PaPUC shows brotherly love for private water companies

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Pennsylvania has been lauded by water sector analysts for having the most constructive regulatory environment in the U.S. As the Pennsylvania PUC explains, the state’s vibrant climate is no accident.

While some states’ public utility commissions have spent the past several months refereeing for investor-owned water utilities and their increasingly vocal political opponents, the Pennsylvania PUC (PaPUC) has been reaping the benefits of forwardlooking programs and a shrewd regulatory template designed to boost capital investment. The PaPUC isn’t being shy about attracting capital to its state, but the agency has also maintained a Zen-like balance between utilities’ growth and customer demands. For PaPUC Chairman Robert Powelson, it’s all a part of achieving what he calls “regulatory nirvana.”

In a report published in June, Baird Equity Research called Pennsylvania the “premier regulatory climate for water” and cited its high allowed return on equity (ROE), single tariff pricing option and early adoption of a distribution system improvement charge (DSIC) as things that have placed Pennsylvania head and shoulders above other states in terms of regulatory favorability. Analysts at Janney Montgomery Scott agreed last year, ranking Pennsylvania No. 1 in their 2011 Regulatory Climate Index.

“They’ve actually gone on the road with us to go talk to investors to explain what they’re trying to do and what they’re trying to accomplish,” said RW Baird analyst David Parker. “Really being transparent is extremely helpful for investors, but I also think extremely helpful for ratepayers and customers as well. They listen, they’re very good communicators and they really have set the bar very high for other state regulatory agencies.”

The PaPUC has purposefully adopted measures to incentivize capital expenditure and boost the financial health of investorowned utilities, Parker said. These measures have been especially welcome given how many of the sector’s largest players run systems in Pennsylvania. Operations in the state accounted for 55.8 percent of Aqua America’s revenues in 2011 and 19.3 percent of American Water’s. Artesian Resources, Middlesex Water and York Water are also active in Pennsylvania, making it one of the densest markets for large-scale investor-owned water utilities outside of California and New Jersey. Powelson, who was appointed PaPUC chairman in June 2008, said his state’s reputation is the result of acknowledging the role private utilities can play in developing a state’s infrastructure, and then encouraging them to do so.

“There’s an old saying: lead, follow or get out of the way. I think Pennsylvania is a leader when it comes to our regulatory climate,” Powelson told AWI. “Look at the health of our utilities both in terms of their credit ratings [and] return on equity. Look at replacement of aged infrastructure. Governors talk about it. Mayors talk about it at a national level. Well, we’re doing it here in Pennsylvania.”

Pennsylvania boasts some of the highest allowed ROEs in the U.S., and Powelson said they have been set to attract capital to Pennsylvania. Though the state’s recent ROE allowances for Aqua, American and York Water were not announced publicly, estimates from RW Baird placed all of them above 10 percent – among the highest in the nation. Steve Klick, executive policy manager for Chairman Powelson, said utilities’ actual, earned ROE often comes close to the allowed amount.

Pennsylvania was the first state to adopt a DSIC in 1997, which allowed utilities to collect a monthly fee from ratepayers to be used for pipe replacement and system improvements. A number of other states including New York, Connecticut and Delaware have followed suit, and New Jersey recently approved a pilot program to get its own DSIC mechanism off the ground. The DSIC has sparked a wave of capital expenditure by Aqua America and American Water since its implementation (see chart above), and the PaPUC has guided other states as they’ve moved to establish similar mechanisms. The DSIC has been widely accepted by ratepayers, Powelson said.

“Since the passage of the DSIC in the mid-90s, there has not been one consumer complaint filing in a DSIC case. That tells me the customers are happy with the surcharge they’re seeing on their bills used to replace the pipe,” Powelson said. “The utilities are happy because they’re getting this aged infrastructure that needs to be replaced and it’s being done in a timely fashion.”

The PaPUC’s policies have also enabled the state’s larger water firms to acquire and refurbish tiny, distressed water systems. These small systems, which are often located in rural areas, require a great deal of capital investment and rehabilitation. Pennsylvania’s single-tariff option allows companies to spread the cost of system improvements over a broader base of ratepayers. The mechanism lets a company raise rates by a tiny amount for all its customers in the state to pay for upgrades to a small system.

The state also recently moved to a future test year so utilities can better plan for usage changes and minimize rate shocks, Powelson said. In addition, Pennsylvania has a relatively quick average for turning around rate cases. By law, rate cases must be settled in nine months or less. Many are settled sooner.

Though much of Pennsylvania’s regulatory climate has been engineered to encourage utilties to grow, Powelson said some credit is also due to the investor-owned utilities themselves. Having so many companies nearby has meant more equity and more chances for distressed systems to be consolidated into larger, more financially stable companies.

“I think it was a situation where we were fortunate enough to have the major players here, and I think thanks to regulations and regulatory certainty, they’ve become bigger, they’ve become healthier and our customers have been better served,” Klick said.

The PaPUC’s successes, however, are not to suggest that the state’s utilities function perfectly. The DSIC has encouraged water companies to replace pipes, Powelson said, but water utilities often fail to coordinate with gas and power companies. With so much work going on, public works projects can be staggered in such a way that a water project will end as a gas project begins. Coordinating those projects could mean more efficient work and less construction-related stress on cities.

The PaPUC’s secret to success seems to be a willingness to embrace private sector participation, and neither Powelson nor Klick regret being lauded by Wall Street or ranked so highly by industry analysts. While some state agencies might shy away from such a distinction, the PaPUC sees it as a good chance to encourage investment and better serve customers, Klick said. Powelson said that interfacing with Wall Street and Main Street can support small business development and reinject muchneeded capital into the state.

“We like being at the top. A number of other commissions, I feel pretty certain, don’t want to be at the top because that tends to be viewed as siding with the companies’ side of things too much. We differ with that view,” Klick said. “We think being thought of positively on Wall Street obviously supports utilities’ credit ratings. They’re still borrowing close to or at 50 percent of their capital needs. A better credit rating helps reduce those interest costs, which are directly passed on to customers.”