Regulation matters: A comparative analysis of state regulatory climates

Over the past several years the pace of regulatory evolution has accelerated, as the energy utilities and their state regulators address challenges posed by robust capital spending plans designed to remediate aging infrastructure and safety/reliability concerns, address environmental compliance requirements and replace retiring generation capacity, and the proliferation of new technologies and resources.

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The use of innovative regulatory constructs, such as performance-based ratemaking, formula rate plans and rider mechanisms has become more pervasive. However, the pace of change has been far from uniform across the 53 regulatory bodies followed by Regulatory Research Associates, an offering of S&P Global Market Intelligence.

With that in mind, RRA has undertaken a comprehensive audit of its state regulatory evaluations. As a result of that process, more than half the jurisdictions under coverage experienced some type of shift in their assigned rankings.

The accompanying table lists the 32 jurisdictions where RRA's rankings were adjusted since the issuance of the previous evaluations summary on Oct. 18, 2016.

For the most part, the states that changed only moved one ranking up or down, and given the subjective nature of the rankings this is not surprising. However, certain changes bear discussion.

Prior to the recent review, RRA had declined to assign any state an Above Average/1 ranking, due to concerns that such a ranking could prove politically challenging with unintended consequences for the utilities in the state(s) that are so ranked.

As part of the recent review, the team determined that in order to maximize the accuracy of the rankings, it was necessary to eliminate this "bias." Consequently, the ranking of Alabama moved to Above Average/1 from Above Average/2.

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There were five jurisdictions where the ranking moved by more than one rating up or down: Illinois, Kansas, Missouri, New Jersey and Pennsylvania.

The ranking of Illinois was raised to Average/2 from Below Average/1. The ranking change accounts for the constructive ratemaking steps the state has taken in recent years, including allowing the use of formula rate plans for the large electric utilities and infrastructure investment mechanisms for the gas utilities.

Although the ROEs authorized by the Illinois Commerce Commission in recent years for both the electric and gas utilities have been considerably below prevailing industry averages at the time established, the statutory use of a formulaic approach to setting electric ROEs is the primary impetus for many of these returns.

RRA's ranking of Kansas was lowered to Below Average/1 from Average/2 to reflect a gradual shift toward a more "consumerist" approach to ratemaking, as well as the Kansas Corporation Commission's recent decision to block Great Plains Energy Inc.'s proposed acquisition of Westar Energy Inc., which is negative from an investor vantage point.

RRA's ranking of Missouri was lowered to Below Average/1 from Average/2 in light of the state's inability to adopt meaningful changes to its regulatory structure, despite the considerable effort put forth by the utilities, and the recognition by the Missouri Public Service Commission and certain members of the legislature that certain changes could be warranted. The state's traditional approach to ratemaking is less investor-friendly than the more constructive frameworks now being utilized in many other jurisdictions.

The ranking of the New Jersey regulatory climate was lowered to Below Average/2 from Average/3. This change stems largely from attrition rather than an identifiable shift in policy; i.e., the jurisdiction has not moved to implement certain innovative policies that have been adopted in other jurisdictions, and has retained others, such as consolidated tax adjustments, albeit in a modified form. In addition, the state’s consumer advocacy agency remains vocal and has a strong influence, rendering it difficult for the utilities to achieve constructive regulatory outcomes from the New Jersey Board of Public Utilities.

RRA's ranking of Pennsylvania regulation was raised to Above Average/3 from Average/2. This move reflects an overdue change to fully recognize the state's transition to fully forecasted test years, which was effectuated by a change in state law and has been embraced by the commission. Another constructive aspect of the Pennsylvania regulatory climate has been the implementation of mechanisms to reflect new infrastructure investment in rates on a regular basis, through quarterly rate adjustments, for almost all of the state's utilities. While this was occurring, the Pennsylvania Public Utility Commission has sought to maintain authorized ROEs at levels that are attractive to investors, despite the declining interest rate/ROE environment.

Overview of RRA rankings process

RRA evaluates the regulatory climates for energy utilities of the jurisdictions within the 50 states and the District of Columbia, a total of 53 jurisdictions, on an ongoing basis. The evaluations are assigned from an investor perspective and indicate the relative regulatory risk associated with the ownership of securities issued by each jurisdiction's electric and gas utilities.

The rankings look at various state commission policies, but also take into account actions by state governors, legislatures, courts and intervening parties in major proceedings before the state commissions.

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RRA maintains three principal rating categories, Above Average, Average and Below Average.

An Above Average designation indicates that, in RRA's view, the regulatory climate in the jurisdiction is relatively more constructive, representing lower risk for investors that hold or are considering acquiring the securities issued by the utilities operating in that jurisdiction.

At the opposite end of the spectrum, a Below Average ranking would indicate a less constructive, higher risk regulatory climate from an investor viewpoint.

A rating in the Average category would imply a relatively balanced approach on the part of the governor, the legislature, the courts and the commission when it comes to adopting policies that impact investor and consumer interests.

Within the three principal rating categories, the designations 1, 2 and 3 indicate relative position, with a 1 implying a more constructive relative ranking within the category, a 2 indicating a mid-range ranking within the category and a 3 indicating a less constructive ranking within the category.

RRA attempts to maintain a "normal distribution" of the rankings, with the majority of the states classified in one of the three Average-range categories. The remaining states are split relatively evenly between the Above Average and Below Average classifications, as seen in the accompanying chart that depicts the current distribution of the rankings.

For a more in-depth discussion of the factors RRA reviews as part of its ratings process, see the May 11, 2017, report entitled State Regulatory Evaluations-- Regulatory Climate for Energy Utilities.

For a discussion of the regulatory climate in each jurisdiction, refer to RRA's Commission Profiles.

For a complete, searchable listing of RRA's in-depth research and analysis please go to the S&P Global Market Intelligence Energy Research Library.