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How Regulatory Environments Affect Utilities

Constructive regulatory environments can foster growth.

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Andrew Bischof: We spend a lot of time differentiating utilities with constructive regulatory environments versus utilities that operate in more difficult regions. And this is important, as a company's regulatory environment is a key consideration in determining a utility's moat. So what is a constructive regulatory environment? It's an environment that allows its utility to earn an attractive and timely return, giving us greater confidence that a utility can earn a positive spread over its cost of capital. Utilities operating in regulatory environments that consistently put consumers' interests before shareholders' struggle to earn their costs of capital, highlighting the importance of regulatory stability.

Management also plays a key role in developing a utility's regulatory environment. A constructive regulatory environment is supported by management's ability to control operating costs and capital costs, as any overages are likely to come at shareholders' expense while greater efficiencies benefit both shareholders and customers and give leeway for further capital growth opportunities.

We assess regulatory quality for our coverage universe on five key pillars: 1) allowed returns on equity; 2) recovery through nonfuel rate-adjustment mechanisms, which reduces the time from investment to recovery; 3) management's ability to manage operating expenses; 4) history of regulatory stability and outlook; and 5) retail rates.

NextEra Energy's Florida Power & Light leads our ranking. It operates in utility-friendly Florida, where it benefits from high allowed returns, little regulatory lag, and low customer rates. Atmost Energy enjoys regulatory support across its operating units. Its Texas operations are its crown jewel with little regulatory lag and significant support for its capital investment plans that are focused on safety. Wisconsin has proved to be a strong partner for WEC Energy Group over the past two decades. Alliant Energy also benefits from Wisconsin's favorable regulatory environment.

On the bottom of our list, OGE, Hydro One, and PG&E operate in some of the toughest regulatory and political environments. OGE has the misfortune of operating in Oklahoma. Hydro One's top shareholder, the province of Ontario, has a history of putting consumers' interests above shareholders'. PG&E management's mistakes in California created a political and regulatory firestorm in an otherwise historically constructive state.

Andrew Bischof does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.