The Inflation Reduction Act and certain state policy changes are expected to culminate in a better business environment for U.S. investor-owned utilities, but investors are wary of recent commodity price surges. In fact, executives from the nation's top utilities frequently addressed potential impacts from state and federal legislation during their fourth-quarter 2022 earnings calls.

"For the extended [fourth-quarter 2022] earnings season, it appears the focus was on regulatory or legislative overhang ... and non-core earnings," Mizuho Securities USA analyst Anthony Crowdell wrote in a report recapping key takeaways.

American Electric Power Co. Inc., Duke Energy Corp. and Eversource Energy are among the latest utilities in the sector marketing or in agreement to divest nonregulated businesses.

"Over the last several years, we have seen the shift to fully regulated stories making comparing 'apples to apples' easier, and we believe any regulatory/legislative proceeding will weigh more on stock valuation," Crowdell wrote in the March 1 research report.

Dominion Energy Inc. executives held off on providing a substantial update on the company's business review as Virginia lawmakers hammered out changes in the state's regulatory landscape. The Virginia General Assembly later agreed on legislation that revamps the earnings review process for the state's two largest utilities.

"In our view, the deal is welcome execution on a key stage of the strategic reset, and while several of the more favorable components that underpinned our prior estimates did not ultimately make it into the final document, certain aspects, such as a potential 50 [basis point] performance incentive, were positive surprises," Guggenheim Securities analyst Shahriar Pourreza wrote following the agreement, which now awaits action by Virginia's governor.

Meanwhile, NextEra Energy Inc.'s shares fell as the nation's top investor-owned utility disclosed a change at the head of subsidiary Florida Power & Light Co. and management updated investors on its review of allegations that the utility violated state and federal campaign law.

NextEra Chairman, President and CEO John Ketchum told analysts and investors that management does not believe that Florida Power & Light will be found liable for any violations of state law and that NextEra will seek dismissal of a civil Federal Election Commission complaint. "The total amount of contributions referenced in the complaint is less than $1.3 million, and we do not expect that allegations of federal campaign finance law violations taken as a whole would be material to us," Ketchum said.

Navigating rising prices

Wall Street expected management teams to hone their strategies to manage deferred fuel balances and rising customer bills.

"We continue to expect utilities to be able to recover most, if not all, of bad debt expense and the settlement in [New York] earlier this year is a nice blueprint that we see being mirrored by other states," CreditSights analyst Andrew DeVries wrote in a March 8 report.

The New York Public Service Commission approved a $672 million rate-relief plan in January, allowing utilities to cover past-due costs for tens of thousands of customers.

Guggenheim's Pourreza noted that the commodity backdrop in 2023 is moderating, but price volatility "remains an overhang on customer bills and a challenge for regulators in many of the jurisdictions we cover."

"While 2022 commodity inflation created a lot of bill shock and some regulatory concerns as regulators grappled with extraordinary costs and clause-based recovery smoothing, early 2023 commodities present a reprieve from further escalation and pancaking of customer bills," Pourreza wrote in a March 6 report. "[A]s most utilities work to recover and close out deferred fuel and power balances, there is a relative level of headroom for 2024 regulatory proceedings, especially when taken in context of broader economic inflation [with energy prices falling and high consumer good prices lingering]."

The macroeconomic backdrop also continued to weigh on some utilities' earnings outlooks.

"The current macro backdrop of higher interest rates and inflation impacted most utilities, particularly the [small- and mid-cap] space, but the management teams that continue to navigate the challenges are rewarded with premium [price-to-earnings] valuations," Crowdell wrote.

Black Hills Corp., for instance, lowered 2023 earnings guidance based on a "rapid shift in macroeconomic factors." The company's stock slid following its earnings release and decision to end the sale process for a minority interest in its gas utilities following lower-than-desired bids.

"This is one of the most disappointing financial updates we can remember," Scotia Capital (USA) analyst Andrew Weisel wrote. "Yes, the macroeconomic backdrop is challenging, and rapidly changing. However, our industry thesis has been that many utilities will be able to overcome the headwinds around inflation, interest costs, and gas price volatility, and initial results from peers have supported this view."

A market for M&A?

While Black Hills decided to end its sale process, American Electric Power and FirstEnergy Corp. were able to reach agreements with third parties interested in their portfolios.

American Electric Power expects to net about $1.2 billion in cash from the sale of its 1,365-MW portfolio of unregulated renewables assets to IRG Acquisition Holdings LLC, a partnership owned by Invenergy LLC, Caisse de dépôt et placement du Québec and Blackstone Infrastructure Partners LP.

FirstEnergy on Feb. 2 announced a deal to sell an additional 30% ownership interest in its FirstEnergy Transmission LLC subsidiary to Brookfield Super-Core Infrastructure Partners LP for $3.5 billion in cash. The company said the transaction is "equivalent to issuing common equity at $93 per share."

NiSource Inc. continues to pursue bids to unload a 19.9% stake in utility subsidiary Northern Indiana Public Service Co., while both Duke Energy and Dominion took impairments on their contracted renewables businesses.

Duke Energy disclosed a $1.3 billion impairment on more than 5,000 MW of solar, wind and battery storage capacity up for sale, while Dominion reported a $1.5 billion impairment on about 1,000 MW of solar generation with long-term power purchase agreements.

Perhaps the biggest splash came in the merchant space with Vistra Corp. agreeing to pay $3 billion in cash and assume $430 million in debt to acquire Ohio retail and power provider Energy Harbor Corp. Energy Harbor's largest shareholders, Avenue Capital Group LLC and Nuveen Investments Inc., will receive a 15% ownership interest in a new subsidiary known as Vistra Vision in addition to cash awarded to shareholders at closing.

"We've got now clear visibility that we'll be able to provide our investors as to the earnings potential of a carbon-free business," James Burke, Vistra's president and CEO, said during a March 6 call with analysts and investors.

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.