By Rebecca Smith
Families in New York are paying 40% more for electricity than
they were a decade ago. Meanwhile, the cost of the main fuel used
to generate electricity in the state--natural gas--has plunged
39%.
Why haven't consumers felt the benefit of falling natural-gas
prices, especially since fuel accounts for at least a quarter of a
typical electric bill?
One big reason: utilities' heavy capital spending. New York
power companies poured $17 billion into new equipment--from power
plants to pollution-control devices--in the past decade, a spending
surge that customers have paid for.
New York utilities' spending plans could push electricity prices
up an additional 63% in the next decade, said Richard Kauffman, the
former chairman of Levi Strauss & Co. who became New York's
energy czar in 2013. It's "not a sustainable path for New York," he
said.
New York is no outlier. Capital spending has climbed at
utilities nationwide--and so have their customers' bills.
The average price of a kilowatt-hour of electricity rose 3.1%
last year to 12.5 cents a kilowatt-hour, far above the rate of
inflation. Since 2004, U.S. residential electricity prices have
jumped 39%, according to federal statistics.
Over that same period, annual capital expenditures by
investor-owned utility companies more than doubled--jumping to $103
billion in 2014 from $41 billion in 2004, according to the Edison
Electric Institute, a trade association. The group expects total
capital spending from 2003 through 2016 to top $1 trillion.
"This is the biggest splurge in capital spending we've seen in
at least 30 years--it's the reason rates have been going up," said
Bob Burns, an independent consultant and former energy researcher
at Ohio State University.
The biggest chunk of that spending--38% in 2013--went into new
power lines and other delivery systems, the Edison Electric
Institute said. Almost as much went to generation, often for new
gas-fired plants to replace coal-fired ones that don't meet new
environmental rules.
Experts say there are several reasons for soaring spending,
including environmental mandates, and the need to harden the grid
to protect it from storms, physical attacks and cyber hacking.
But utilities have another incentive for heavy spending: It
actually boosts their bottom lines--the result of a regulatory
system that turns corporate accounting on its head.
In most industries, companies generate revenue, deduct their
costs, and are left with profits, which can be expressed as a
percentage of revenues--the profit margin. Regulated utilities work
differently. State regulators usually set an acceptable profit
margin for utilities, and then set electric rates at levels that
generate enough revenue to cover their expenses and allow them to
make a profit.
At the moment, it is common for utilities' allowable profit to
be capped at 10% or so of the shareholders' equity that they have
tied up in transmission lines, power plants and other assets. So
the more they spend, the more profits they earn.
Critics say this can prompt utilities to spend on projects that
may not be necessary, like electric-car charging stations, or to
choose high-cost alternatives over lower-cost ones.
"Until we change things so utilities don't get rewarded based on
how much they spend, it's hard to break that mentality," says Jerry
R. Bloom, an energy lawyer at Winston & Strawn in Los Angeles
who often represents independent power companies.
Southern California Edison, a unit of Edison International in
Rosemead, Calif., plans to spend about $1 billion in debt and
equity replacing or repairing thousands of power poles, which cost
$13,000 each. Every time the company replaces a 50-year-old pole
with a new one, it has a fresh investment on which it is eligible
to earn an annual profit, currently 10.45%, for 45 years.
The sudden interest in poles "suggests they've been negligent in
the past or they're just looking for ways to spend money," said Bob
Finkelstein, a lawyer at the Utility Reform Network, a San
Francisco-based watchdog group.
Mike Marelli, SoCal Edison's rates director, said his company
analyzed 5,000 poles before deciding a massive program was needed
to deal with deferred maintenance.
Overall, SoCal Edison intends to spend $15 billion to $17
billion on dozens of initiatives from 2014 through 2017. Similarly,
Charlotte, N.C.-based Duke Energy Corp. expects to make $17 billion
worth of capital expenditures from 2014 and 2016. A rule of thumb
it recently shared with investors: for every billion dollars in
assets it adds to its inventory, it boosts earnings by about 8
cents a share.
Utilities can't bill customers for new capital expenditures
without first getting the consent of state or federal regulators,
notes Richard McMahon, a vice president at the Edison Electric
Institute.
But Ken Rose, an energy consultant in Chicago, says that
regulators don't always do enough to make sure projects are the
best deal for the customers footing the bills. He says companies
have a propensity to choose expensive solutions to
problems--building a new power plant instead of promoting energy
efficiency, for example--because it puts big chunks of capital to
work that lift profits.
Some analysts say utilities' capital spending has been necessary
and smart at a time of low interest rates.
"I don't subscribe to the belief that utility companies are
gold-plating their systems just to increase profits," says Jim
Hempstead, associate managing director of the global infrastructure
finance at Moody's Investors Service.
Utilities earned $36 billion in 2013, excluding nonrecurring
items, up 36% from 2004, according to the Edison Electric trade
group.
So long as electricity consumption is growing, utilities can
spread hefty costs across their customers without increasing rates.
But since 2008, power sales haven't been growing fast enough to
absorb the impact of all the added spending.
Kansas City Power & Light has raised rates about 60% since
it kicked off its current investment cycle in 2007. It is seeking
rate increases of 12.5% in Kansas and 15.5% in Missouri.
Some states are pushing back.
In New York, regulators balked at Consolidated Edison Inc.'s
plan to build a $1 billion electrical substation in Brooklyn and
Queens by 2017. Instead, the company has decided to help customers
cut energy use by improving the efficiency of their electrical
equipment through a $500 million program that defers a decision
about a new substation for at least a decade.
"What we're doing is an alternative that's less costly," said
Stuart Nachmias, vice president of regulatory affairs for
ConEd.
From now on, utilities must prove that their spending will make
an electric system cleaner, more efficient or stronger, says Audrey
Zibelman, chair of the New York Public Service Commission.
"Business as usual has become unaffordable."
Write to Rebecca Smith at rebecca.smith@wsj.com
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