IOU profitability up despite economy, legislative and regulatory challenges – EEI

The 61 U.S. shareholder-owned electric utilities were financially strong and outperformed the overall financial markets last year, despite a lackluster economy and legislative and regulatory challenges, according to the Edison Electric Institutes’ (EEI) 2011 EEI Financial Review.

The review is an annual report on the financial performance and strategic direction of the country’s shareholder-owned electric utility industry, and includes discussion of policy developments that continue to shape the industry.

Output down; profits up

Electric output for the nation as a whole was down 0.6% in 2011, due to “a slow-growth economy and little year-to-year benefit combined with several other factors,” according to the report. Reduced output in New England, the Mid-Atlantic, Central Industrial, West Central, and Southeast regions was partially offset by output growth the South Central, Rocky Mountain, Pacific Northwest and Pacific Southwest regions.

Despite the net reduction in output, industry revenue rose 0.6% in 2011 over 2010, from $371.1bn to $373.5bn. Net earnings also increased to $30.85bn in 2011 from $27.7bn in 2010 for U.S. shareholder-owned electric utilities.

Energy operating expenses declined 1.8% overall, though the decline increased to 2.4% when adjusted for merger and acquisition (M&A) activity.

The decline in operating expenses was largely attributable to a 7.4% decline in the cost of natural gas. That decline, coupled with the drop in demand and strong hydropower output, affected the fuels used for power generation, according to the report.

Coal was still the primary fuel used to generate electricity in the U.S. in 2011, but its share of the overall fuel mix has steadily declined over the past 10 years. Coal’s share of generation dropped to 42.2% in 2011 from 44.8% in 2010, according to the report.

To meet future demand increases, the electric utility industry added 21,833 MW of new capacity to the electric grid in 2011, an increase of about 9% over 2010’s total. Shareholder-owned electric utilities brought 7,272 MW online, of which 5,296 MW came from the expansion of existing facilities. Just 1,977 MW of that total came from new power plants.

Of new generation, 1,442 MW was wind, 318 MW was solar and 210 MW was natural gas, which translates to 89% of the shareholder-owned new plant capacity built in 2011 coming from renewable sources.

Strong financial performance; benefits to shareholders

The industry’s consolidated balance sheet remained healthy in 2011, and showed a nominal drop in the debt-to-capitalization ratio, which dropped to 56.6% from 56.7% at year-end 2010. Electric utilities issued long-term debt at very low interest rates, taking advantage of what the report called “rock-bottom Treasury yields and at spreads … below the elevated levels of 2009, when markets were reeling from the financial crisis.”

Continuing an eight-year trend, the industry increased the dividends paid to shareholders during 2011. For the second straight year, 60% of companies raised their dividend, up from 55% in 2009, the report said. The average dividend paid out rose 6.8% from the 2011 level, with increases ranging from 0.8% to 50%.

Further, companies in the EEI Utility Index (EEI Index) paid out 57.9% of earnings in the form of dividends. The dividend payout ration of the EEI Index was better than any other sector tracked, including utilities as a whole, which paid out 56.8% in 2011. By comparison, the next-highest sector, the consumer staples sector, paid out 44.6%, while the energy sector as a whole paid out 18.6%.

The EEI Index comprises 55 publicly traded utilities in the U.S.

M&A recovering slowly

M&A activity, when defined as mergers or acquisitions of whole operating companies with a regulated service territory, was moderate in 2011. As in 2010, five deals were announced. Although the activity was modest, the report described it as “extending the recovery from the deep freeze of 2009, when nearly all merger talk was sidelined by the worst financial crisis since the Great Depression.”

2011’s deals included the Duke/ Progress Energy merger; the AES acquisition of DPL, the holding company for regulated utility Dayton Power and Light; the Exelon/ Constellation merger; and Gaz Metro’s acquisition of Central Vermont Public Service (CVPS) after CVPS terminated a planned merger with Canadian distribution utility Fortis, which had been announced in late May.

Capital performance outpaces market

The EEI Index produced a positive 19.99% return during 2011, its strongest annual gain since 2006. The EEI Index ran counter to the broader markets, delivering a significantly stronger return than the Dow Jones Industrial Average’s 8.38% return, the S&P 500’s 2.11% and the NASDAQ’s -1.8% returns for the same period, according to the report.

While the major averages finished the year with small gains, those gains masked considerable volatility and uncertainty as the year progressed, the report said.

Total shareholder return for the EEI Index also bested investments in other sectors in 2011, including the broader utility sector’s 19.15% return, the consumer goods sector’s 8.79% return, the tech sector’s return of 0.16%, and the -12.84% return in the financial sector.

Policy changes

The industry faced a number of policy issues during 2011, with industry members actively involved in public policy debates in Congress, the EPA, FERC, the Commodity Futures Trading Commission, DOE, and other agencies.

In the environmental arena, the industry identified a number of priority issues around EPA’s Maximum Achievable Control Technology (MACT) standards, each of which plays an important role in improving compliance flexibility, minimizing cost impacts to customers, and helping to protect electric reliability.

The industry’s “constructive, consensus-based comments” improved the EPA’s final rule in several significant respects, according to the report. While the final rule did not provide all of the flexibility mechanisms many companies will need to implement it, the report said EEI and its member companies are working with EPA, FERC, RTOs, state utility commissions, and planning authorities approved by NERC to address the issues.

Throughout 2011, the industry engaged on a range of other critical issues in the regulatory arena including FERC’s Order 1000, NERC critical infrastructure protection standards, and SEC disclosure requirements.

Industry members were also actively engaged in customer-focused initiatives, including plug-in electric vehicles, cyber security, grid modernization, data privacy, and energy efficiency, among others.

Recognizing the many challenges facing the industry in 2012 and beyond, EEI President Tom Kuhn sounded an optimistic note. “With our strong, industry-wide engagement on the issues that face us, we are confident that the electric power industry’s future will be cleaner, smarter and more efficient than ever before,” he said in a letter accompanying the report.