Here’s the word on New York’s regulation of Con Edison: Booyah!
Last week, Con Ed declared a 61.5-cent quarterly dividend. With its shares trading at around $56, that works out roughly to a 4 percent yield for the company’s stockholders. Try getting that on a Treasury bill, or in your plain-vanilla savings account at Chase, Citibank or wherever.
CNBC stock guru Jim Cramer loves Con Edison for its high returns. “It is a company that has a fabulous balance sheet, arguably much better than that of the United States, and it is backed up by the full faith and credit of people who don’t want their lights turned off,” Cramer said of the company last year.
“If you own Con Edison’s stock it gives you a revenue stream that is more than two-and-a-half times that of a 10-year Treasury and, unlike Treasuries, you can expect that revenue stream to be increased, not kept at the same level,” he went on.
It’s not easy for Con Edison to keep raising its dividends, as it has for 39 consecutive years. It tries to maintain its shareholder payouts through efficient operations and by growing its customer and revenue base. Things like new Internet server farms and homeowners switching to gas heat help on that score.
But Con Ed is also counting on the Public Service Commission to keep its prices high enough so that it’ll earn profits that please its investors. Since January, Con Edison has been pleading with the commission to boost its gas and electric prices in 2014.
The case isn’t being argued in the context of what customers pay. It’s not that Con Edison or the PSC don’t care about customer prices – they do, and their estimates of how much customers might pay are discussed in the papers through which lawyers, economists, accountants and others are arguing the case.
Instead, the debate is over Con Ed’s return on equity, which is how much the utility’s shareholders and bondholders should be allowed to earn from customers.
Return on equity is a term obscure to those of us going through life without a thorough understanding of public utility finance, or of finance in general. In simple terms, return on equity is the percentage return Con Edison can make from the estimated value of its gas mains, transformers, transmission wires and other infrastructure.
Con Edison wants a 10.15 percent return on equity next year. For residential customers, that shakes out to a boost of around 4 percent on electric bills and 1.5 percent on gas bills. Typical apartment dwellers who use 300 kilowatt hours of electricity and 113 therms of heating gas each month would see their electric bills jump to $84.90 and their gas bills jump to $190.44.
If that happens, Con Edison executives and shareholders would shout: Booyah!
But the Public Service Commission staff says a 10.15 percent return is way too much. It would give Con Ed an 8.7 percent return, which it says is enough to compensate Con Ed investors and pay to harden the electric grid against future Hurricane Sandys. The PSC staff plan works out to a 1.7 percent cut in electric bills, and a 6.7 percent cut in gas bills. That typical apartment dweller using 300 kilowatt hours of electricity and 113 therms of gas would see their electricity bill drop to $80.23, and their gas bill drop to $175.17.
Gov. Cuomo, via the state Utility Intervention Unit, would push bills down further. The UIU says Con Ed deserves only a 7.87 percent return on equity. The UIU hasn’t done the all the math, but estimates its plan works out to around a 10 percent drop in electric bills and gas bills that are about in line with the PSC staff plan.
At the bottom line, Con Ed wants $461 million more from its customers next year, while the PSC staff proposes cutting the company’s revenues by $252 million. That’s a gap of $713 million.
Con Ed says the PSC staff’s 8.7 percent return on equity proposal “would be the lowest granted in the United States in 30 years.” And it labels the UIU/Cuomo plan as “so far afield of the reasonable range” that the commission “cannot accord it serious consideration.”
So booyah might not be the word for Con Ed executives and investors if the governor or the PSC staff get their way.
If you’re going to fight over $713 million, you’ll want a small army of lawyers and accountants – which Con Ed and the state both have. They’ve also brought to bear the expertise of consultants who make their livings as experts on things you just don’t want to know about, like embedded costs, variance incentive mechanisms, revenue decoupling and depreciation.
Those experts are deep in the details of the case. Besides arguing over the percentage return on equity, Con Edison and the state are also debating the value of the assets on which the return on equity is based – what’s called the company’s rate base. Con Ed says its electric, gas and steam infrastructure is worth about $22.9 billion, while the PSC staff values the property at a little less, at about $22.2 billion.
Also, Con Ed, the PSC staff and others involved in the case dispute how much money the company should spend on upgrading its system and whether particular expenses ought to be paid directly by customers, or taken out of the company’s returns.
The arguments are beyond complicated. They are technical. But after the technical issues are sorted out, the return on equity numbers remain the key to the case.
A couple more things to note about return on equity:
One is that the PSC will look at the returns on equity given to utilities in recent rate cases. In that regard, things don’t look good for Con Ed’s request for 10.15 percent.
In its last three-year electric rate case, which expired in March, Con Edison had a 10 percent return on equity. But interest rates are down since that case was decided, and so are the returns being granted by regulators.
In a three-year electric and gas case decided in March, the PSC gave National Grid’s upstate Niagara Mohawk utility a 9.3 percent return on equity, which lowered that company’s rates. In a case decided in August, Connecticut officials gave United Illuminating Company in New Haven a 9.15 percent return on equity.
Secondly, you may be wondering: If Con Ed earns 9 or 10 percent on the value of its assets, why do shareholders only end up with 4 percent? The answer is that a lot of that return on equity money goes to pay back bondholders. Some also goes to expenses the PSC won’t allow to come directly from customers, such as some executive compensation. Also, the share price doesn’t necessarily reflect the value the PSC puts on Con Ed’s assets.
In any case, the shareholders are the last people to be paid. What they get is what’s left.
The five-member PSC is expected to decide the Con Ed case in December. Then we’ll know whether it’s customers or shareholders who get to say “Booyah!”