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The electric utility industry is always dealing with new regulatory issues. It should come as no surprise that rules issued by the U.S. Environmental Protection Agency can affect many of these companies greatly. On the other hand, it will probably surprise many investors that the industry needs to be concerned with the Dodd-Frank law, which was aimed at commercial banks.

The industry is facing financial pressures, too. Capital spending needs are rising, due, in part, to environmental requirements. At the same time, volume is flattening out, and allowed returns on equity are declining.

In July of 2011, the EPA issued new cross-state air pollution rules, which are intended to reduce the amount of pollutants coming from coal-fired plants. The rules take effect in 2012. The industry has expressed concern about the cost of compliance and (perhaps even more so) the short time frame before the rules take effect.

Some utilities have already installed (or are installing) pollution-control equipment for their coal-fired units. Others won’t be able to do so by the EPA’s deadlines. Among their near-term options for compliance are purchasing emission allowances or dispatching their coal-fired facilities less, even if it means using more-costly sources of power. Regulated utilities should be able to pass the increased costs on to customers, but owners of nonregulated assets will be adversely affected unless market prices rise to reflect the higher costs. In the long run, some older coal-fired plants will be shut down.

Already, there have been a lot of complaints about the new rules, and even some litigation. Some in Congress have expressed their opposition. There is sure to be more squawking in November of 2011, when the EPA is scheduled to issue new rules concerning mercury emissions.

Due in part to the stricter environmental regulations, the industry’s capital spending needs are much higher than they were a few years ago. The Edison Electric Institute, a group representing investor-owned utilities, projects that the industry’s capital spending will amount to more than $80 million annually from 2011 through 2015 (compared with less than $50 million in 2005).

In 2012, the U.S. Commodity Futures Trading Commission will finalize new rules about swaps and swap dealers, in accordance with the Dodd-Frank law, enacted in 2010, which was aimed at commercial banks. The electric utility industry hopes that its members are not treated as swap dealers. This would increase the compliance burden by requiring them to post margins for energy-marketing transactions that are a normal part of a utility’s operations.

As all of these regulatory concerns are occurring, the electric utility industry is facing operational worries. For many years, the demand for power increased steadily (although weather patterns caused fluctuations from year to year). This is no longer the case. The recession of 2007-2009 reduced industrial demand for electricity, and the sluggish economic recovery since then has limited the rebound in kilowatt-hour sales. Many business and residential customers have increased their emphasis on energy efficiency, and appliances are using less power than in the past. Utilities are also dealing with lower allowed returns on equity that state regulatory commissions are granting in rate orders. Some of this is due to low interest rates, but some commissions are also reducing allowed ROEs in order to lessen the burden on ratepayers.

This is not meant to suggest that electric utility stocks are no longer worthy of consideration by investors. Most of these issues offer dividend yields that are well above the market median. However, electric utility investors need to be aware of regulations and investment considerations that have changed considerably since the middle of the previous decade.

 

At the time of this article’s writing, the author did not have positions in any electric utility stocks.