🔒Investors raise red flags over CT’s regulatory environment, as utilities overseer Gillett touts benefits of new ratemaking scheme

Very adversarial. Contemptuous. Hostile.

Those are some of the concerns laid bare by investors about the regulatory environment in Connecticut, in light of the Public Utilities Regulatory Authority’s (PURA) recent cut to Aquarion Water Co.’s rates, and the upcoming launch of performance-based ratemaking (PBR), a controversial new approach the state will use to evaluate rate increases proposed by electric utilities Eversource and United Illuminating.

PURA Chair Marissa Gillett would have it no other way. The state’s chief regulator, who will finish her first term next March, embraces investors’ characterization of her as a heavy-handed regulator.

“The governor … brought me in to be a disruptor,” Gillett said during a recent interview with the Hartford Business Journal. “... If there is discomfort with the fact that I’ve kind of thrown the doors wide open here and invited in different perspectives, I would embrace that critique because that was intentional.”

Gillett, who studied bioengineering and is an attorney, makes no bones about her penchant for change. Previously, PURA employed cost-of-service regulation, which looked at utilities’ perspective on costs and set rates accordingly.

Gillett developed a new framework for evaluating utility rates that factors in outcomes and value to customers.

Performance-based ratemaking will enable PURA to take into consideration utilities’ performance, including affordability and reliability, before they can obtain an increase on delivery rates they charge consumers for operating, maintaining and upgrading electric transmission and distribution systems, and complying with state and federal mandates that fund financial assistance, energy efficiency and renewable energy programs.

Rather than evaluating utilities’ expenditures from the lens of whether their costs are “prudent and reasonable,” PURA will evaluate whether they achieve public policy outcomes under PBR, Gillett said.

Financial incentives and penalties to encourage utilities to achieve the objectives PURA lays out are baked into the process.

“If our goal is to have more reliable service, we can measure that by saying, ‘How many minutes of power are you out per year? And how frequently are you out of power?’” Gillett said. “And then we can say to the utilities, ‘We want you to reduce that by a certain number, or a certain percentage,’ and then we can incentivize them.”

If PURA is different now than it was prior to her appointment by Gov. Ned Lamont in 2019, that means Gillett has achieved her goal, she added.

“If folks were looking for a more passive regulator, someone who reacted only to what was put in front of them, clearly they’d be disappointed because that’s not me,” Gillett said.

Lower outlook

While PBR has put the state’s electric utilities Eversource and Avangrid-owned United Illuminating in the uneasy spot of wondering how their next rate cases will be handled, it’s a recent PURA decision that has also spooked investors.

In response to Eversource-owned Aquarion Water Co.’s first rate increase request in 10 years, PURA in March not only rejected the water company’s request, but decreased its annual revenue requirement by $2 million from the current level — about a 1% reduction.

Bridgeport-based Aquarion was purchased by Eversource in 2017 for $1.6 billion.

PURA approved an annual revenue requirement of $195.5 million for Aquarion, which serves 208,000 customers in 59 cities and towns, primarily in western Connecticut. That revenue requirement is expected to deliver a return on equity of 8.7%, significantly less than the utility enjoyed in prior years.

In August 2022, Aquarion originally applied for a roughly $37 million increase in distribution revenues and a 10.35% return on equity.

Aquarion appealed PURA’s decision in New Britain Superior Court, and a temporary stay was granted.

A hearing on Aquarion’s motion for a permanent stay was held before Superior Court Judge Matthew Joseph Budzik on May 15. On Thursday, Budzik issued a decision granting Aquarion's request for a stay, blocking PURA from enforcing its decision to cut rates.

The uncertainty over Aquarion’s revenue in coming years led credit-rating service Moody’s to lower the water company’s financial outlook to “negative” amid a regulatory environment it called “unpredictable.”

A spokesman for Aquarion, Peter Fazekas, said the change from a stable to negative outlook “poses significant risks for Connecticut customers as they will pay more for the necessary infrastructure for the reliable delivery of high-quality drinking water.”

That’s because the lower outlook could make it more expensive for the company to borrow money that helps fund infrastructure projects.

In its decision, PURA said Aquarion’s five-year capital program “provides no basis on which the Authority could conclude that the projected level of expenditures is reasonable or prudent.”

Two of the three PURA commissioners voted in favor of the revenue reduction. Vice Chair John W. Betkowski III dissented, saying he thought an 8.7% authorized return on equity provided a negative signal for utility investment in Connecticut.

Although Aquarion represents just 3% of Eversource’s business, investors fear that PURA’s rate cut foreshadows how performance-based ratemaking will be applied.

“This decision was worse than expected and falls below expectations of investors we have spoken to,” wrote Paul Zimbardo, a securities analyst with Bank of America, in a note to investors.

He continued: “Our investor conversations have revealed a growing unease with Eversource’s outlook with the challenges in Connecticut.”

PURA’s proposed decision on the Aquarion rate case was issued Feb. 16. Since then, Eversource’s stock price, a reflection of investor confidence, declined by about 7.6% to $72.75 as of the end of trading on May 23.

Since the beginning of the year, Eversource’s stock price was down more than 13.6% as of May 23.

Meanwhile, United Illuminating has a rate case currently pending before PURA. It is seeking an 8% increase in rates over the next three years.

During its parent company Avangrid’s first-quarter shareholder conference call in April, investment analysts asked whether performance-based ratemaking would impact the rate case.

Angie Storozynski, senior equity research analyst at Seaport Global, said she had heard comments from the PURA chair that “sounded really scary and highly punitive for utilities.”

Attracting capital

Connecticut’s performance-based ratemaking system is the result of the Take Back Our Grid Act, which Lamont signed into law in 2020, following Tropical Storm Isaias, which left some residents without power for more than a week.

State Sen. Norm Needleman (D-Essex), co-chair of the Energy and Technology Committee and a key sponsor of the legislation, said he believes that PBR will hold utilities accountable for providing better service.

“There has generally been, unfortunately, a lack of confidence and such high cost in our state that I think the ratepayers deserve to have a utility that functions to the best of our sense of how they should function,” Needleman said.

The initial PBR rollout will apply to the state’s two electric utilities, but Gillett wants to expand it to all utility companies overseen by her agency, which also include natural gas, water and telecommunications businesses.

The tools for PBR to go into effect will be ready at the end of next year, but it will not be implemented until Eversource or United Illuminating file a rate case.

In October 2021, Eversource agreed to settle a lawsuit brought by the state for $103.4 million, for its handling of power restoration following Tropical Storm Isaias. Based on the agreement, Eversource’s rates would remain flat for four years.

Eversource is still operating under that agreement, but has told investors it plans to request a rate case in 2025.

Eversource’s last rate case, in 2018, ended with a settlement that set its return on equity at 9.25%.

While Eversource says it’s well-equipped to meet the performance metrics under PBR, company officials are anxious about the impact on the investment community in light of the “chilling effect” of the Aquarion decision.

Gillett said PURA is required, based on a Supreme Court precedent, to ensure that the health of utility companies and their ability to attract necessary capital remain intact.

“I don’t care, and I should not care, and I’m legally not required to care what their profit is, or what they actually earn,” Gillett said. “What I am required to do, legally, is in a rate case, set a rate of return that … looks at what my actions will do to their credit rating, their ability to attract capital. … So, at the end of the day, yes, do they need to make a profit? Of course, to the extent that it contributes to them being able to attract capital.”

‘Reasonable returns’

Eversource says healthy profit margins are needed to attract investors, because they signal that the company is a quality investment option. That investment helps fund capital projects and system upgrades by spreading out the cost over time.

Without enough outside investment from the capital markets, those costs would be passed onto customers.

“We need investors to install the projects, the infrastructure that our customers need,” said Doug Horton, Eversource’s vice president of distribution rates and regulatory requirements. “And if we can’t get that money from investors, it has to come from customers. If we can’t get it from customers or investors, that infrastructure can’t be built.”

Jeffrey Kotkin, Eversource’s vice president of investor relations, said the company invests about $4.4 billion a year in its three territories – Connecticut, Massachusetts and New Hampshire.

“I think there are some concerns by investors about being able to achieve reasonable returns on that investment (in Connecticut) going forward,” Kotkin said.

The unpredictable regulatory environment is especially problematic for risk-averse investors who expect modest but consistent returns from utilities.

“The constructive regulatory environment produces consistent outcomes for investors, which utility investors are looking for,” Horton said. “They’re consistent, they’re not looking for inconsistency or taking a gamble. Utilities are a going concern. We are here to provide our customer service over the long haul. And that’s how investors also look at us.”

Horton said Eversource is not opposed to PBR, but is worried about how it could be applied.

“We hold ourselves to high standards, we control our costs and our general strategy has been to try to enter into rate agreements that provide a level of stability and predictability…,” he said. “We’re not afraid of PBR. We’re not afraid of having to be measured by performance, as long as it’s constructed in a fair way, and we know what the goal posts are going to be that we need to hit, and that those goals are things that we’re going to be able to control.”

Hawaii’s influence

Nationally, PBR is gaining traction, with a handful of states — including Massachusetts — having already implemented pieces of it.

The Edison Electric Institute, an association that represents all U.S. investor-owned electric companies, said that performance-based ratemaking can be a useful tool that has provided transparency to customers, regulators and stakeholders.

“PBR and performance metrics are best for things that are completely within a company’s control — if PBR is reasonable and balanced, then there should be no investor concern, particularly for high-performing utilities,” said Shelby Linton-Keddie, executive director of state regulatory affairs at the Edison Electric Institute.

Investor concerns arise when there are “too many performance incentives and possible penalties attached that make something otherwise predictable and stable, risky and unknown,” Linton-Keddie said.

Gillett points to the success of performance-based ratemaking in Hawaii, the first state in the country to fully implement it. Connecticut will be the second state to do so.

When PURA developed the framework, it met with officials from Hawaii’s electric company and its regulatory oversight agency, and modeled its framework after theirs.

“My understanding is that the investment community there expressed similar concerns,” Gillett said. “But, towards the end of the process, and now that Hawaii is implementing it, my understanding is that the investment community has really done a 180, and they now understand PBR in Hawaii.”

Eversource officials said they have not seen a similar backlash from investors in Massachusetts, because the regulatory environment there is different.

According to investment bank UBS’ regulatory rankings, Connecticut is one of eight states that ranks in the lowest tier for utilities regulatory environment.

The rankings are based on criteria that include tendency to settle vs. litigate rate cases, regulatory lag, regulatory mechanisms and a subjective investor-friendliness factor.

“The investor community,” Eversource’s Horton said, “is looking at Connecticut and saying, ‘Is this really a good place for investors to be spending their capital?’ when they have choices, … and can decide to invest their capital in places that have a constructive regulatory environment.”

On the other hand, Needleman sees performance-based ratemaking as an enhancement to the regulatory climate in Connecticut.

“I wouldn’t say that the regulatory climate of the state is onerous, but it’s more stringent,” Needleman said. “And I think that the ratepayers in the state are appreciative of that.”