Burned By The Sun: Why Investors Fled SunEdison

There is something rotten in the electric power business. Investors are calibrating risk very differently for regulated utilities and non-regulated power companies. Of course, it makes sense that investors would calibrate risk differently for regulated and non-regulated utilities, but the calibration seems to have become wildly distorted, to the detriment of non-regulated power companies like SunEdison.

Regulated utilities seem to be immune to even the most toxic corporate risks. Investors just don’t seem to care what regulated utilities do.

Take Pacific Gas & Electric ( PG&E ). Last year, the utility was indicted on federal criminal charges related to the 2010 gas pipeline explosion that leveled a San Bruno neighborhood and killed eight people, including allegations that it did not conduct required inspections that could have prevented the disaster. The company’s stock price doesn’t blink.

Not convinced?

Consider Consolidated Edison of New York. A few years ago, more than a dozen middle managers from Con Edison are sent to prison for taking kickbacks from contractors. To make matters worse, a forensic audit concludes that the New York utility likely lost as much as a quarter billion ratepayer dollars to contractor fraud over the better part of a decade. The fallout of this systemic fraud? As far as investors are concerned, there has been no fallout. Con Edison has raised its dividend payment every year for the past 40 years – fraud or no fraud.

And then there is the Southern Company catastrophe. Mississippi Power, a utility subsidiary of the Atlanta-based holding company, is constructing an Integrated Coal Gasification Combined Cycle (IGCC) project in Kemper County, MS.

Southern Company owns the intellectual property used at the Kemper plant and is actively marketing it in to companies abroad. While Southern Company has eagerly claimed the benefits of commercializing a complex and risky energy technology, it has simultaneously avoided accountability for the ongoing financial train-wreck taking place at the construction project. Indeed, SNL reported yesterday that Mississippi Power had reached a tentative agreement with utility regulators that would make temporary rate increases imposed to pay for the Kemper facility permanent.

And what happened to Southern Company’s stock price? Nothing. Ditto the dividend. Earlier this year, Mark Burnett, an equity analyst at Morningstar, explained why in a research note on Southern Company:

Southern's total return proposition remains appealing for patient investors in a world of few decent income alternatives. This giant Southeast utility enjoys some of the best regulation in the United States and strong, consistent regulatory relationships in its key service territories of Alabama and Georgia . . . Southern has more upside to economic improvement than most peers and has traditionally traded at a premium to the sector. While that premium has shrunk with uncertainty around Kemper and Vogtle, investors shouldn't underestimate Southern's constructive regulatory structure, despite above-average recovery risk during this investment cycle. Favorable and supportive regulation is a key driver behind the company's huge construction program and above-average returns.

In other words, investors are nowhere near as worried about the problems at Southern Company as they would be if those problems had arisen at a company that was not shielded by state regulators. The story if the same for all regulated utilities. State utility regulation has created the mother of all moral hazards.

And captive ratepayers are by no means the only casualties. In many cases, utility regulation is facilitating what amounts to a massive transfer of wealth from utility ratepayers to utility shareholders despite the lack of meaningful investment risk.

While speaking at a press luncheon in 2013, Commissioner Brandon Presley who represents North Mississippi on the Mississippi Public Service Commission described the Kemper project as “the greatest transfer of wealth from customers to a monopoly in the history of the state of Mississippi.”

Presley was the sole voice of opposition on the three-member Commission when the utility had asked to construct the coal plant on the ratepayers dime.

Regulated utilities are practically risk free income investments compared to other non-regulated power companies. This is not because they are necessarily well run companies (some of them are and some are not) but because they are shielded from conventional market forces by the government. The result is that regulated utilities are distorting investor expectations and – in the process – foreclosing technical and business innovation in the utility industry. So long as regulated utilities exist, non-regulated power companies like SunEdison and NRG Energy will seem riskier than they are.

SunEdison’s stock price has dropped 73% during the last three months and 34% in the last five trading days. Similarly, NRG Energy’s stock price has imploded over the past three months.

There are several explanations for how SunEdison’s problems began, but none of them are especially convincing. What is clear is that the perception of a liquidity risk at SunEdison seems to have become the reality. As for NRG Energy, utility investors voted with their feet when NRG tried to reinvest earnings in a long-term growth strategy that did not include a regulatory guaranteed return.