An Electric Utility Perspective

1. An Electric Utility Perspective Eric Ackerman Director, Alternative Regulation MD/DC Utilities Association 89th Annual Fall Conference September 12, 2013 1

2. Overview • Infrastructure investment needs are great • Financing needs are large • Benefits justify investments • Financing new investment under today’s market conditions requires alternative regulatory approaches • Because of declining sales growth, utilities cannot finance improvements in the old way • To maintain credit worthiness, new regulatory approaches needed

3. Industry Capital Expenditures p = projected Source: EEI Finance Department, company reports, SNL Financial (August 2012)

4. Projected Functional CapEx 2010P 2012P as of August 2010 as of August 2012 $94.4 B 14% $82.8 B Generation Distribution Transmission Gas-Related Environment Other Source: EEI Finance Department, company reports (August 2012)

5. Benefits Are Substantial • Economic stimulus - jobs • Increased reliability & power quality • Reinforce the grid • Replace aging infrastructure • Harden the system • Connect new customers • Deploy new “smart” components • Meet renewable resource mandates • Ability to integrate renewables • Increased energy efficiency

6. Overview of the Problem Financing Infrastructure In Today’s Environment Energy Growth Per Customer Capital Investment Regulatory Lag Realized Return Cost of Capital Credit Worthiness

8. Can Utilities Earn Their Allowed ROEs? Due to improved regulatory mechanics, regulatory lag has outperformed expectations. Lag has averaged 100-150bp vs a 200-300bp forecast. Lag is virtually non-existent where fully forecast test years and/or tracking mechanisms are employed. 2011 US$ Million Source: SNL Financial, FactSet, Bureau of Economic Analysis, The Federal Reserve, Barclays Research Estimates

9. Alternative Regulation Toolkit • Limited scope remedies: • Capex cost trackers • Revenue decoupling • Comprehensive remedies: • Forward test years • Multi-year rate plans (price caps, revenue caps, negotiated) • Formula rate plans http://www.eei.org/whatwedo/PublicPolicyAdvocacy/StateRegulation/Pages/RegulatoryFrameworks.aspx

10. Conclusions • Infrastructure investment is a great way to fuel the economic engine in Maryland and the District of Columbia. • It’s important to manage investment in a way that preserves utility credit worthiness. • Alternative regulatory approaches are the key to preserving utility credit, access to capital on the most reasonable terms possible.

11. Appendix

12. Allowed vs Realized Returns • Allowed returns - what regulators focus on • Return levels (debt, equity) the PUC approves in a rate case • Objective is to determine the return on equity required by the market • A cost of business, goes in to revenue requirements • Realized returns – what investors focus on • ROE the utility actually earns • Affected by actual kWh sales and costs, regulatory lag • Usually diverges from allowed level

13. US Electric IOUs Rating History1970 – 2012 Source: EEI Finance Department, Standard & Poor’s, Macquarie Capital

14. Rating Agency Perspective • “Moody’s views automatic adjustment clauses …as supportive of utility credit quality…Generally, the more of these clauses a utility has in place… the lower the credit risk.” • “Forward test years are generally better predictors of future utility conditions than historical test years, and their usage is more likely to reduce regulatory lag.” • “The inclusion of CWIP in rate base provides great regulatory certainty.” • “Decoupling mechanisms to ‘de-link’ utility revenues and profits from volumes are essential to credit quality if energy efficiency and demand side management programs become more prevalent in the sector as anticipated.” Cost Recovery Provisions Key to Investor Owned Utility Ratings and Credit Quality, Moody’s June 18, 2010