Transmission Business Is An Important Growth Driver For Some Electric Utilities
If you had to invest equity capital in a long lived asset and have its return regulated by the government, would you prefer to earn 9.73% annually or earn 10.74%, and possibly earn 11.74% if you were an independent company? This basic question is being asked in electric utility boardrooms around the country. The difference is the average 2nd quarter 2015 state-PUC approved return on equity ROE vs the Federal Energy Regulatory Agency’s “new and improved” New England ISO allowed ROE for transmission investments.
Transmission investment is being driven by not only the need to upgrade aging infrastructure but to expand the delivery of new sources of power to population centers. The following map from American Electric Power (NYSE:AEP) AEP Transmission website outlines the current emphasis on moving electricity from its generating source to population centers.
In addition to replacing aging assets and demands from new power generation sources, there are shifts in regional end user requirements for electricity. For example, below is a chart of requests to AEP for new service in the Utica and Marcellus shale area. While some may think this is a flash in the pan from one-time drilling, the increased demand is driven by midstream operators of industrial-size natural gas processing plants, mainly in Ohio and West Virginia.
Last Oct, the FERC reduced the allowed ROE in the Northeast to a maximum of 10.74% plus an incentive of 100 basis points for independent companies. In addition to implementing a new rate structure, the FERC announced hearings to review the Midwest MISO rate structure with an eye of reducing those as well from its current 12.8% to something close to the revised New England structure. ITC Holdings (NYSE:ITC), the only FERC-regulated independent transmission company, currently earns between 12.1% and 13.8% on its regulated asset base.
While not seeming like a big deal, the difference between the average state-PUC 2nd qtr rate approvals and the reduced FERC rate is a minimum of 1.0% added ROE. The industry trade group, Edison Electric Institute eei.org, published an in-depth report on various proposed transmission projects and the report identifies a total of 170 projects costing $48 billion. While not completely inclusive of all ventures, the report identifies projects specific companies are willing to disclose. The report gives insight into the industry and which companies are moving ahead with higher transmission investments.
EEI expects transmission investment in the range of $19 to $20 billion a year for the next several years. With an average 50% equity in these projects and an average 1% higher allowed ROE, the difference between state and fed allowed ROE could amount to an additional $100 million a year industry-wide in additional profits from new transmission investments.