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Challenges in Financing for Electric Utilities ROBERT W. GEE PRESIDENT GEE STRATEGIES GROUP LLC Challenges in Financing for Electric Utilities ROBERT W. GEE PRESIDENT GEE STRATEGIES GROUP LLC MID-AMERICAN REGULATORY CONFERENCE TRAVERSE CITY, MICHIGAN JUNE 15, 2009

Disclaimers, etc. • I am not a financial analyst, nor do I play one Disclaimers, etc. • I am not a financial analyst, nor do I play one on television. . . • I am a former regulator whose forte is listening to what others say, usually in jargon. . . • Then explaining what is said into plain English and, if necessary, into “regulatory speak” to regulators 2

Overview • The recent crisis in the financial markets over the last several months Overview • The recent crisis in the financial markets over the last several months and how that has affected electric utilities • Policy Implications • The options utility regulators face 3

How The Financial Crisis Has Changed Things • Volume of capital available for borrowing How The Financial Crisis Has Changed Things • Volume of capital available for borrowing has shrunk significantly – Fewer traditional lenders of capital after bankruptcies and government interventions – Bank Mergers facilitated but. . • One plus One Two One • Currently, capability of banks to lend is down 20 percent, or approx. $10 trillion less than before the crisis • Result: Existing borrowers chasing less available capital 4

Electric Utilities Are Uniquely Affected • They are capital Intensive enterprises • They rely Electric Utilities Are Uniquely Affected • They are capital Intensive enterprises • They rely more on bank-provided liquidity to meet needs than other industrial sectors – one half on average versus 76 percent • Previously, credit of majority (79 %) of utilities was rated AA or better in the 1970’s, but most today (69 %) rated BBB; less room for error to avoid falling below investment grade • This exposes them to additional risks at a time of economic stress • Their balance sheets are contracting under this stress 5

Losses in Equity Markets Mirrored in Utility Sector • Losses in public equity markets Losses in Equity Markets Mirrored in Utility Sector • Losses in public equity markets = >$34 trillion • US electric utilities: 40 % equity value loss from Dec. 2007 level (vs. 53% for S & P 500) as of April 2009 • Losses have lessened lately, and markets have recovered slightly, but stock price volatility remains 6

Consequences to Consider • What all this means: Competition for available capital will be Consequences to Consider • What all this means: Competition for available capital will be fierce, and cost of capital will be higher as reflected in cost of debt • Example: bonds for BBB rated utility seeing estimated 346 basis point spread (over 10 -year Treasuries) versus 108 bps in July 2007 • Higher debt cost results in higher cost of equity • Bad news for a capital intensive industry such as electric utility sector • One unnamed investment banker: “These are the most extraordinary and scary times I have seen in my 27 years as a banker. ” 7

Will There Be Sufficient Capital to Meet All Obligations? • Crisis arrives at worst Will There Be Sufficient Capital to Meet All Obligations? • Crisis arrives at worst time since sector in need of capital to finance build out and modernization of power delivery infrastructure – Between $1. 5 and 2. 0 trillion estimated for infrastructure investment between 2010 and 2030 (Brattle Group) – Needs for smart grid investments, environmental compliance, including carbon mitigation for some • One estimate: for 2009 and 2010, utilities will have a funding gap of at least $50 billion (calculated as capital expenditures plus dividends subtracted from funds from operations) -- JP Morgan • Utilities will need to rely greater on internally generated funds and/ or seek assistance from nontraditional sources of capital 8

Impacts on Regulators • Quality of utility regulation will be key to maintaining sector’s Impacts on Regulators • Quality of utility regulation will be key to maintaining sector’s competitiveness with other sectors • Investors even more sensitive now to regulatory policies • Investors looking to see if regulators sensitized to utilities’ current cash and liquidity conditions and whether their responses are timely and certain • If market perceives quality of regulation to be 9 not supportive, capital will migrate elsewhere

What Do We Mean By “Not Supportive” Regulation ? * *From an Investor Perspective What Do We Mean By “Not Supportive” Regulation ? * *From an Investor Perspective • Regulatory policy not comprehending that the paradigm has been significantly altered, and that financial markets have undergone structural change • Persistence of regulatory lag and timely recovery of costs impeded • Authorizing equity rates of return not reflective of actual or current market conditions • Unreasonably restraining rate levels to accommodate public constituencies 10

Recommended Actions for Regulators • Open and maintain an ongoing dialogue with your utilities Recommended Actions for Regulators • Open and maintain an ongoing dialogue with your utilities • Understand the financial circumstances they operate in • Build trust if not there • Collaborate with utilities in partnership to seek solutions 11

Additional Measures Bolstering Utility Competitiveness In Capital Markets • Consistent with state law, utilize Additional Measures Bolstering Utility Competitiveness In Capital Markets • Consistent with state law, utilize tools to accelerate cost recovery and reduce risk of under recovery – – – CWIP in rate base Regulatory predeterminations of prudence Pass-through of targeted costs or capital expenditures Forward looking test year More frequent rate cases • “Be realistic” about return on equity -- don’t be slave to formulaic outcomes that have unrealistic effects • Be mindful of “earned return” versus “allowed return” – avoid giving with one hand taking away with another 12

Lesson for Regulators: Exhibit a “Profile in Courage” • Regulators forced to make decisions Lesson for Regulators: Exhibit a “Profile in Courage” • Regulators forced to make decisions that are unpopular, particularly if public perceives rates are rising in this economically distressed environment • Avoid the “easy way out” – this only passes the buck to successors • Spend time consensus building with all of your stakeholders and the public • Repeatedly explain your decisions to the public – designate knowledgeable staff to assist • Educate the public to understand the difficult choices you need to make • In the end, the public may not like the decisions, but will understand their wisdom – most likely after you are gone! 13

Robert W. Gee President Gee Strategies Group LLC 7609 Brittany Parc Court Falls Church, Robert W. Gee President Gee Strategies Group LLC 7609 Brittany Parc Court Falls Church, VA 22304 U. S. A. 703. 593. 0116 703. 698. 2033 (fax) [email protected] com www. geestrategies. com 14