Mr. May: Well, I think the main investment thesis on utilities is that we've got an industry that is in good shape, both from a financial standpoint and a regulatory standpoint as well. In the last recession, seven or eight years ago, the utility industry was right smack dab in the middle of it. As a result, we had a lot of volatility in the stocks and even had some bankruptcies. Subsequently, the industry rebuilt balance sheets and focused on less risky, more core-regulated investments. As a result, when we had the recent financial crisis in 2007-2009, the utility industry found itself in relatively good shape. And just about every utility I know of was able to finance at least with first mortgage bonds all the way through the financial crisis. So right now, as I look forward, I see an industry in very good shape and, I might add, relatively boring compared with other sectors that are recovering, such as financial services, real estate investment trust, homebuilders or other cyclical-type stocks. They perhaps have better investment prospects over the next years than utilities do. Nevertheless, utilities are a very stable industry here, trading at a little bit of a discount to the S&P 500, based upon an 89 estimate of 2011 earnings. So I view the utility as one with decent prospects, though not perhaps with the recovery potential of some of the other hard-hit industries.
TWST: Daniele, what's your view? What is the key issue for the utility space at this juncture?
Ms. Seitz: Well, obviously the industry is facing many issues. I agree with Maurice the financial fundamentals are pretty good. The electrics are not overburdened by cap ex and there is no major excess capacity so far. Plus companies have strong cash flows, and reasonable payout ratios averaging 61% should allow for dividend growth. Also traditional electrics have been able to file for rate relief to compensate for lower demand. This was particularly easy because energy prices dropped sharply, making it easier for regulators to raise rates. So roughly three times as many rate cases have been filed in 2008 and 2009, and rate relief should help the regulated sector to support ROEs. And from an economic standpoint, inflation seems under control and long bond rates remain at low levels. These factors are helping obviously capital-intensive industries, like the electric utility sector, to redeem high-coupon debt.
Despite these positive factors, the group is facing significant challenges and the market perceives these risks. The continued uncertainty associated with Washington policies concerning the environment is adding pressure on the group. Washington's policies are trying to reshape the electric generation industry by advocating renewable energies and banning coal generation. The Obama administration, Congress and the EPA are attempting to build a climate bill that would lead to the retirement of older coal plants. This should lead to another sharp rise in gas generation and a doubling of renewable capacity. These policies could cause a substantial shift, an expensive shift, in the electric generation sector. Washington policies are also trying to affect electric consumption through the installation of smart meters. It's not going to be business as usual. Thus, electric companies and investors are trying to estimate how much these policies are going to change both the supply and demand picture of the industry. The coal generation sector's majority of cap ex over the past five years was directed toward curbing SO2 and NOx emissions. This program, completed by 2010 - the EPA is looking at other areas, which they see are also important, like coal ash and liquids - because the program is likely to be expensive, the EPA is basically inciting the shutdown of 60-year-old-plus coal plants too small and inefficient to be retrofitted. As a result, the management of electric companies is assessing the potential costs of reshaping their fleet. The traditional sector is seeing these costs as a potential expansion of rate base, while the merchant industry is weighing them relative to potential economic benefits.
To motivate the building of more expensive renewable generation, the administration is providing stimulus money and other tax incentives. With these policies, the retirement of coal plants will likely reduce coal-fired generation to 40% of the electric output, while other sources, especially combined-cycle gas plants, may rise to 30%. Renewables, at a rate of more than 8,000 megawatt a year, are likely rise to at least 10% of total demand by 2020 - 20% if hydro included. And most of the additions are likely to occur before 2016, during the stimulus years. So these trends should raise prices, especially on the traditional side, and lessen price pressure on the merchant side. So while Washington policies are changing the landscape on the supply side, it is also promoting efficiency products, which could affect the demand side. Through stimulus money distributed by the DOE, the administration is financing the installation of smart meters and smart grids that could shave peak load and electric demand growth. Electric demand, which was affected by the recession and a sharp decline in industrial load, may not rebound as rapidly as a post recession would presume. Previous expectations of 1.5% to 2% demand growth might be reduced by up to 1%. So although we are looking at demand growth of 2.9% in 2010 and probably in the 2% in 2011, these estimates might be shaved by the installation of smart meters.
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