Many companies cheered with the passing of the new tax bill which decreased corporate taxes from 35% to only 21%. On the surface, this law could be projected to save utilities billions of dollars. But a more detailed review reveals repercussions that might be a little more challenging. While many companies in other industries are enjoying the competitive benefits of lower US tax rates, utilities are still trying to figure out how to share that tax savings with the customer. According to a report from, The Brattle Group, Six Implications of the New Tax Law for Regulated Utilities, regulators in 25 states are pressing utilities to produce customer benefits from the tax cut.
With these expected rate reductions, utilities will inevitably be collecting less from customers which will reduce their cash flow. The Brattle Group measures that on average utilities will end up collecting 3.4% less in rates while increase earnings volatility relative to EBITDA. In fact, the following are key implications from the new tax rates:
- Tighter coverage ratios
- More earnings volatility
- Deferred cash flows
- Stressed credit assessments
- Weakened rationales to build (rather than buy)
In the report, they list 24 utilities that Moody’s has put as having a “Negative” outlook and are projected to have, “incremental cash flow shortfall caused by tax reform on projected financial metrics that were already weak.” Now, couple this with the financial pressures already in play resulting from the decrease in energy demand and increase of alternative generation methods. Consequently, more than ever, utilities need to look beyond traditional energy sales to balance their cash flow.
A Rich New Business Model – Home Energy Management
Home Energy Management (HEM) presents a natural value-added opportunity to extend the utility business model and begin to address the concerns brought on by the new tax rate. As consumers feel the benefit of reduced rates, they are becoming more willing to increase investment in the smart home market. Utilities have the opportunity to meet the consumer where they are going, in a new way that expands their usage of smart home products through intelligent coaching and advanced automation. By rolling out value-added Home Energy Management solutions, utilities like AEP Ohio and DTE Energy have bridged the smart grid to the smart home. Not only has this engaged the customer by combining energy efficiency and demand response with home automation, but has built a foundation to create new streams of revenue.
One can imagine that a natural addition to this foundation could be to develop a line of business that can offset the 3.4% revenue requirement reduction. The addition of service revenues, which may have similar margins to the traditional energy business, won’t require the depth of capital for maintaining target debt equity ratios. This reduces the stress of raising additional capital and can help strengthen the utility’s cash position, as well as help the longer-term balance sheet. Given the example where this utility has revenues 3X EBITDA, the revenue required would be about $13.8 million on a base operating revenue of $406 million. Specifically, new service revenue from Home Energy Management can help deliver the following offsets to the tax impacts:
- Maintain top line performance (adding 3.4% in new revenue)
- Counteract impacts to debt and interest coverage ratios by 33% through new margin
- Fully offset FFO to Debt reductions reducing stress on credit ratings
In addition to the financial benefit, utilities that take this approach will also see the benefit of providing their customers with broader value propositions that will strengthen the utility’s brand image and provide greater engagement with a core set of consumers. Utilities and regulators need to continue to work together to solve for new business models that enable the utilities to creatively mitigate the effects of the tax rate reductions. At the same time, this will allow them to create a thriving Home Energy Management market, as opposed to non-utility channels which have failed to produce lasting and meaningful results.
The customers are ready, the technology is ready, but is the industry finally ready given this additional cut to the utility balance sheet?
To keep up to date on more utility and smart home insights, subscribe today.