Utilities aim to balance growth plans with customer impacts in tough economy

U.S. investor-owned utilities are emphasizing that ambitious growth plans remain intact despite inflation and many customers grappling with rising bills.

While Fitch Ratings and Moody's gave negative outlooks on the utility sector, management teams gathered at the Edison Electric Institute Financial Conference in Hollywood, Fla., expressed optimism heading into 2023 against a backdrop of rising interest rates, higher natural gas prices and recession risk.

"We have had a strong legacy of financial discipline around cost management, and I think our size and scale helps us there as well. But where that shows up most notably is in our customer bills," Exelon Corp. Executive Vice President and CFO Jeanne Jones told S&P Global Commodity Insights at the Nov. 13-15 conference. "So, we're starting from a good place. Our rates are 18% below the top 20 metropolitan cities in the country, and we serve four of the major metropolitan cities in the United States."

Still, Jones said Exelon customers are seeing increases in their bills, and the Chicago-headquartered multi-utility is working to keep its operations and maintenance expenses flat while connecting customers to energy efficiency and financial assistance programs.

"This is an incredibly important time to not have those dollars go unused," Jones said.

Exelon President and COO Calvin Butler Jr. said the company serves "some of the most under-resourced communities out there."

"You can't ignore that," said Butler, who will take over as Exelon's CEO at the end of the year. "A dime to a dollar for some of our customers is very significant."

Along with Chicago and northern Illinois, Exelon utilities distribute electricity in service territories that include Philadelphia, Washington, D.C., and Baltimore.

Guggenheim Securities LLC described the Edison Electric Institute Financial Conference as "one of the most volatile in recent memory."

Compared to "pervasive exuberance on growth, decarbonization," and typical utility rate cases or initiatives, "this week was far more polarized between optimism, caution, and curtailment of expectations," with inflation, interest rates and other macroeconomic challenges taking shape, Guggenheim analyst Shahriar Pourreza wrote in a Nov. 18 recap.

CreditSights analysts said they do not share the same negative view on the sector as rating agencies Fitch and Moody's.

"We appreciate in some cases deferring rising gas and power costs have led to [funds from operations] pressure, but we highlight commodity costs [natural gas and power] have been in sharp decline over the last several months since spiking this past summer," CreditSights analysts wrote in a Nov. 17 report.

However, CreditSights analysts said they are "concerned regulators lower future capex and thus EPS growth to help alleviate bill pressure since it is hard to cut [returns on equity] when rates are rising."

Cost mitigation

Charlotte, N.C.-headquartered Duke Energy Corp. also is mindful of macroeconomic headwinds, especially rising interest rates.

"We are in the debt markets quite frequently, so we saw this coming and we launched a cost program really focused on our corporate and support organizations," Duke Executive Vice President and CFO Brian Savoy said in an interview on the sidelines of the conference.

The company recently increased its 2023 cost mitigation target from $200 million to $300 million, with a focus on operational efficiencies.

"That is ultimately going to help customers over the long term because most of these changes are structural and permanent in the cost structure," Savoy said.

While fuel costs also have been high, the Duke CFO noted a recent decline in volatility with Henry Hub natural gas prices projected to hover around $5/MMBtu in 2023 and $4/MMBtu in 2024. "If we can hold at this $4 to $5/MMBtu level, that will give time for customer bills to stabilize and catch up to the market," Savoy said.

While Fitch based its "deteriorating" sector outlook on the risk of a mild recession, Southern Co. Chairman, President and CEO Thomas Fanning said, "I just do not see that data for the Southeast."

"Yes, we've had enormous growth. Yes, it is slowing. But I don't see economic growth going negative in the Southeast," Fanning said.

When it comes to balancing customer affordability, Fanning said the new units at the Alvin W. Vogtle Nuclear Plant in Georgia will contribute to cost savings when they come online, beginning with unit 3 in March 2023. "The energy coming out of that nuclear unit is at the equivalent of about $1/MMBtu of natural gas. So, it is exceedingly efficient from an energy standpoint," Fanning said.

The company also uses hedging mechanisms and has submitted rate case filings below the level of inflation, the CEO said.

American Electric Power Co. Inc.'s incoming CEO said the Midwest utility makes its financial and operational decisions with a keen focus on customers.

"Every step that we take and every dollar that we spend, you have to be mindful of the customer rates," Julie Sloat, president and CFO at American Electric Power, or AEP, said in a Nov. 17 interview. "We're kind of in a situation where we have a once-in-a-lifetime opportunity to serve the customer better with the investments that we're making."

AEP recently unveiled a $40 billion capital plan for 2023 through 2027 with nearly $26 billion funneled to transmission and distribution investments and $8.6 billion earmarked for regulated renewables.

"As a result of being able to invest in renewable generation or resources, that allows me to essentially sidestep a lot of my otherwise fuel costs," Sloat said. "I get rid of a lot of my O&M, so variable costs. So effectively, my costs are not going up as much because I've made that transition from traditional fossil-related activities to renewable sources."

AEP also has "multiple levers" it can pull to manage its costs, said Sloat, who will take over as AEP's next CEO on Jan. 1, 2023. Sloat pointed to contract management and labor practices, saying, "But when I think about taking care of the customer, that will ultimately allow me to take care of my investor whether that is somebody owning our shares or owning our bonds."

As AEP grows its investment base, "that allows me to grow my earnings stream but it also allows me to grow my balance sheet in a responsible way," Sloat said. "I'm literally taking care of all those three points of the triangle; the customer comes first ... but then I take care of the equity investor and the fixed-income investor."

AEP, on average, expects customer rates to increase about 4% on an annualized basis over the next five years. "Had we not gone through the exercise of determining we need to make this energy transition, it would probably be in excess of 5%," Sloat said.

Managing equity, seeking cost recovery

Exelon's Jones said the company did most of its financing for 2022 at the beginning of the year following the separation of its power generation business into Constellation Energy Corp.

In addition, Exelon in August completed more than half of its $1 billion in equity needs through 2025 and has about $425 million remaining.

For short-term debt, Exelon uses "interest rate caps," which involves paying a small premium upfront to lock in costs and protect against rate volatility, the CFO said.

Exelon has a $29 billion capital plan from 2022 through 2025, which the company expects will grow its rate base to about $65 billion in 2025 from about $48 billion in 2021.

"It's not like we are investing and then coming in for approval," said Butler, the incoming CEO, adding that the company is making its investments and filing forward-looking multiyear rate plans with input from stakeholders and regulators.

"No one, to date, has asked us to do less," Butler said. "They've always asked us to do more."

Duke's CFO said rate cases in this environment "are going to be challenging."

Duke Energy Progress LLC filed its first multiyear rate plan in North Carolina in October, seeking an increase in electric base rates of $623.5 million over three years.

"There are a few compelling points," Savoy said. "The O&M expense in this rate case is $100 million lower than what is in rates today because we've managed costs really well."

In addition, Duke Energy Progress is focusing most spending on transmission and distribution investments, storm response and system resiliency.

"We do believe they are powerful arguments," Savoy said. "It also enables the grid to integrate renewables and prepare for electrification of other sectors like electric vehicles."

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