US utilities set to run out of steam on financial changes RSS Feed

US utilities set to run out of steam on financial changes

US utilities, sustained for years in a warm bath of favourable financial conditions, are facing a cold shower.

An expected rise in interest rates and the shake-up of the tax system passed into law at the end of last year are threatening to squeeze utilities’ finances. Already, the S&P 500 utility sector index has dropped 13 per cent from its peak in November.

Duke Energy, one of the largest US utility groups by market capitalisation, on Tuesday gave an indication of the changing times, saying it planned to raise $2bn from selling shares this year and would cut its five-year capital spending plan by $1bn. Lynn Good, chief executive, said the share sale was needed “to maintain the strength of our balance sheet”.

FirstEnergy, another large utility, last month announced a $2.5bn investment in shares and convertible preferred shares, backed by investors including Elliott Management and GIC, to pay off debt, contribute to its pension fund, and “strengthen the company’s investment-grade balance sheet”. The colder financial climate is expected to prompt other utilities to rethink their capital allocation, pushing some of them towards disposals or acquisitions.

An immediate impact from expectations of rising interest rates has been to make utilities less attractive investment propositions. Listed utility groups generally make most of their income from regulated assets, which means that their earnings and dividend payments are steadier and more reliable. That makes their shares behave more like bonds.

In a note on Wednesday, strategists at JPMorgan listed 50 “bond proxies” that were “stocks to avoid in a rising rate environment”. More than half of them were utilities, including Duke, Exelon, NextEra Energy and American Electric Power.

Beyond the “bond proxy” effect, higher interest rates also threaten to disturb the cosy financial equilibrium that has supported US utility companies through a turbulent time for their industry. Demand for electricity in the US is stagnating: total power consumption was slightly lower last year than in 2010, according to the Energy Information Administration. Meanwhile, there has been a dramatic shift in the fuel mix. Since 2010 the proportion of US electricity generated by coal-fired plants has dropped from 45 per cent to 30 per cent, while the proportion from gas rose from 24 per cent to 32 per cent and the proportion from renewables rose from 4 per cent to 10 per cent.

But through all that, the US utility industry has been able to prosper. The sector index rose 82 per cent from the start of 2010 to November 2017. The relatively comfortable position of US utilities has been in sharp contrast to their European peers, which have undergone a gruelling decade of financial pressures and forced restructuring.

A key reason for that has been the low cost of two of the US industry’s principal inputs: natural gas, and money. Utilities have been able to keep regulators happy with modest increases in rates, while increasing their earnings and dividends. Gas seems set to stay cheap but the cost of money is rising.

Read full article at Financial Times