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Hurricanes, pandemic may pressure US utilities' rate recovery

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Power crews work to restore power after tropical storm Florence hit Newport, N.C., on Sept. 15, 2018.
Source: AP Photo

A potentially active 2020 hurricane season coinciding with a global pandemic could compound financial pressures on U.S. utilities and test the ability of regulators to balance electric providers' right to earn returns on prudent expenses with consumers' capacity for higher bills in a recession.

The National Oceanic and Atmospheric Administration estimated that 13 to 19 named storms will form in the northern Atlantic Ocean area this season, with up to six becoming Category 3 or higher. While Southeast U.S. utilities have experience with outage restoration after strong storms, the ongoing coronavirus outbreak will likely add to costs for companies' disaster recovery.

"The quick answer is, yes," there will likely be increased restoration costs due to COVID-19, Tom Gwaltney, the senior director of emergency preparedness for Florida Power & Light Co., told the Florida Public Service Commission on May 19. For example, the NextEra Energy Inc. subsidiary has to break large base camps for restoration workers into smaller sites to accommodate social distancing.

"We are looking 20 ways to how can we mitigate those costs," Gwaltney told the PSC. "What can we do and how can we streamline activities utilizing technology? Where can we eliminate some of that?"

"But, yes, we do anticipate that there could be, you know, additional costs," Gwaltney added.

READ MORE: Sign up for our weekly coronavirus newsletter here, and read our latest coverage on the crisis here.

More utilities are also incurring incremental bad-debt expense due to mandated and voluntary moratoriums on disconnecting customers with unpaid bills as well as safety-related costs from the virus. FPL's sister company, Gulf Power Co., reported about $6 million less in total customer bill payments in April 2020 compared to previous years, spiking the utility's bad-debt expense to approximately $2.1 million for the month. Southern Co. subsidiary Georgia Power Co. disclosed that the virus may add up to $30 million in labor and safety costs for its already over-budget Alvin W. Vogtle Nuclear Plant expansion project.

As of June 5, utility commissions in 20 states and the District of Columbia have issued orders to allow deferral of bad debt for later accounting treatment, while 18 other states have cases pending on similar matters, said Lillian Federico, research director of Regulatory Research Associates, a group within S&P Global Market Intelligence.

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The deferral of COVID-19 costs is not a guarantee that utilities can recover those expenses from customers, Federico said. Regulators will review deferred amounts in future rate cases, and could disallow some of them. Once the recoverable balance is determined, regulators will have to decide how recovery occurs: amortize the costs over time or securitization, where bonds are backed by a revenue stream "guaranteed" by policymakers.

This parallels how utilities traditionally recover storm costs. But most regulatory jurisdictions also have some baseline recovery clause in place or some emergency reserve to deal with storm costs, and regulators try to plan for historical "100-year" weather events.

Several states are also considering other mechanisms to more flexibly incorporate COVID-19 costs, like liberalized customer repayment plans, automatic adjustments for uncollectibles, decoupling or other ratemaking alternatives.

But the pandemic and its far-reaching economic restrictions is the first disaster in modern times to affect the entire country and every participant in the sector at once, Federico noted. The industry does not typically have a provision in base rates for when utilities' normal operating expenses suddenly increase.

"How often do we have something this bad? And I mean, this is really the first of its kind," Federico said in a June 3 interview. "There are other things that are kind of similar to it, say, Hurricane Sandy or Hurricane Katrina or the wildfires in California or things like that," but those events are localized to a certain state or region.

"It is really virgin ground that we're crossing here in trying to deal with this issue as an industry," Federico added.

Hurricanes and their associated costs are "always a wild card" and difficult to predict, Glenrock Associates LLC analyst Paul Patterson said. But regulators have the means and mechanisms to mitigate the pain given the utility industry's monopolistic nature.

"You have the ability to defer and recover, to blend and extend these costs that a lot of other industries don't have at all," Patterson said in a June 2 interview.

Certainly, utilities have some policy advantages to withstand additional financial pressures compared to other industries, but there are also limits to how much regulators will allow monthly bills to increase.

"There have been a lot of costs that have been coming into the utility rates over many years now," such as capital expenditure programs, Patterson said. "Now you may have less tolerance in certain jurisdictions to rate increases because of COVID-19 and the economic situation on the ground."

Federico echoed those sentiments, noting that some regulators and customers have historically pushed back against utilities trying to recoup various costs and may have "a little regulatory fatigue" with multiple riders and recovery clauses. She mentioned as an example the Virginia State Corporation Commission's decision to not allow Dominion Energy Inc. subsidiary Virginia Electric and Power Co. to recover more than $600 million in grid improvement projects.

On the other hand, as regulated monopolies, utilities are entitled to recover money that they spent prudently and in good faith as part of their regulated rate of return, Federico said. If commissions do not allow companies to recover costs that incurred in "these extraordinary events," it can turn into a constitutional takings issue.

What will likely happen in future rate cases to recover these balances is that utilities' return on equity will face pressure to drop, Federico said. Regardless of the specific formulas used to calculate ROE and other factors such as discounted cash flow and risk premium, the inputs to those formulas are subjective based on who is doing the analysis.

"And at the end of the day, that's where the commission really has the most discretion because they make a judgment call on which stakeholders' proposal is the most appropriate and if it balances that need to maintain affordability and allow the utility to recover costs," Federico said. "So rate of return sometimes becomes the fudge factor."