Monthly Archives: February 2020

Measuring Equity Risk Characteristics in Real-Time

Using Stock Options to Measure Rapid Change 

It is difficult to measure how investors’ expectations change during catastrophic events like the announcement of criminal investigations, bankruptcies and natural disasters.  In November 2018 Pacific Gas and Electric (PG&E)’s equity holders were exposed to the risks from all three of these issues.

The Camp Fire ignited on November 8, 2018 by a faulty PG&E transmission line. It was not contained until November 25th.  Over these 17 days it burned over 230 square miles in Norther California, killing 85 people and doing billions of dollars of damage.  PG&E’s  stock price was down over 30% by November 12th as equity investors realized that PG&E would likely be liable for the death and destruction.  By November 25th PG&E’s stock was down about 50%, equating to $15 billion in stock value.

We can see stock price changes in real time. PG&E’s declining stock price indicated that investors thought the company was worth less because of its potential wildfire liabilities.  Common measurements of the risk take longer to adjust, however.  In particular, the beta (how much a stock moves in relation to the overall market) of a stock can take weeks to adjust to changing levels of risk exposure because they are based on historical data.

As shown in the chart below,  the beta of PG&E’s stock took significant time to adjust.  The beta calculated based on returns over a 5-year period had barely changed over the course of the Camp Fire.  Betas calculated over shorter time periods (2-years and 6 months) started to show small increases during the early stages of Camp Fire.  The chart shown that it took over a week for the 6-month beta to reflect the changing risk characteristics of PG&E’s stock. Before the start of the Camp Fire PG&E’s 6-month beta was under 1.  It did not increase significantly until about November 20th.

On the other hand, the beta calculated based on stock option prices measure changes in risk characteristics immediately.  The yellow line shows that as soon as it was suspected that PG&E was responsible for the start of the Camp Fire, its option-implied beta reacted.  During the initial chaos PG&E’s option-implied beta plunged into negative territory for one trading day.  The next time the market opened PG&E’s option-implied beta jumped into a range mostly between 4 and 5 for the remainder of the wildfire fire and in the initial stages of the aftermath.  Before the Camp Fire PG&E’s option-implied beta was about 1.

 

Setting a utility company’s authorized Return on Equity (ROE) based on investors’ expectations is the best interests of investors and consumers.  An ROE below investors equity return expectations will make it difficult, or impossible, for it to raise the funds needed for it to provide safe and reliable service.  On the other hand, setting an ROE that is above investors’ equity return expectations overcharges consumers.  Using market data, including option-implied betas shown in the chart above, is one way Utility Commissions can determine an ROE that is based on investors’ current market return expectations and thus balance the interests of investors and consumers.

At Rothschild Financial Consulting we use established methodologies to calculate a cost of equity of equity that is a direct reflection of capital markets so utilities can rise the funds they need without overcharging consumers.

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RFC Rate of Return Testimony

South Carolina 2020 Water Utility Rate of Return Testimony

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List of Filed Testimonies – Past 15 Years

CALIFORNIA

Southern California Edison, Application 19-04-014, Rate of Return, August 2019

Pacific Gas and Electric Company, Application 19-04-015, Rate of Return, August 2019

San Diego Gas & Electric Company, Application 19-04-017, Rate of Return, August 2019

Southern California Gas Company, Application 19-04-016, Rate of Return, August 2019

Great Oaks Water Company, Application A.18-05-001, Rate of Return, August 2018

Liberty Utilities, Application A.18-05-006, Rate of Return, August 2018

San Gabriel Water Company, Application A.18-05-005, Rate of Return, August 2018

Suburban Water Company, Application A.18-05-004, Rate of Return, August 2018

California American Water Company, Application A.17-04-003, Rate of Return, August 2017

California Water Service Company, Application A.17-04-006, Rate of Return, August 2017

Golden State Water Company, Application A.17-04-002, Rate of Return, August 2017

San Jose Water Company, Application A.17-04-001, Rate of Return, August 2017

COLORADO

Public Service Company of Colorado; Docket No. 11AL-947E, Rate of Return, March

2012

CONNECTICUT

United Water Connecticut; Docket No. 07-05-44, Rate of Return, November 2008

Valley Water Systems; Docket No. 06-10-07, Rate of Return, May 2007

DELAWARE

Tidewater Utilities, Inc.; PSC Docket No. 11-397, Rate of Return, April 2012

Delmarva Power & Light, PSC Docket No. 09-414, Rate of Return, February 2010

Delmarva Power & Light, PSC Docket No. 09-276T, Rate of Return, February 2010

FLORIDA

Florida Power & Light (FPL); Docket No. 070001-EI, October 2007

Florida Power Corp; Docket No. 060001 Fuel Clause, September 2007

NEW JERSEY

Aqua New Jersey, Inc.; BPU Docket No. WR11120859, Rate of Return, April 2012

MARYLAND

Potomac Electric Power Company; Case No. 9311, Rate of Return, 2013

Delmarva Power & Light; Case No. 9317, Rate of Return, June 2013

Columbia Gas of Maryland; Case No. 9316, Rate of Return, May 2013

Delmarva Power & Light; Case No. 9285, Rate of Return, March 2012

Potomac Electric Power Company; Case No. 9286, Rate of Return, March 2012

NORTH DAKOTA

Otter Tail Power Company; Case No. PU-17-398, Rate of Return, May 2018

Montana-Dakota Utilities Co; Case No. PU-15-90, Rate of Return, August 2015

Northern States Power; Case No. PU-400-04-578, Rate of Return, March 2005

PENNSYLVANIA

Twin Lakes Utilities, Inc., Docket No. R-2019-3010958, Rate of Return, October 2019

City of Lancaster Sewer Fund, Docket No. R-2019-3010955, Rate of Return, October 2019

Newtown Artesian Water Company, Docket No. R-20019-3006904, Rate of Return, May 2019

Community Utilities of Pennsylvania Inc. Water Division, Docket No. R-2019-3008947, Rate of Return, July 2019

Community Utilities of Pennsylvania Inc. Wastewater Division, Docket No. R-2019-3008948, Rate of Return, July 2019

Hidden Valley Utility Services, L.P. – Water; Docket No. R-2018-3001306, Rate of Return, September 2018

Hidden Valley Utility Services, L.P. – Wastewater Division; Docket No. R-2018-3001307, Rate of Return, September 2018

The York Water Company; Docket No. R-2018-3000019, Rate of Return, August 2018

SUEZ PA Pennsylvania, Inc.; Docket No. R-2018-000834, Rate of Return, July 2018

UGI Utilities, Inc. – Electric Division; Docket No. R-2017-2640058, Rate of Return, April 2018

Citizens’ Electric Company of Lewisburg, Pa; Docket No. R-2016-2531550, Rate of Return, December 2016

Wellsboro Electric Company; Docket No. R-2016-2531551, Rate of Return, December 2016

Columbia Gas of Pennsylvania, Inc.; Docket No. R-2016-2529660, Rate of Return, June 2016

Columbia Gas of Pennsylvania, Inc.; Docket No. R-2015-2468056, Rate of Return, June 2015

Pike County Light & Power Company; Docket No. R-2013-2397237(electric), Rate of Return, April 2014

Pike County Light & Power Company; Docket No. R-2013-2397353 (gas), Rate of Return, April 2014

Columbia Water Company; Docket No. R-2013-2360798, Rate of Return, August 2013

Peoples TWP LLC; Docket No. R-2013-2355886, Rate of Return, July 2013

City of Dubois – Bureau of Water; Docket No. R-2013-2350509, Rate of Return, July 2013

City of Lancaster – Sewer Fund, Docket No. R-2012-2310366, Rate of Return, December 2012

Citizens’ Electric Company of Lewisburg, Pa; Docket No. R-2010-2172662, Rate of Return, September 2010

Wellsboro Electric Company; Docket No. R-2010-2172665, Rate of Return, September 2010

York Water Company; Docket No. R-2010-2157140, Rate of Return, August 2010

T.W. Phillips Gas and Oil Company; Docket No. R-2010-2167797, Rate of Return, August 2010

Joint Application of The Peoples Natural Gas Company, Dominion Resources, Inc. and Peoples Hope Gas Company LLC, Docket No. A-2008-2063737, Financial Analysis, December 2008

York Water Company; Docket No. R-2008-2023067, Rate of Return, August 2008

VERMONT

Central Vermont Public Service Corp., Docket No. 7321, Rate of Return, September 2007

 

 

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