shareholders
cost inflation risk
Cost Inflation Risk
  • Construction material costs have soared in recent years.
  • Labor also on the rise
  • Inflation clauses required by builders
  • Risk – Ratepayers, Management/Shareholders
transmission risk
Transmission - Risk
  • Largely regulated, less financing risk
  • Political (siting) challenges
    • Communities, landowners, environmentalists
  • Enormous long-term planning
  • Generation Planning risk – when will transmission be in place?
  • Risk – Management/Shareholders
generation risk
Generation - Risk
  • General Risks
    • Project management, fuel choice

Regulated

  • Cost Risk - Management/Shareholders

Ratepayers

  • Overruns (retroactive disallowance) – Mgmt/SH

Merchant

  • Risk – Management/Shareholders
margins projected to fall below minimum target levels
Margins Projected to Fall Below Minimum Target Levels

RFC (MISO)*

2008/2008

MRO

2009/2009(US)

RFC (PJM)

2012/2014

NewYork

2011/2016+

Rocky Mtn

2008/2011

New England 2009/2009

California

2009/2012

AZ/NM/SNV

2009/2011

SPP

2015/2016+

*Excludes MISO resources outside the RFC boundary

TRE (ERCOT)

2009/2016+

Source: NERC 2007 Long Term Reliability Assessment

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coal fired generation risk
Coal-Fired Generation - Risk
  • Most companies delaying construction starts
    • Proposed capacity fell 11% from Feb to Aug ’08
    • Large capital outlays, long build time
  • Carbon regulation
    • How expensive will coal generation be?
    • What model used?......Price of CO2 allowances?
    • Environmental opposition
natural gas fired generation risk
Natural Gas-Fired Generation – Risk
  • Lower capital costs - less financing risk
  • Shorter construction time - less project management risk.
  • “Bridge” fuel pending nuclear and clean coal
    • Proposed capacity rose 20% from Feb to Aug ’08
  • Least risky for continuous power
nuclear generation risk
Nuclear Generation - Risk
  • Financing risk is largest risk
    • Capturing financing cost in rates is key
  • Considerable project management risks
    • No nuclear built in decades
    • Majority of in-service dates targeting 2015-2020
    • Proposed capacity rose 70% from Feb to Aug ’08
  • Fuel disposal?
  • Risk – Management/Shareholders

Ratepayers (built in rate base)

renewables risk
Renewables - Risk
  • Financing risks are less
    • Government incentives
    • ….but higher KW hour costs than fossil fuels
  • Intermittent, RPS driven
  • Low political risk
    • Political and cultural popularity
  • “Transmission access” risk associated with prime wind and solar areas
    • Proposed Wind capacity +69% from Feb to Aug ’08
    • Majority of proposed build by IPPs and foreign utils.
opinion leader outreach
Opinion Leader Outreach
  • “Get Energy Smart – Get Energy Active” Internet campaign to help educate consumers about the key issues facing the electric power industry today
      • 1.8 million visits to Web site since launch
  • Keeping the Lights On—Our National Challenge: Conference in New York focused on industry’s infrastructure needs and the role of energy efficiency
state capital road shows
State Capital Road Shows

October 22, 2007  Santa Fe, NM

March 17-18, 2008  Topeka, KS

June 11, 2008  Albany, NY

May 13-14, 2008  Sioux Falls-Rapid City, SD

April 16-17, 2008  Fargo and Bismarck, ND

wall street outreach
Wall Street Outreach
  • EEI’s State-of-the-Industry address to Wall Street
  • EEI Leadership Wall Street Visit
  • Wall Street-Regulator Dialogues
    • Nearly 20 dialogues to date
  • Wall Street-Utility Leadership Forums
    • 2 forums on climate issues
    • Pre-NARUC Convention Discussion of Market Conditions (November ‘08)
    • Energy Policy Leadership Forum (Dec. \'08)
contact information
Contact Information

Mark Agnew

Manager, Financial Analysis

Edison Electric Institute

(202)508-5049

[email protected]

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