Building for the Long Run

By Richard McMahon, Executive Director, Alliance of Energy Suppliers, Edison Electric Institute

THE U.S. ELECTRIC POWER INDUSTRY posted strong financial gains again in 2006. The positive numbers were cheered by the industry's shareholders. The consistent gain in earnings was also welcome news for the industry's investors. To sustain these results, which is vital for attracting the capital the industry will need as it enters a long-term investment cycle, electric utilities are working together to develop solutions to a range of political and regulatory challenges at both the federal and state level.

Financial Returns

The Edison Electric Institute Index tracks the stock performance of the 64 U.S. shareholder-owned electric utility holding companies. Last year it returned 20.8%, with 53% of the EEI Index companies producing double-digit percentage gains. The Index edged out the Dow Jones Industrials' 19.1% and the S&P 500's 15.8%. The more volatile and tech-heavy NASDAQ trailed with a 9.5% gain for the year.

The US industry's strengthening balance sheets are supporting a dramatic rise in capital expenditures. In 2005, capex totaled $46.5 billion. This was the first significant rise since 2001 — the peak of the industry's competitive generation build-out. And capex for 2006 is expected to show an increase of nearly 30 percent over 2005, with investment approaching $60 billion.

These investments are funding the environmental upgrades, new transmission lines, new generation, and other major financial challenges associated with keeping up with the country's steadily growing demand for electricity. Electric output last year was the second highest yearly total ever. It fell just shy of 2005's record. Looking ahead, the U.S. Energy Information Administration is predicting that electricity use will grow by almost 40% over the same period. To supply it, 258 GW of new generating capacity, representing an investment of approximately $412 billion (2005 dollars), will be needed by 2030, according to EIA.

Although the price of one kilowatt-hour of electricity remains a bargain in comparison with food, gasoline, health care and many other items, one of the major challenges facing the industry will be improving public and regulator understanding of the need to increase electricity rates to meet the industry's growing investment requirement. In most states, electricity prices have already been rising because of a substantial increase in fuel and purchased power costs. And as the media has widely reported, some of these new electric bills reflected a substantial increase over what customers had been paying in the states whose rates had been frozen in the mid-1990s.

Devising ratemaking strategies that enable utilities in these markets to recover their costs, while at the same time show sensitivity to customers, will be a challenge. But, they are a necessary step if the electric utility industry is to make the long-term investments needed to help ensure reliable, affordable, and increasingly clean electricity.

Energy Efficiency

EEI is now leading an effort driven by its member companies to enable energy efficiency to help offset more of these higher costs. The industry is pursuing actions to improve the efficiency of buildings and appliances, encourage the development of plug-in hybrid electric vehicles, and accelerate the development of advanced metering infrastructure. When coupled with innovative approaches to rates and ratemaking design, energy efficiency, demand response, and smart technologies will be able to expand the industry's portfolio of resource options. They will be able to help mitigate the effects of volatile fuel costs. And they will make regulated retail markets more responsive to competitive wholesale markets. The result will be a foundation for a dynamic partnership between utilities and their customers to achieve the mutual goals of greater reliability, power quality, environmental protection, cost control, and risk management.

Environment

The industry is also working together to address environmental issues — especially climate change — as it plans to increase its infrastructure investments. The industry's formal efforts on climate change began in 1994, with participation in the Climate Challenge, a joint government-industry partnership, and continue today with a similar partnership, Power Partners ^SM .

The electric utility industry is now also involved with the Asia-Pacific Partnership on Clean Development and Climate. APP partner countries — Australia, China, India, Japan, Republic of Korea, and the United States — together produce about half of the world's carbon dioxide. These nations have agreed to work together to meet goals for climate change, energy security, and air emissions in ways that promote sustainable economic growth and poverty reduction.

In the widening public debate over U.S. policy to address climate change, EEI earlier this year released a set of principles to help guide the industry. Broadly, the principles stress three components that are critical to any federal action or legislation to reduce greenhouse gas emissions:

*Ensuring the development and cost-effective deployment of a full suite of "climate-friendly" technologies;

*Minimizing economic disruption to customers and avoiding harm to the competitiveness of U.S. industry, and

*Ensuring an economy-wide approach to carbon reductions.

Dividend Tax Rate Cut

The industry is also focusing on taxes, especially a permanent or long-term extension of the dividend tax rate reduction that took effect in 2003. Since it went into effect, electric utilities have produced an 86.8% total return for shareholders. This compares to a 50.1% return by the Dow Jones Industrial Average. After the dividend tax reduction was extended through 2010 in May 2006, the EEI Index of electric utilities produced a 20.5% total return—nearly all of the return posted for last year. Another tax emphasis for the industry will be promoting a 5-year extension of the production tax credit for renewable energy sources. This will give those businesses the stability they need to plan and finance renewable energy projects. The current PTC is due to expire on December 31, 2008.

With a stronger financial base, the nation's electric utility industry is now poised to address the major challenges ahead on both the supply and the demand side. And by working together as an industry to get the job done — we are confident that the result will be a stronger electric system, a healthier environment, and a more competitive nation.