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How Utilities Make NH Profits


Captain Ahab here, with some info on what I hope to spear while I sail.

I am not the fictional Captain Ahab, the single-minded captain invented by author Herman Melville in the great American novel of the 19th century, Moby-Dick. Rather than hunting whales, I am firmly planted here on land and the target of my harpoon is a bloated utility ROE.

By “utility” I primarily mean the big three in New Hampshire – Eversource, Liberty, and Unitil. And by ROE, I mean “return on equity,” which is a fancy way of saying profit. As the state’s consumer advocate, my job is to ensure that utility shareholders do not reap unreasonably high profits at the expense of residential utility customers.

As natural gas and, in particular, electricity prices have skyrocketed in recent months, there is widespread concern that utilities, their shareholders and executives are profiting generously at the expense of taxpayers by difficulty. So I thought I should try to explain precisely how these companies make money.

Here’s how they do it: They buy toys.

By “toys” I mean fixed assets – substations, poles, cables, pipelines, even gigantic liquefied natural gas storage tanks of the type that Liberty hoped to build a few years ago at Epping. The Public Utilities Commission (PUC) sets utility rates that are designed to enable them to generate a return on these investments for their shareholders. This is where the profit comes from.

Money – what is used to finance these fixed assets – comes in two forms: yours and that of others. For public services, other people’s money means funds borrowed from banks. Your money, if you’re a utility, is the shareholders’ investment.

Thus, when the PUC sets tariffs, it relies on a weighted average cost of capital for each company. How much of the company’s assets are financed by borrowed money, and at what interest rate? What is a reasonable return on everything else – the percentage of company assets that are funded by the shareholders themselves? In other words, what should the allowed ROE be?

These decisions are made through tariff cases – huge PUC proceedings that only happen every few years because they are expensive and complicated. This leads to the dreaded regulatory “lag” – the fact that, over the years and the utility buys new toys, those toys are not reflected in the rates.

Fortunately for utility shareholders — less fortunately for taxpayers — utilities have found a way around this problem. They persuade the PUC to allow “phased adjustments” to rates – basically, increases that account for these new toys automatically, without having to make a full rate case in which everything the utility does, well or wrong, is under review. .

Of course, the other way for a utility to combat regulatory lag is to operate more efficiently. If operating costs are lower than what is included in the rates, any savings are passed directly to the bottom line as profit.

Which gives me the impression that Captain Ahab is one of the fundamentals of corporate finance: ROE and shareholder risk are supposed to go hand in hand. If you are 4D Molecular Therapeutics, developing experimental gene therapies that usually don’t work, your shareholders will demand a high ROE or they will invest their money elsewhere.

Conversely, if you’re Eversource, Liberty or Unitil – which rely on proven technology to provide an essential public service to captive customers – then your ROE should be modest. But you should hear how utilities complain to regulators about the risk of their activities!

Now that I have offended the utilities, I would like to defend them a bit.

Recently, I attended a public forum where young activists handed out questions to state legislators and legislative candidates. Here are two of the questions:

“Are you going to publicly ask the NH Public Utilities Commission to reverse its decision to allow utilities to raise their rates by 100% or more? Will you vote for rate caps that would prohibit utility companies from increasing[ing] 100 percent rate while enjoying record profits? »

These people aimed their harpoons at the wrong target. I say this reluctantly, because the righteous outrage among New Hampshire youth is both welcome and justified, especially when the subject is energy.

Price caps would be a great idea if they weren’t unconstitutional. The United States Constitution prohibits the government, among other things, from taking private property for public use without “just compensation.”

Thus, the United States Supreme Court ruled nearly a century ago that if a regulator denies a utility the opportunity to obtain a reasonable return on shareholder investment, the tariffs approved by the regulator are “confiscatory”. In other words, it’s as if the government has confiscated utility property – all those toys – without fair compensation.

So yes, the PUC could reverse its recent series of rulings that roughly doubled the default energy service rates charged by electric utilities. But the utilities would turn around and sue the PUC in federal court. And utilities would win.

In a way, the huge increases in default energy service rates are a feature, rather than a bug, of the 1996 State Electric Industry Restructuring Act. Thanks to this status, you are not forced to buy the energy service by default when the price becomes exorbitant, you can migrate to the world of competitive energy suppliers.

Another feature is that Eversource, Liberty and Unitil make no profit on energy service by default. They simply buy it in the wholesale market and pass on their costs to their energy service customers by default. There are no toys involved – so no return on equity and no profit for utility shareholders.

In Melville’s story, Ahab’s quest to kill the great white whale Moby-Dick did not go well for the mad captain or his crew. The moral of the story, in the current context, is to choose your targets well.

And lest you find the analogy with Moby-Dick unnecessary, remember that Melville’s novel is about a key energy technology of its time – whale oil.