Blackout plays may go dim
Need for spending outdistances sources of funds
By Lisa Sanders

August 22, 2003

DALLAS (CBS.MW) — Even with the cause of the Northeast blackout still under investigation, some investors already anticipate a surge in investment in the nation's overloaded electrical grid.

Most analysts recognize the need to ramp up capital spending — by more than $100 billion by some estimates. What's not so clear, however, is whether the utilities that provide the electricity can afford or finance it.

Over the last decade, the U.S. electric load has surged more than 35 percent, while transmission capacity has grown only 17 percent, according to the Electric Power Research Institute, an industry funded group based in Palo Alto, Calif.

“There's been underinvestment, but there's also a lack of incentive for transmission owners to increase investment,” said Luther Dow, the group's director of power delivery and markets. “The tariffs and the rules don't allow a rate of return equivalent to the risks associated with the upgrades. Regulators are reluctant to increase rates because consumers have to pay.”

In the days immediately after the blackout, shares of companies providing alternative power supplies, such at Plug Power (PLUG: news, chart, profile), and Capstone (CPST: news, chart, profile) Turbine surged on expectations that blackout and reliability worries would spur demand for their products. Both companies make on-site electricity generation systems that allow industrial customers to control their electricity production without relying on big utilities. Plug's use fuel cell technology, while Capstone's micro-turbines run on natural gas.

Adoption of such technologies, let alone more prosaic improvements in old-fashioned power lines, is likely to take time.

“There are a lot of fingers pointing at utilities for underinvesting,” said George Bilicic, a managing director and head of the global energy and power group at Lazard Freres. “But these companies have to earn a return for shareholders. If the particular investment won't earn a reasonable rate of return, then publicly-traded utility companies will find it difficult to make that investment.”

Corporations that specialize in power-grid reliability systems are likely to benefit from the new political focus on electricity, thanks to the failure that shut out the lights for 50 million people in the Northeast earlier this month.

“I think it is the time to particularly pay attention to companies who have developed or are developing solutions for energy or power grid infrastructure management,” said William Lese, managing director at Braemar Energy Ventures in New York. Germany's Siemens is “very active in demand-side management programs and smart energy systems for energy management,” and Switzerland-based ABB Ltd. “ensures the integrity of transmission of power,” he said.

The blackout also highlighted the need for backup generation, a natural benefit for Caterpillar (CAT: news, chart, profile), which makes diesel and natural gas fired electrical generators.

But Cat already has a market value of nearly $25 billion. With that kind of size, the prospects for a big impact on their stock is likely to be somewhat muted for it and many of the companies that play a supporting role in ensuring power continuity.

There should also be a “serious look to any technology that could provide physical security to the company that can provide the capability to take the pressure off the grid,” Lese said.

Alternative energy companies — Ballard Power (BLDP: news, chart, profile) and FuelCell Energy (FCEL: news, chart, profile), for example — “will be critical to making things work down the road,” he said.

And their relative small size gives them more upside potential should their products catch on in a significant way. Shares of both companies rose sharply at the time of the blackout.

Credit crunch

For the old-line utilities the problem is finding money to pay for improvements and a place to put new power lines. Neither is likely to be easy.

In a report Thursday, Standard & Poor's noted that electrical utilities could see credit risk rise if politicians extend the debate over reform.

“Standard & Poor's warns that as long as political and regulatory disagreements persist among policy makers, credit risk will remain elevated and will discourage new capital, or at least make it more expensive,” said analyst Peter Rigby. “Moreover, if reform efforts, which could include infrastructure investment, are delayed further, credit risk arising from the costs of further blackouts, lost revenue opportunities for generators, and potential lawsuits could increase.”

Indeed, FirstEnergy (FE: news, chart, profile), the utility at the center of the investigation into the blackout, narrowly avoided a credit crunch earlier this week with a key regulatory filing. See Due Diligence.

Rigby said credit could be further compromised if utilities are forced to make sizable investments without a guaranteed return on capital employed.

Dale Landgren, vice president and chief strategic officer, of American Transmission Co., said the blackout “reinforced what we've already been telling people. We need to look for ways to strengthen the grid.”

American Transmission, one of three transmission-only companies in the Midwest, was created in 2001 from assets divested by regional utility companies. Because it transmits wholesale power, it is regulated by the Federal Energy Regulatory Commission, which sets the wholesale rates American Transmission can charge its customers.

State commissions oversee utilities and regulate rates for retail customers and distribution.

“The rates have been frozen in many retail jurisdictions, and rate freezes are a death knell for new investment because it doesn't provide incentive,” Landgren said.

American Transmission, with equity from its utility owners and the debt market, has been increasing its investment. It plans to spend $150 million this year as compared to $115 million last year.

Federal moves

Jim Owen, a spokesman for the Edison Electric Institute, said the government needs to implement rules that require utilities to meet a certain reliability standard. At the same time it has to provide greater incentive for investment, which, he argues, could be achieved with the passage of a comprehensive energy bill.

If there's a positive outcome to the debate, utilities could benefit.

“Earnings growth for regulated utilities is directly driven by rate base growth,” Bilicic said. “Accordingly if the focus on transmission and system enhancement results in new investment and thus growth in the rate base, utility companies could experience greater earnings growth, assuming they earn a reasonable rate of return.”

The Electric Power Research Institute estimates it would cost $100 billion to upgrade the U.S. grid, while the Edison Electric Institute has projected a rough cost of $56 billion to bring the power grid up to snuff. Much of those costs centers on simply acquiring the land and right of ways to build additional power lines.

But it's never an easy fight to build new power lines, says Michael Peevey, president of the California Public Utility Commission.

“The problem is that in many cases, people don't like transmission. I mean, there's lots of opposition everywhere to putting large transmission lines around, unless you go underground … People don't want them.”