Many Canadians might be surprised to learn that the share price-to-free cash flow ratio cannot be used in conducting market-based valuations of utility companies (Crown owned or publicly traded). Nearly all the utilities in North America, and even some Brazilian hydro-electric companies that trade on New York, have either negligible or even outright negative free cash flow. These reasons should concern Canadian taxpayers.
Power utilities across the world confront new challenges, nearly all of which have to be met with larger amounts of money, or ‘capital’. These challenges include moving towards natural gas or renewables (or face carbon-tax or other penalties), adding new capacity and flexibility to handle more unplanned intermittent solar, wind and other renewable capacity from other producers and former consumers, and losing customers to their own generating capacity (solar or gas, usually).
The list continues: ‘smart grid’ and other interconnection and expensive new long-distance transmission requirements (such as High Voltage Direct Current, or HVDC); independent ‘merchant power’ competition; energy conservation requirements to reduce demand; slow growth in commercial and household demand with increased demands for reliability; improving security (from cyber attacks).
All of these demands entail substantial increases in capital expenditure, over and above what is required to maintain normal, legacy service. There are additional items that are uniquely self-inflicted in Canada, such as the expansion of vast, ill-considered hydro projects by three Crown-owned power companies.
These capex demands can only be met four ways: increasing prices or ‘tariffs’ charged to consumers, businesses and institutional customers; borrowing more money; lowering dividends paid out to shareholders; or issuing more share capital. The last two are generally not available to Crown corporations, however,in the past many have cut or eliminated payments to provincial governments, and received injections of more capital from their government masters (paid for by taxpayers).
All of these threats will likely be met by private-sector utilities, through rate-board-sanctioned rate increases, juggling of peak-demand and bulk or conservation pricing, some borrowing, the occasional share issue, more careful prioritizing in capital budgeting, restraining dividend growth, and mergers to reduce overheads and increase scale, will be handled, by private investors taking their own risks, and sometimes losses.
Eventually, one thing that needs to change is the entire rate-regulation architecture and established interconnection arrangements. It needs to be entirely reformed, if not torn down completely. It is becoming clear that it is in no condition to deal with changes to the energy industry, new technology, and new sources of supply and demand. It is not obvious what will replace it, but a place will have to be found for all the independent merchant producers and customers making their own arrangements, and to make intermittent suppliers pay for their undependability.
The risk to taxpayers of owning Crown firms that are slow to adapt to new realities such as abundant, cheap shale gas and customers opting out of their grid is growing, and so are their debts. The capital demands for the Crown utilities alone are in the tens of billions of dollars over the next decade, and the rates are set to rise, even though natural gas, uranium, and coal prices do not.
Something is wrong here. Hard thinking needs to happen to change the systems, the Crowns, and seriously consider selling them to remove the risk to taxpayers. and possibly breaking them up to foster more flexibility, original strategy and speed of adaptability. The present situation will inevitably evolve, and could worsen if tough choices are not made soon.