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The Rising Significance of Electric Transmission
Among the three functions of the electric utility business—generation, transmission, and distribution—transmission gets the least attention from investors and even companies. The generation function draws a lot of interest because it has been deregulated in many states. Distribution remains regulated even in states with deregulated generation, so it attracts the interest of traditional utility investors. In recent years, however, electric companies have been focusing more attention (and money) on the transmission business.
Increased transmission investment stems from a few factors. Due to past years’ underinvestment, the equipment in some areas must be repaired or replaced. In fact, in order to encourage investment in the nation’s transmission system, the Federal Energy Regulatory Commission (FERC) grants allowed returns on equity that are typically higher than the ROEs that state commissions grant on distribution investment. The use of renewable energy—mandated in many states--also spurs transmission spending, since wind and solar generation is typically built in remote areas.
There is only one publicly traded, pure-play electric transmission company: ITC Holdings (ITC). Its stock doesn’t trade like other electric equities. Due to the company’s superior earnings growth potential, its yield is lower, and the price-earnings ratio higher, than those of the typical electric issue. Another transmission-only entity is American Transmission Company (ATC), which is jointly owned by numerous utilities (not all investor-owned) in the upper Midwest. Among publicly traded utilities, ALLETE (ALE), Alliant Energy (LNT), Integrys Energy (TEG), MGE Energy (MGEE), and Wisconsin Energy (WEC) have stakes in ATC, which is not publicly traded. The owners can invest additional equity in ATC as needed, which they are glad to do because they are earning healthy returns on their investment.
Other companies have increased their budget for transmission in recent years. Included in this group is American Electric Power (AEP), Northeast Utilities (NU), and OGE Energy (OGE). AEP, the largest owner of transmission in the United States, is forming joint ventures with other electric utilities. NU’s five-year capital budget includes $2.9 billion for transmission spending, which is a large amount for a company of NU’s size. This investment should be especially lucrative for the company because it earns a higher ROE on transmission than on distribution. OGE plans to spend $1 billion on transmission in the next four years. Other companies are getting into the game, as well. Ameren (AEE) hasn’t been a major transmission player to date, but plans to step up its spending in the next few years.
Some transmission projects within a state are regulated by that state (e.g., AEP’s projects within the Electric Reliability Council of Texas), but most major transmission projects are interstate and are FERC regulated. Accordingly, the federal government has much influence on transmission, through FERC regulation and congressional legislation.
Despite the need for transmission, utilities must overcome some obstacles. Siting is one; there is always opposition to building anything as extensive as a transmission line. Cost allocation is another; who should pay for these projects? The federal Energy Policy Act of 2005 helped address some siting questions, but more needs to be done, and additional legislation might well be helpful for transmission owners. In the absence of legislation, FERC has put forth a Notice of Proposed Rulemaking, and some power pools have implemented their own cost allocation rules after receiving FERC authorization.
As mentioned above, ITC Holdings is the only publicly traded option for investors desiring a pure play in electric transmission. Still, investors ought to pay attention to what is happening in this part of the utility business because electric transmission is, increasingly, a source of attractive investment opportunities for many companies.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.