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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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Table of contents

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

31


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

    magnew@eei.org