How Utility Stocks Became Risky
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.
With senators McCain and Obama in a virtual dead heat in the presidential race, the direction of economic regulation over the next four years is a big question mark. What are investors to do? Can they still find low-risk investments in utility stocks, whose fate is not tied to usual ebbs and flows of the business cycle?
This was the case for most of the 20th century: Cautious investors sought safety in utility stocks such as telephone and electricity companies, including AT&T and Consolidated Edison. Utilities had guaranteed rates of return on investments, a protective relationship with state and federal governments, and stable — even countercyclical — revenues. Federal and state regulation protected utility investors while promoting utility services to consumers.
Times have changed. The share of the national economy devoted to telephone and electricity services has slowly decreased, but the role of regulation has not correspondingly shrunk — indeed, it has risen.
Since the 1990s, much of the electric utility industry has been either in bankruptcy, teetering on the verge of bankruptcy, or recently escaped from bankruptcy. The scapegoat is usually “competition,” but it is hard to characterize as competitive an industry in which behavior and prices are heavily regulated. In no other business are rates regulated years in advance regardless of the subsequent cost of providing service, or the cost of energy inputs.
In fact, it is the lack of actual competition that has stunted the electric utility industry.
While the industry is countercyclical, few investors would heavily weight long term a low-risk portfolio with electric utility stocks. As long as regulators at the federal and state levels have the authority to complicate the financial success of electric utilities, they will be risky investments.
Telecommunications companies are slightly better positioned today than their electrical counterparts, but only after scores of companies disappeared between 2000 and 2003. The assets of some, such as WorldCom, were bought by other companies, often in bankruptcy court. Others, such as publicly traded NorthPoint and countless private companies, simply disappeared. It is impossible to disentangle regulation from many of the failed investments.
The remaining telecommunications companies do not have nearly the regulatory constraints facing the electric utility industry. Rate regulation is largely past, and certainly not as pervasive as in the electric utility industry. Telecommunications companies may enter or exit a service offering with little, if any, government review.
But telecommunications companies do face regulatory challenges at both the federal and state levels that raise the cost of doing business and frighten away all but the heartiest of investors. Burned in the past by investments in the telecommunications industry, many investors simply avoid the industry altogether.
Between the 1940s and the 1980s, presidential candidates did not speak about electricity or telephone regulation. Rate regulation was an issue largely addressed by state regulators, and the American public did not look to presidents to ensure that their phone or electricity bills were reasonable. Millions of Americans quietly invested in utility stocks with the false belief that they were the least risky of all possible investments.
We live in much different times. Investments in the utility sector were rocked over the past decade, and the future portends even more, not less, regulation. Regulation of service quality, sometimes with political overtones, has replaced price regulation as the focus of debate.
As evidence, look no further than Messrs. Obama and McCain. They do not insist on lower utility bills, but at least one of them promises mystical service concepts such as greener electricity production, network neutrality, and expanded broadband services. A necessary corollary is a greater role for Washington in regulating the electricity and telecommunications companies of America.
The more our presidential candidates speak about the need for service quality in an industry, the higher will be the cost of capital and the greater the difficulty of raising investment dollars. Senator Moynihan coined the term “benign neglect” for other purposes, but he could accurately have used the same phrase to describe presidential inattention to investments in corporate America.
As voters assess Messrs. Obama and McCain in the weeks leading up to the election, they should remember that the less said about regulation, the better.
A former FCC commissioner, Mr. Furchtgott-Roth is president of Furchtgott-Roth Economic Enterprises. He can be reached at email@example.com.