Va. Takes Heed of Md.'s Electric Rate Backlash

By Jerry Knight
Monday, April 10, 2006

While Maryland politicians and Constellation Energy Group Inc. executives muck around in the mess they've made of electric rates, Wall Street is looking across the Potomac and worrying that something similar could happen in the Old Dominion.

Just as in Maryland, Virginia politicians and utility executives made a deregulation deal with the devil (in this case, the devils being themselves).

In return for getting the government out of the business of setting electric bills, power companies and pols in both states agreed to freeze rates for several years and then to set rates based on the wholesale cost of electricity or the cost of fuel for producing power.

The freeze is about to thaw in Maryland -- and that threatened an overnight rate hike of as much as 72 percent for residential customers of Constellation's Baltimore Gas and Electric Co. and a 38 percent increase for those served by Pepco.

Lawmakers, utility lobbyists and Maryland Gov. Robert L. Ehrlich Jr. (R) spent the weekend trying to find a way to hold down electric bills lest they fry every politician within range.

Free-floating rates won't come to Virginia until 2011, but fallout from Maryland is already drifting across the Potomac.

Credit Suisse analyst Dan Eggers warned last week of "political winds blowing south."

"The political backlash and utility commission bashing in Maryland has apparently caught the attention of the Virginia commission" that regulates utilities, he wrote.

The Virginia State Corporation Commission has told Dominion Virginia Power to get to work now figuring out how much rates will have to be increased to account for rising fuel costs. Under Virginia's electricity deregulation law, the power companies are entitled to a "fuel cost adjustment" in summer 2007.

On Friday, Virginia Gov. Timothy M. Kaine (D) heeded the warning from Maryland. He proposed changing his state's law to adjust customers' bills for fuel costs every year rather than just once in 2007 and not again until 2011.

Annual adjustments could minimize rate shocks like the one that snuck up on Maryland consumers, whose rates have been frozen since 1999. Between 1999 and 2005, Pepco officials point out, the price of coal climbed 150 percent, oil prices rose 300 percent and natural gas costs jumped 400 percent.

The gas price increase is particularly important because back when gas was cheap, utility companies calculated that the most efficient way to generate more power was to build small plants powered by natural gas. The economics of that equation don't work at today's gas prices.

Gas prices also are the villain in home heating costs, which would have gone through the roof last winter if we hadn't had an extraordinarily warm heating season.

Ironically, natural gas prices nationally have fallen significantly since the first of the year. That helps on the cost of fuel for power plants, but lower prices also reduce the revenue that utilities generate from selling gas.

The recent retreat in natural gas prices is a particular problem for Dominion Resources Inc. of Richmond. In addition to being the parent of Dominion Virginia Power, Dominion is a major player in the natural gas business. Because of its exposure to the natural gas gamble, Dominion's stock was downgraded to "hold" recently by Wachovia Corp., which slashed ratings on the entire gas industry.

Dominion has been the poorest-performing stock among the four local utility companies, lagging behind the shares of Constellation Energy Group of Baltimore, which owns BG&E, and the two District-based utilities, WGL Holdings Inc. and Pepco Holdings Inc.

Utilities are usually one of the most reliable buys a Washington investor can make, but now only Pepco is paying off, with its stock up not quite 1 percent this year.

Shares of WGL are down 1.5 percent since the beginning of the year, Constellation is down 5.8 percent and Dominion is down 8.1 percent.

Utility stocks generally pay healthy dividends. That's what has attracted many investors looking for reliable, if unspectacular, returns over the years. But even counting dividends, Dominion shareholders have lost money over the past 12 months.

Dominion's dividend per share is 69 cents per quarter, but the share price has gone down so much that even after collecting dividends, the total return over the past 12 months is negative 3.8 percent.

Constellation Energy investors collect a dividend of 37.75 cents a quarter, which partially offset the slipping stock, producing a 3.6 percent total return for the year. Washington Gas pays a 33.75-cent dividend a quarter, which gave investors a positive total return, but only 0.7 percent.

Pepco remains the powerhouse, giving investors a total return over the past 12 months of 12.5 percent, including a 26-cent a share quarterly dividend.

Yet investment analysts are not enthusiastic about any of the local utility companies.

Utility stocks in general are being hurt by rising interest rates. Utilities were the worst losers Friday when stocks fell in response to fear of higher interest rates.

Utility dividends draw lots of investors when rates are low, but with 12-month certificates of deposits paying about 5 percent and riskier investments offering more, utility stocks look less attractive. At the same time, higher rates increase borrowing costs for utilities, which need to raise large amounts of capital to finance their costly investment in facilities.

Pepco and WGL get twice as many "hold" as "buy" recommendations from Wall Street, according to ratings compiled by Bloomberg News. The "holds" and "buys" on Dominion and Constellation are about equally divided, with a slight edge for the "buy" ratings.

Neither what the analysts say nor what the stocks do matter much to most individual investors, because they tend to buy the stocks and hold on to them. In fact, some investment strategists argue that the best time to buy utilities is when rising interest rates are driving down the prices of the stocks.

But the Maryland mess painfully illustrates that, along with all the usual factors that go into investment decision-making, utility stocks also involve political risk.

Constellation Energy has a high-powered, innovative and aggressive management, which has engineered a pending $11 billion deal to merge with Florida's FPL Group Inc. Still, the company's prospects lie partly in the hands of the politicians.

Maryland lawmakers passed the legislation that threw the company and its customers into this mess. They are ultimately responsible.

In retrospect, it's clear the politicians had no idea what they were doing when they swapped the right to regulate electric rates for a guarantee that rates would not be raised for several years.

Clouding the debate over whether deregulation was a good idea is the political clout of the utility companies, which are among the biggest, oldest and most influential corporations in Maryland and Virginia.

Competition was supposed to hold rates down, but competition simply hasn't developed the way deregulation advocates hoped. In fact, it's doubtful that even an intensely competitive market could have prevented the sticker shock now facing local utility customers. Nobody had a clue six years ago that oil, gas and coal prices would climb as high as they are today.

Maryland politicians were so embarrassed at how bad a deal they made on deregulation that they seemed willing to renege on their promise to let the power companies pass fuel costs to consumers.

That's bad government, but politics as usual.

Virginians had better be ready.

They're next.

Jerry Knight's e-mail isknightj@washpost.com.