Guest Editorial: I need your advice

By on October 13, 2011

by State Sen. Chris Lauzen
25th District

Sorry to have to ask, but I need your help. I voted “No” on SB1652, the Electrical Energy Infrastructure Improvement Program. Although I agreed with its objectives of strengthening reliability, reducing outages, and stabilizing rate-setting procedures, I thought that the initial proposal’s cost was too expensive. SB1652 passed the Senate and House over my objection in close votes. Governor Quinn vetoed the bill, and I anticipate that we will vote on a “veto override” motion in the Senate within the next month.

The general impact of the legislation is good, but the initial interpretation of how the utility rates and increases would be set was incorrect. That original impression was that utility rates and the ensuing increases would be automatic, which is very bad, in my view. However … the utility rate review process would become a stable and methodical annual process rather than one that leads to spikes and troughs. We want reliability and stability, but we don’t want to overpay.

Unfortunately, the cost issue boils down to facts about definitions of complicated financial measurements of return on investment. When I first learned that the “return on equity” for the infrastructure improvements would be 600 basis point (6 percent) over the 30-year government bond interest rate (currently, approximately 4 percent), I said, “Whoa Nellie, no one gets 10 percent on their investments these days!” Therefore, I voted “No.”

However, after deeper study of what statistics I ought to be using to make an accurate assessment, I have learned that there is a substantial difference between “return on equity” and “shareholder return.” Knowing that these statistics can be as different as watermelon and oranges, that knowledge doesn’t make it too much easier for me to understand. I asked one expert, “If it’s this hard for me to distinguish after a lifetime in finance and accounting, how are my constituents … who are busy with raising families, running small businesses, and fighting hard to just make ends meet … going to assess the fairness of this proposed legislation?”

One way of better understanding what something like “return on equity” is, is to understand what it is not. Return on equity is not the interest rate that Commonwealth Edison pays to its bondholders. This statistic is currently approximately 6.2 percent for all maturities and going down as new bonds at lower rates are issued in an environment of declining long-term interest rates.

Return on equity is not a “shareholders return”. Shareholders return is dividends paid and appreciation of stock price divided by a company’s average share price in any year calculated.

Return on equity is a financial statistic that divides net income by a company’s book value. Ugh!

Sometimes it is easier to understand something by comparing size relative to similar things. For example, if I take a basket of all the Illinois Standard and Poor Companies (i.e. Boeing, Baxters, Abbott, Walgreens, Illinois Tool Works, Motorola, Tellabs, etc.), ComEd’s regulated-rate return on equity is one-sixth to one-half as much as the average. Its profit margin is also one-third to one-half what the average of these Illinois S&P companies is … so lower.

Then I looked at 315 return-on-equity utility rate-making decisions over the past 10 years in the United States and found that the mean average was 10.55 percent, the statistical median (just as many decision are lower than higher) was 10.5 percent, and only 40 were less than 10 percent. Looking at 59 utility rate-making decisions in Illinois only, the average was 10.35 percent, the statistical median was 10.26 percent, and 75 percent of the cases in 2010 allowed returns on equity of more than 10 percent.

One more consideration that makes this even more complicated is that the 30-year government bond interest rate could change. With the depressed condition of economic activity and low employment, the rate could stay the same or go down. But at the rate that the U.S. federal government is printing money and depreciating our currency, rates could go up. Also, predicting which way interest rates will go over the eight to 10 years that this legislation is in effect, we need to analyze the impact of European, Asian, and other markets’ currency and interest rate trends. No wonder they call predicting interest rates a “fool’s errand”.

If your eyes haven’t glazed over or if you haven’t flipped past this article to the sports or comics, would you do me a favor and call/e-mail me at (630) 264-2334 or chrislauzen@lauzen.com in order to share your thoughts before I am required to vote on your behalf?