Utility stocks have historically been considered a proxy for bonds. This thought came to mind during a flash back to my old days at the Florida Public Service Commission. Utility regulators have as their credo striking a balance between the interests of utility shareholders and the interests of ratepayers.
The ratemaking forum is a performative one. Ratepayer advocates earn their salt by taking the position that utility regulators are only concerned with the interests of utility shareholders. If they have any sense of compromise, they have done, in my opinion, a good job of keeping compromise way on the backburner from public view.
Utility investor advocates are savvy enough to give the impression that they are incorporating ratepayer interests in affordable rates into their ratemaking proposals. I have never participated in a rate case where a utility failed to give lip service about how their rate proposal provides benefits to the ratepayers. It would be regulatory suicide not to express an attempt at balancing their interests with that of the energy consumer.
I can understand why the ratepayer feels outgunned during ratemaking proceedings. Ratepayers and their advocates are not privy to most of the data that regulators and regulated utilities have access to. While advocates may have knowledge of the regulatory lingo tossed around between regulator and regulated, ratepayers do not.
And unless you are a nerd like yours truly, rate case proceedings, where stakeholders make their arguments before a regulator about which rates are appropriate, can result in eyes glazing over. Rate case hearings combine economics, policy, law, engineering, and finance. To the seasoned regulatory professional, the merger of the disciplines creates a sweet singularity.
Like I said. I’m a nerd.
Any and all enterprises are first and foremost capital allocators, moving around resources into the most profitable activity. But to attract capital, the utility must offer a rate on return that incentivizes investors to send capital its way. Regulators, utilities, and ratepayers discuss what this rate of return should be. What I learned to appreciate over the last thirty years is the importance of the markets in determining that rate.
The last twelve or thirteen months in particular should be of interest to ratepayers and shareholders when asserting the appropriate rate of return for attracting capital. A utility’s stock price provides a signal for attracting capital. If we look at a utility as a giant bond, we can get a glimpse into why utilities are referred to as proxies for bonds.
A back-of-the-napkin analysis of the movement of Georgia Power’s stock price over the last twelve months when compared to changes in the effective federal funds rate during the same period provides some insight. The effective federal funds rate, the weighted average of the federal funds rate assessed by banks the previous day, climbed 1,363% between April 4, 2022, and April 4, 2023. Meanwhile, over the same period, the rate on the ten-year Treasury note rose 32.2%.
Georgia Power’s stock price, between April 2022 and April 2023, decreased .008%. Granted, this decrease does not make the strongest case for the rule of the inverse relationship between bond prices and yields. When yields rise, bond prices fall. Technically, as the fed funds rate and interest rates on bonds increased, the price of Georgia Power’s stock fell. To see a stronger indicator of the rule, you would have to take a look at how the rates performed between a tighter timeframe.
Between August 15, 2022, and October 10, 2022, Georgia Power’s stock price fell 13%. During the same period, the ten-year Treasury note rate increased 39.4% while the effective federal funds rate increased 32.8%. A tighter snapshot of the inverse rule, but I would advise against putting too much weight on this tight window.
Ratepayer advocates in particular should keep in mind that ratemaking occurs in an environment outside of a public utility hearing room; that the rates used by a utility to attract investors and determine the rate of return on the assets used to generate energy are impacted by what happens in the banking environment. How you structure your strategy on rates should take this environment into consideration.
4 April 2023
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