De Blasio’s ConEd Threat Is a Sign of What’s to Come

(Bloomberg Opinion) -- On reflection, New York Mayor Bill De Blasio didn’t choose the best day to spitball about a government takeover of Consolidated Edison Inc.’s grid. Hours after he made those comments on TV, some New Yorkers were emerging from long-delayed subway trains to find their neighborhoods transformed into a dystopian Venice, light on gondolas but heavy on garbage, as the city’s sewers struggled to cope with heavy rains.

Recent blackouts, including during the weekend’s heatwave, have put ConEd in the mayor’s crosshairs, and things sure have escalated quickly. Raising the prospect of effective municipalization of the company’s main asset is akin to threatening a nuclear strike – and just as likely, given the not-obvious benefits of having New York’s grid run from City Hall.

Perhaps more consequential, given ConEd is regulated at the state level, is the parallel displeasure of Governor Andrew Cuomo. ConEd is in the middle of one of its periodic rate-setting procedures, essentially where it makes a case to regulators to be allowed to raise bills to pay for capital spending and the return its investors earn on that. As it stands, regulators have recommended less-generous terms than the company wanted for the New York City utility, which provides the vast majority of its income. ConEd sought a financing structure of 50% equity and an allowed return on that equity of 9.75%. Regulators have instead preliminarily recommended 47.3% equity and a return of 8.3% – small tweaks, seemingly, but enough to drop the implied net income by roughly a fifth, all else equal.

With those recommendations made in late May, the market has priced this in to some degree already. Where the blackouts and subsequent political ire could potentially come into play is in the negotiations this summer over where those numbers settle. It could also prompt greater scrutiny of how the utility is allocating its budget with regards to updating and replacing older equipment. Even if staff on the Public Service Commission aren’t inclined to take their cues from the latest news cycle, we all tend to take notice when our boss is mad.

For investors, such considerations matter especially because ConEd’s stock trades close to the all-time high it hit a month ago. ConEd has undergone a big re-rating upward over the past five years, jumping from 12 times forward earnings to almost 20 times, overtaking the broader regulated utilities sector. 

That performance acts as a headwind to ConEd’s regulated return due to the formula used by the PSC in setting it (a higher multiple essentially reads as a lower rate of return demanded by investors). The bigger issue, however, is that, as with any stock, a higher multiple leaves little room for error. Greg Gordon, who covers utilities for Evercore ISI, noted in a recent report that, even assuming the allowed return comes in above the PSC’s recommendation, his model implies the company needing to issue $2.6 billion of new equity – about 9% of the current market cap – over the next two years if it wants to protect its current credit rating. In part, that is a result of ConEd’s decision to buy Sempra Energy’s California renewable-energy assets late last year – just before they got mired in the bankruptcy of PG&E Corp.

The latter is also currently facing calls by politicians in one of its big urban markets, San Francisco, to take over their grid. That situation is clearly an acute crisis compared to what’s been happening in New York, and yet there are also good reasons to be wary of thinking municipalization is a silver bullet there (see this).

Nonetheless, as my colleague Mark Chediak points out, several cities across the U.S. have now raised the prospect with a greater or lesser degree of seriousness. Besides politicians letting off steam, other factors may be fueling such talk. In part, it reflects the flatlining of electricity demand over the past decade or so, which has raised questions about how power is paid for and led some prominent companies to break away from their local grid, or attempt to. It is also a function of technology, as notions of what may be possible outside of the traditional regulated utility model expand. Indeed, Cuomo’s own Reforming the Energy Vision strategy for the state’s power sector reflects this. (Disclosure: My wife runs a company developing a distributed energy platform in New York.) 

There is also the issue of climate change and the balkanized response to it across the U.S. Patchwork policy is inevitable in America’s federal system, especially as utilities are regulated mostly by the states. This tendency is given added impetus by the current federal administration preferring to ignore the problem. Individual locales don’t necessarily have that luxury.

While it takes a leap to pin this or that extreme weather event specifically on climate change, the West Coast’s wildfires and the East Coast’s heatwave and heavy rains unequivocally tell us one thing. With such events due to occur more frequently as a result of climate change, it is becoming abundantly clear that our 20th-century infrastructure isn’t built to handle it. Don’t expect the battle over how we address that, who pays and gets compensated for it, to let up.

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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