Investors have generally seen power utilities as safe havens for capital earmarked to earn reliable yields. And although that probably continues to be the case, the apparently tranquil exterior of the utility industry has been shaken in recent decades by shocks such as gas shortages, deregulation of the electricity industry, the infamous power supply problems in California and, currently, global warming concerns.
“This is far from the steady industry that people tend to think it is,” Frank Ingrassia, a managing director and chairman of the public sector infrastructure group in Goldman, Sachs, told the Alaska Energy Authority Technical Conference on the Alaska Railbelt Electrical Grid on Nov. 27. Ingrassia was providing an overview of the changing and evolving picture of investment in the U.S. utility infrastructure.
Gas shortages and deregulationNatural gas shortages in the Lower 48 in the 1970s precipitated a surge in interest in coal and nuclear generation, both of which subsequently went out of favor again, Ingrassia said.
“In the 1990s we went through another cataclysmic period, which was the deregulation, disaggregation, diversification and globalization (of the industry),” Ingrassia said. “… By 2000 we had the biggest financial crisis in the utility sector in memory, and in fact things really came to a screeching halt.”
There’s a lesson there, he said.
“Invariably whenever everyone in the utility industry does the same thing, it’s the wrong thing,” he said.
The implementation of deregulation in the Lower 48 was, however, quite patchy, with power supply arrangements changing much more in some states than in others, he said. Deregulation proved quite successful in the Northeast but didn’t work well in California and the West.
In Illinois, Maryland, Ohio and Pennsylvania long-term rate freezes are just about to come to an end. Utilities in these states are about to request huge rate increases, and legislators, regulators and others are questioning the wisdom of deregulation, Ingrassia said.
Credit downgradingBeginning in 2000 utility credit ratings tended to be downgraded, although that situation stabilized beginning in 2004, Ingrassia said.
“What that means is … everybody got downgraded as a result of the pitfalls of deregulation,” he said.
Utility share prices have, however, enjoyed a rebound since the early 2000s and have outperformed the overall market since the mid-2000s.
“That’s an indication that stability’s back,” Ingrassia said.
And a capital-intensive industry such as the utility industry tends to do well in a low-interest-rate environment. In addition, utilities tend to create dividend income, and the cut in the tax rate on dividends helped the utility sector. Investing in utilities is also something of a flight to safety in the midst of recent political and economic uncertainties, Ingrassia said.
“There has also been a big pickup in merger activity in the utility space and the character of the merger activity has changed a lot,” Ingrassia said.
Beginning in 2005 people started looking at creating critical mass in utility businesses as a reason for mergers, rather than taking over companies in the interests of business diversification to reduce risk after deregulation.
Huge pool of capitalThere is also now a huge pool of capital looking to invest in infrastructure assets. And some non-traditional utility investors such as private equity firms and financial services companies are flooding the market in utility investment, Ingrassia said.
“There’s lots of money in this sector looking for a home,” he said.
Recent years have also seen the emergence of specialist infrastructure funds.
“These are funds that look to have a long-life investment in infrastructure assets that have a debt-like return characteristic,” Ingrassia said. “It really caters to (businesses) like pension funds and life-insurance companies that have actuarial lives that go way beyond what you normally expect for a debt application. … It’s not uncommon to find assets in this category that go 75 or even 100 years out.”
In total these funds have more than $300 billion in buying capacity looking at, among other things, utilities, he said. And the debt-plus-equity structure of an investment from an infrastructure fund may result in better infrastructure economics than the more traditional approach of using municipal bonding.
Need more powerBut what is the significance of all of this in terms of the demand for investment in new utility infrastructure?
The construction of new electrical infrastructure is not keeping pace with the increasing demand for electrical power, Ingrassia said.
“One thing that is happening, and I think this is going to become a crisis, is we’re running out of juice,” he said. “… We’re not building enough stuff.”
Current projections show the United States running out of reserve electrical capacity in 2015, he said.
At the same time, despite a growing wind energy industry, natural gas has become the dominant fuel for new generation capacity.
“Everything we’ve built for the past decade, really, has been gas,” Ingrassia said. “… We only have one arrow in our quiver at this point.”
It is very difficult to build coal power plants at the moment because of the concerns over global warming and environmental issues, he said.
“We have seen coal plants all over the country being cancelled,” Ingrassia said. “… The other thing is we haven’t even seen the other shoe drop with respect to coal, and that relates to carbon taxes and carbon sequestration.”
Nuclear power has been gaining some popularity, but involves many regulatory and technical issues and it would likely take 10 to 15 years for new nuclear power generation to come on line.
Wind and renewables are not yet cost-competitive with natural gas or coal and most of the good wind sites in the Lower 48 have already been taken, Ingrassia said.
Global warmingRegardless of who believes that global warming is real, there are influential people who do believe it. The actions that some scientists think need to happen to address the issue would involve dramatic changes in fuel usage. And that is what the utilities are up against when they evaluate coal vs. gas in future power generation, Ingrassia said.
That leads to predictions of continued expansion of gas-fired power generation.
And at the moment 32 percent of the U.S. carbon emissions emanate from the utility industry.
“They’re far and away the biggest contributor to carbon emissions. … So they will be a big target for whatever is going to happen,” Ingrassia said.
Regional actionIndividual states and regional organizations have already started taking action.
“I think the states have basically given up on the federal government and decided to preempt the feds on … renewable portfolio standards and greenhouse gas emission,” Ingrassia said. “In 2001 there were only 10 states that had RPS standards and as of this year we were up to 24 and counting.”
And there has also been an enormous increase in investment in renewable energies since the global warming concerns really started taking off around 2005 — less than $1 billion in 2004 to about $10 billion today.
As far as wind power is concerned, the United States is now up to about 12,000 megawatts of wind capacity and is expected to reach about 45,000 megawatts by 2015, which is just about what the RPS standards call for, Ingrassia said.
“45,000 megawatts is a pretty good showing but it’s not going to solve the problem,” he said.