Research — 20 Jun, 2024
Connecticut Water vocalizes concerns with recent proposed decision
By Heike Doerr
On June 10, SJW Group subsidiary Connecticut Water Co. filed written exceptions with the Connecticut Public Utilities Regulatory Authority contesting a proposed decision filed in late May. The Office of Consumer Counsel filed a letter in lieu of written exceptions, expressing its "strong support" for the draft decision.
The company referenced investors' declining opinion of the Connecticut regulatory climate and the impact the Connecticut Public Utilities Regulatory Authority's (PURA's) rate decisions for other utilities operating in the state has had on its own credit rating and investor sentiment. "The company is under pressure from debt rating agencies as well as equity investors to demonstrate that past decisions are not indicative of the ability to achieve returns consistent with other utilities in other states."
➤ Connecticut Water Co. (CWC's) modifications to the proposed decision would increase revenue by an additional $5.4 million and address cost of capital parameters, regulatory treatment of depreciation and a more accurate reflection of operating expenses. The proposed decision called for only a $2.7 million rate increase (plus an opportunity for an additional $1.1 million increase based on certain performance metrics). The company initially sought a $21.4 million rate hike.
➤ If adopted, the proposed decision would increase CWC's return on equity (ROE) by 20 basis points. While the 9.20% ROE would be an improvement over the current authorized return and is above the punitive 8.70% authorized Aquarion Water Co. of Connecticut Inc. (AWC-CT), Connecticut regulators appear poised to continue to issue authorized ROEs below the prevailing industry average. In its brief, CWC stated that "at a minimum," the ROE should be increased to 9.30%.
➤ The company's brief highlights the negative impact of PURA's March 2023 decision for AWC-CT on investor sentiment for other utilities operating in the state. CWC's California affiliate, San Jose Water Co., is authorized an ROE of 10.01%.
➤ Regulatory Research Associates views the Connecticut regulatory environment as restrictive from an investor perspective. In 2023, RRA lowered its ranking of the state's regulatory environment for both energy and water utilities in light of restrictive PURA decisions and recently enacted legislation that alters certain aspects of the regulatory construct for the state's utilities. All three members of the PURA are serving beyond the expiration of their terms, and the governor can expand the PURA to five members, further heightening regulatory risk.
CWC serves more than 107,000 customers in 60 Connecticut towns and provides wastewater services to 3,000 customers in Southbury, Conn.
RRA evaluates water utility regulation in 20 state jurisdictions and monitors rate proceedings involving rate change requests of at least $1.0 million for the 12 largest investor-owned and privately held water utilities.
CWC's concerns with proposed decision
On May 29, the PURA filed a proposed decision that would increase CWC's revenue by $2.7 million, with an additional increase of $1.1 million associated with executive compensation, if certain performance targets are met. The increase is based on a 9.20% return on equity (52.00% of capital) and a 6.6325% return on a $692.5 million rate base for a 2022 test year with certain plant additions beyond the test period.
Net operating income
The PURA's treatment of operating and depreciation expenses account for the largest portion of the difference between the company's request and the increase specified in the proposed decision, totaling over $11 million, as calculated by RRA.
In the proposed decision, the PURA reduced CWC's operation and maintenance (O&M) expense by $5.7 million, which the company said "ignores the true cost of serving customers."
– Chemical costs. Of note, the company took issue with the PURA's disallowance of chemical expenses, stating that "both chemical volumes and pricing are known and measurable, and should not be ignored simply because the result reflects a significant increase over the test year." The company utilized an annual competitive bid process and said the expenses filed were "well supported in testimony."
– Depreciation. CWC noted that the proposed decision reflected the effect of depreciation for the period during which plant additions were disallowed. The company stated that its five-year capital expenditure plan, which the PURA supported, indicated that the company would complete plant additions that will "far exceed" the depreciation that will be recorded for that same period, and there is "no scenario" under which CWC's rate base would decline.
Cost of capital parameters
In stressing the importance of fair authorized returns, the company said: "Debt and equity capital providers will not, and cannot be expected to, continuously invest money where they will not receive adequate credit quality protection or equity capital returns."
In supporting a 9.20% ROE, the PURA characterized its regulatory environment as one that "reduces risk," pointing to the company's use of revenue adjustment mechanisms and infrastructure surcharges.
RRA calculates that approximately $7.6 million of the difference between the company's request and the increase specified in the proposed decision is related to the difference in ROE. A 10-basis-point increase in the ROE would increase revenue by about $500,000.
Rate base
RRA estimates that approximately $1.6 million of the revenue requirement difference is related to rate base. CWC proposed a total rate base of about $718 million, of which $654.0 million was for the 2022 test year, an additional $50.7 million was for pro forma adjustments through Sept. 30, 2023, an additional $8.0 million was for adjustments through Dec. 31, 2023, and an incremental $5.8 million pertained to adjustments through Dec. 31, 2024.
In the proposed decision, the PURA said the company had failed to provide evidence that $25.9 million of the proposed rate base was used and useful and prudently incurred. The PURA removed $32.5 million in utility plant in service from its rate base calculation.
The company would be permitted to recover carbon filter expenses, tank painting and well maintenance, and O&M expenses.
While the PURA had taken issue with AWC-CT's capital spending forecast, the PURA accepted CWC's five-year capital spending plan of $590 million without contention.
Comparing Conn. ROEs to national averages
In its written exception, CWC said the recent downgrade of its parent-level debt by S&P Global Ratings "is a warning sign that the company is not performing sufficiently to maintain its current rating."
The ROEs approved in utility rate decisions in Connecticut have historically been below the national average when established. The 8.70% ROE authorized for AWC-CT is the lowest nonpunitive return authorized for a water utility since 2010, as tracked by RRA.
The average water utility ROE approved in the first quarter of 2024 largely aligns with the 9.64% average ROE approved for water utilities nationwide in cases decided during 2023. The 2023 base rate proceedings spanned nine states, with cost-of-capital parameters provided in seven proceedings, ranging from 8.70% in Connecticut to 9.80% in North Carolina. In 2022, 10 water utility rate cases were completed nationwide, with an average ROE of 9.61%.
Rate case history
On Oct. 4, 2023, CWC filed for a $21.4 million (18.1%) rate increase based on a 10.50% return on equity (53.13% of capital) and a 7.368% return on a year-end rate base of $708.0 million for a test year ended Dec. 31, 2021, with adjustments through the midpoint of the rate year ending Dec. 31, 2024. During the proceeding, the company revised its supported rate increase to $21.8 million (18.4%).
The company attributed inflation associated with rising operating expenses as the largest driver of the rate proceeding. The largest operating expense increases stemmed from employee expenses, purchased power, purchased water and increased chemical costs.
In testimony filed Dec. 14, 2023, the Office of Consumer Counsel (OCC) initially supported a $5.3 million rate increase based on a 9.125% return on equity (51.97% of capital) and a 6.62% return on a $675 million rate base. In keeping with recent water utility proceedings, the OCC recommended the removal of projects "that are not 100% complete as of the last day of the hearing in this case." During the proceeding, the OCC revised its recommended increase to $2.8 million and backed an ROE of up to 9.00%.
The PURA's Office of Education, Outreach and Enforcement (EOE) filed testimony supporting an 8.09% ROE, a 5.98% rate of return, and an equity ratio of 50.053% but did not assess the revenue request or rate base.
Evidentiary hearings were held the last week of January.
Previous rate proceeding
In 2021, CWC requested a $20.2 million, or 19.9%, rate increase, which included rolling $6.0 million of its water infrastructure and conservation adjustment into base rates. The rate request was premised upon a 10.40% return on equity (52.68% of capital) and a 7.11% return on a rate base of $566.6 million.
In a decision issued later in 2021, the PURA authorized a $5.2 million, or 5.06%, rate increase based on a 9.00% return on equity (52.73% of capital) and a 6.465% return on a $540.8 million rate base.
Restrictive decision for Aquarion Water earlier in 2023
In a March 15, 2023, decision, the PURA ordered AWC-CT to reduce rates by $2.0 million based on an 8.70% return on equity (50.35% of capital) and a 6.46% return on a rate base valued at $991.7 million.
The PURA expressed concern that the company's "level of investment substantially exceeds the amount projected" in the company's 2013 rate case. In highlighting the accelerated investment spending, the PURA said "despite the Authority's determination that the company 'should be scaling back,' the company exceeded even its own [capital expenditure] projections, spending $312 million ($57 million per year) from 2013–2017. Since then, capital additions have ballooned to $116 million per year on average."
The PURA noted that the company provided "no basis on which the Authority could conclude that the projected level of expenditures is reasonable or prudent. The Authority's prior admonitions about the company's accelerating capital expenditures have gone largely unheeded. ... The burden will be on the company to demonstrate that its aggregate capital expenditures are prudent, reasonable and protect the relevant public interests, both existing and foreseeable. There is certainly no evidence in this proceeding to support such a conclusion at this time."
The order was approved 2-1. In Vice Chairman John Betkoski III's dissent, he stated: "[A]t a time when Connecticut is very successfully encouraging business growth and job creation in our state, this decision represents a punitive and anti-business practice message from the state government." Betkoski further said disallowing these investments "will tell investors to spend their money elsewhere. Not in Connecticut."
On March 25, the Connecticut Superior Court largely upheld the PURA's decision, disagreeing with the company's claim that a rate reduction would "unconstitutionally diminish Aquarion's financial integrity or deprive it of its ability to attract capital." The decision stated that the agency has "broad regulatory authority and equally broad discretion in setting rates."
AWC-CT, the largest water subsidiary of Eversource Energy, serves approximately 207,000 customers across Connecticut and represents over 90% of Eversource's water revenues and customers.
RRA takes critical view of Conn. regulatory environment for water utilities
RRA lowered its ranking of the Connecticut regulatory climate for water utilities to Average/3 from Average/1 in response to the March 2023 PURA order for AWC-CT and new statutes that alter certain aspects of the regulatory construct for the state's utilities. The 8.70% ROE authorized for AWC-CT is the lowest nonpunitive return authorized for a water utility since 2010, as tracked by RRA.
Historical test years are utilized in Connecticut, and water utilities have been unable to incorporate investments put into service beyond the end of the test year, as seen in the most recent base rate case decisions for AWC-CT and CWC, making it difficult for the utilities to earn their authorized returns. The use of a revenue adjustment mechanism and infrastructure surcharges has somewhat offset regulatory lag.
Water utility mergers between in-state companies have historically been permitted with minimal conditions. The PURA approved Eversource Energy's acquisition of AWC-CT in 2017 without imposing onerous conditions, as well as multiple recent smaller transactions. However, the PURA disallowed recovery of transaction costs, finding that the acquisition benefited Eversource Energy shareholders rather than ratepayers and that the companies had failed to provide evidence demonstrating savings due to the merger. In contrast, SJW Group's acquisition of Connecticut Water Service met with heightened concerns and multiple conditions, but the PURA found that the company had taken a "thoughtful and thorough" approach to merger savings.
Senate Bill 7, enacted in June 2023, is a wide-ranging piece of legislation impacting the regulatory landscape for utilities. Utilities are now precluded from recovering certain costs in rates, expanding the PURA's discretion related to decoupling mechanisms and increasing oversight of large water companies to include four-year rate reviews and mandatory audits.
Connecticut does not have a legislative mechanism to facilitate the acquisition of municipal systems using a market-based valuation. Such legislation stalled multiple times, lacking support from the PURA. The previous regulatory incentive, in the form of an ROE premium for larger, better-capitalized water companies that resolve statewide water issues by acquiring troubled systems, was rejected in CWC's and AWC-CT's most recent rate decisions. Water utilities are less incentivized to consolidate smaller water utilities in a regulatory climate that discourages accelerating investments and offers a lower return on those investments than other jurisdictions.
Vice Chairman John Betkoski III (D) and Michael Caron (R) have served beyond terms that ended some time ago. In addition, Chair Marissa Paslick Gillett, whose term expired March 31, continues to serve.
In Connecticut, any commissioner appointed after 2013 must have a background in at least one of the following fields: economics, engineering, law, accounting, finance, utility regulation, public or government administration, consumer advocacy, business management or environmental management. At least one of the utility commissioners must have experience in consumer advocacy issues. No more than three of the five commissioners may be from the same political party. Since legislation was enacted in 2019, expanding the PURA from three to five members, Gov. Ned Lamont has not announced any new appointments. As such, there are two vacancies on the PURA.
Regulatory Research Associates is a group within S&P Global Commodity Insights.S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.For a complete, searchable listing of RRA's in-depth research and analysis, please go to the S&P Global Market Intelligence Energy Research Library.This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.