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I am impressed with his statement. As some of you may not know, this is a sharp departure from his previous position. Not long ago he told a trade magazine that "every power company and every citizen should oppose any new appropriation for the Rural Electrification Administration."

Perhaps, though, his position has not changed so much after all, for in reading the transcript of his testimony I see that he opposed the supplemental financing proposals, just as he formerly opposed the regular REA appropriations, and that is the general line which has been taken by the power company officials who have testified.

I would like to straighten out some of the references to my State made by this previous witness. He testified that his company charged "the lowest rate charged by an investor-owned utility in the Nation." That remark was featured in some of the papers back home. And it puzzled some people, who know that Montana power rates which they pay are among the highest in the country. The difference, of course, is that he was referring to the relatively small amount of power which his company sells at wholesale to cooperatives.

The reason that it is sold at a reasonable price is that we now have some competition for the company in the wholesale power business. Some co-ops obtain power from the Bureau of Reclamation and the Bonneville Power Administration, and the company had to reduce its wholesale overcharges to look good alongside other wholesalers. I recall back in the 1950's when the Hill County Electric Cooperative was dependent on the Montana Power Co. for its wholesale power supply, and the company charged them 92 mills. The day that Congress voted money for a transmission line to the co-op, which would permit it to get Federal wholesale power, the company walked into the Montana Railroad and Public Service Commission and on the same day put through its wholesale rate reduction, from 912 mills to 51⁄2 mills. That simply meant that the company was charging almost double until the prospect of a little bit of competition came along.

Now, in the retail distribution of power in Montana, we don't have that element of competition. Montana is the only State, except Hawaii, without a single municipal power system. That means that the only competition in the retail power business is provided by the cooperatives, and as they are excluded from the cities there really isn't any effective yardstick. As a consequence, the residential monthly light bill for Montanans in Billings, Butte, Great Falls, Helena, Missoula and other cities is on the order of $5 a month more than is charged in comparable cities elsewhere. The rate of return of the Montana Power Co. in 1964 was almost 11 percent. That was the highest rate of return among electric utilities in any of the 46 States where power companies are subject to regulation.

In fact, not even any of the utilities in Texas and the other three States without regulation of power companies made that much.

The return on equity for Montana Power was 17.5 percent. Actually, when you figure out what Montana Power makes each year, and calculate the difference between their actual earnings and the amount they would earn at a fair and reasonable 6 percent rate of return, you find out that the average residential customer in Montana is overcharged $85 a year.

Now, the reason that this particular company, and the other investorowned utilities, can make such profits is simple. They are granted enormous privileges by Government. Government gives them a monopoly on an essential product. Government permits them to add all of their expenses, including their taxes and their airplanes and all into the operating expenses, add on a nice profit, and pass the entire cost on to the customer.

The customer cannot go down to the store and shop for "Super Krunchy Kilowatts" or an "Anniversary Special Rate." He has to pay the utility bill or the company turns off the lights. Now, Mr. Corette told you that his business was like the grocery business, or the mercantile business, or any other business. But I have yet to find a grocer or a haberdasher who operates on a monopoly, cost-plus basis. It seems to me, that in considering supplemental financing for cooperatives, Congress should take a good, hard look at the financing of all electric systems. Electric power is the largest industry in the country, unless you count agriculture as one industry. There have been some big changes in the financing of the investor-owned systems during the past 10 years. Back in 1954, the utilities financed two-thirds of their construction with money from the stockholders, the remainder from debt financing, retained earnings, and the like. By 1963 the situation had reversed. Only one-third of the money came from the stockholders, the remaining two-thirds came from bonds, retained earnings, and the like. They have made these changes in financing to obtain benefit of advantages granted them by Congress. The president of American Electric Power, Donald C. Cook, pointed out not long ago that it was foolish to sell more stock than you need to, when, by deducting interest from taxable income, a utility can actually get borrowed money at about 22 percent interest.

Mr. Chairman, spokesmen for the electric utility industry have told this committee that co-ops "should be required to go into the open market and raise their money at going interest rates," to use Mr. Corette's phrase. But fewer and fewer of the big power companies, which get 15 times as much revenue per mile of line as the co-ops do, go into the marketplace for money. About half of the major investor-owned utilities won't have to go to the marketplace for new money at all during the sixties. They have overcharged their customers so much that they finance the new construction out of retained earnings and these other accounts. In other words, half of the utilities will pay not 2 percent, not 1 percent, but zero percent interest on money needed for new construction. They are using their customer's money. But those customers won't ever get any stock, or any dividends, or interest, and they will never get their money back.

I know this committee is not considering legislation dealing with supplemental financing of investor-owned utilities. I have gone into this matter simply to help correct, if possible, some of the utility folklore to which you have been subjected. I agree with the chairman's suggestion, out in Las Vegas at the NRECA national convention, that if the big utilities are going to fight every rural electric proposal that comes down the pike maybe we should simply let the co-ops move into town. After a few years of solid revenue from urban areas, the co-ops certainly wouldn't need a 2-percent loan program.

If agreeable, Mr. Chairman, I would like to offer for the record an article in Investment Dealers' Digest, written by a banker, who tells about the extraordinary excess earnings of the utilities. It might be helpful to the committee. The author points out that utilities are internally generating up to 120 percent of the funds needed for new construction. This points up, as he puts it rather delicately, the problem of what to do with too much money. He has some interesting suggestions, about going into the real estate business and such. Mr. POAGE. Without objection, it will be included in the record. (The article referred to follows:)

[From Investment Dealers' Digest, Public Utility Survey, 1964]

CASH FLOW GROWTH AND ITS IMPACT ON FINANCIAL PLANNING FOR ELECTRIC AND GAS COMPANIES

(By William F. Craig,' assistant vice president, Irving Trust Co.)

Cash flow as a percent of construction requirements has steadily climbed since the mid-1950's for the electric and gas companies. This condition accounts for the decline in the need for outside financing. Will this trend continue or is this the result of a cyclical condition? We aim to review the factors contributing to this situation and evaluate future financing needs.

Cash flow has received considerable attention in financial, accounting, and economic journals. This controversial term refers to funds generated from operations and is computed by adding back to net income all noncash charges, such as depreciation, amortization, and deferred income taxes. (Deductions should be made for items which do not currently provide funds, e.g., amortization of deferred income and interest charged to construction.) As an analytical tool, cash flow is used to help judge a company's outside financing requirements and its ability to meet debt retirements and dividends.

Many comments regarding this subject are inaccurate and misleading, leaving the reader with the impression that somehow or other cash flow earnings can be considered a substitute for, or an improvement upon, net income, calculated with a proper and reasonable deduction for depreciation. In truth, depreciation and similar items are merely part of the cycle of investment-recovery-reinvestment. Unlike net income, this portion of the cash flow has no effect upon the shareholders' equity or "net worth." Only net income can properly be compared with the shareholders' investment in arriving at a measure of the success of a business operation.

Much confusion exists concerning depreciation and its relationship to funds. Some claim that since depreciation is only an accounting technique used to distribute the cost of an asset systematically over the useful life of the property. it has no effect on funds. Others recognize it as a substantial source of cash to finance replacements and meet sinking fund requirements. This conflict results from the inherent weakness found in accounting language. A compromise is reached if we disclaim depreciation as a source of funds, but concede that it doesn't use funds provided by other sources.

REASON

Many attribute the declining use of outside financing to growth in earnings and tax savings due to adjustments for depreciation (i.e., accelerated depreciation. investment credit and guidelines). These people overlook the fact that while cash flow has increased, annual plant additions have shown little growth; in fact, since 1957 construction has gone down. This condition is the prime cause for the decline in the use of outside funds. As for the impact of tax adjustments, little of the increased cash flow results from deferred taxes and the investment credit. Normalization of taxes has been providing a declining portion due to the feedback of accelerated amortization. The bulk of the increase simply reflects the

1 William F. Craig, assistant vice president, Irving Trust Co., New York, is a member of the public utility department. He was graduated with a B.S. in economics from Villanova University in 1953, and an M.B.A. degree from Drexel Institute of Technology in 1960. Previously he was associated with the finance and accounting department of the Philadelphia Electric Co. from 1956 to 1960.

steady rise of booked straight line depreciation resulting from growth in total plant investment. The cash flow position of electric and gas companies might be weakened by the accelerated payment provision included in the 1964 tax law. During the 1964-70 period, when companies are switching over to a full pay-asyou-go basis, some utilities will actually be paying out more, rather than less, taxes.

In 1954 internal sources supplied 34 percent of cash needs for electric and 39 percent for gas companies. In 1963 cash flow provided approximately 60 percent of total needs for both the electric and gas industries. Retained earnings and depreciation have been increasing while annual plant additions have shown little growth.

During the 1954-64 period annual power company construction was up 24 percent while noncash charges rose 116 percent and retained earnings grew about 120 percent.

For the gas industry annual construction expenditures in 1963 were 59 percent over the 1954 additions while noncash charges and retained earnings rose 160 and 140 percent respectively.

Unless utilities add plant at a rate equivalent to or greater than the rate of annual increase in cash flow, the declining need for outside financing will continue. Construction forecasts released by the Edison Electric Institute and the American Gas Association suggest that annual additions to plant in the years between now and 1970 will increase at a rapid enough rate to necessitate outside financing at about the current level. However, while cash flow as a percentage of requirements will average between 60 and 65 percent for both of the industries internal generation of cash for individual companies will range from 40 to about 120 percent of funds required. This indicates the possibility of a condition under which equity financing will be unnecessary for some companies for extended periods. It also poses a problem of funds employment for companies generating cash in excess of requirements.

Our retained earnings projections in the table are based upon the application of an average industry return on net plant. We also assume continuance of an average industry dividend payout policy and present capitalization ratios. You will note that the financing figures referred to in the accompanying charts reflect net increases in utility stocks and bonds. Securities sold for refunding purposes were deducted from total new issues. Had we not done this, the volume would have been somewhat larger. We did not attempt to forecast refunding issues since the market outlook is such an important and unpredictable factor. While it is true that there has been a decrease in outside financing as a percentage of total cash requirements, the actual volume of securities sold has remained fairly level for the past 3 years and shows promise of rising in the future.

CONSTRUCTION FORECAST

The forecast of construction for investor-owned electric companies is based upon the EEI forecast of $6 billion for 1970. This projection assumes stable price levels. Should inflation occur, the need for outside financing would increase. Construction forecasts for the gas industry were based on figures supplied by the AGA. Sinking fund requirements account for a significant use of funds for gas utilities and pipeline companies. This cash drain is estimated to be approximately $260 million a year for the gas industry.

The trend of increasing cash flow as a percentage of construction needs is especially meaningful to companies regulated on a net original cost basis. Utilities located in original-cost States might suffer a slowdown of rate base growth corresponding to the relative increase of depreciation reserves. Gross plant additions for electric companies totaled $31.12 billion for the 9 years, 1954 to 1962, inclusive. During the same period, depreciation charges totaled $9.15 billion, resulting in net plant additions of $21.97 billion. Our forecast indicates that during the 9 years, 1962-70, the industry will add $41.85 billion gross plant while increasing depreciation reserves by $17.19 billion, or net plant will grow by $24.66 billion. While the forecasted period calls for construction expenditures of 34 percent more than the earlier 9 years, net plant will increase by only 12 percent. This percentage will be further reduced by plant retirements.

Up to this point we have been discussing industry figures and averages. Now let's consider the outlook for individual electric and gas companies.

Since the end of World War II utilities have been pressed by almost constant expansion demands. Raising new capital has been an ever-present management

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If agreeable, Mr. Chairman, I would like to offer for the record an article in Investment Dealers' Digest, written by a banker, who tells about the extraordinary excess earnings of the utilities. It might be helpful to the committee. The author points out that utilities are internally generating up to 120 percent of the funds needed for new construction. This points up, as he puts it rather delicately, the problem of what to do with too much money. He has some interesting suggestions, about going into the real estate business and such. Mr. POAGE. Without objection, it will be included in the record. (The article referred to follows:)

[From Investment Dealers' Digest, Public Utility Survey, 1964]

CASH FLOW GROWTH AND ITS IMPACT ON FINANCIAL PLANNING FOR ELECTRIC AND GAS COMPANIES

(By William F. Craig,' assistant vice president, Irving Trust Co.)

Cash flow as a percent of construction requirements has steadily climbed since the mid-1950's for the electric and gas companies. This condition accounts for the decline in the need for outside financing. Will this trend continue or is this the result of a cyclical condition? We aim to review the factors contributing to this situation and evaluate future financing needs.

Cash flow has received considerable attention in financial, accounting, and economic journals. This controversial term refers to funds generated from operations and is computed by adding back to net income all noncash charges, such as depreciation, amortization, and deferred income taxes. (Deductions should be made for items which do not currently provide funds, e.g., amortization of deferred income and interest charged to construction.) As an analytical tool, cash flow is used to help judge a company's outside financing requirements and its ability to meet debt retirements and dividends.

Many comments regarding this subject are inaccurate and misleading, leaving the reader with the impression that somehow or other cash flow earnings can be considered a substitute for, or an improvement upon, net income, calculated with a proper and reasonable deduction for depreciation. In truth, depreciation and similar items are merely part of the cycle of investment-recovery-reinvestment. Unlike net income, this portion of the cash flow has no effect upon the shareholders' equity or "net worth." Only net income can properly be compared with the shareholders' investment in arriving at a measure of the success of a business operation.

Much confusion exists concerning depreciation and its relationship to funds. Some claim that since depreciation is only an accounting technique used to distribute the cost of an asset systematically over the useful life of the property, it has no effect on funds. Others recognize it as a substantial source of cash to finance replacements and meet sinking fund requirements. This conflict results from the inherent weakness found in accounting language. A compromise is reached if we disclaim depreciation as a source of funds, but concede that it doesn't use funds provided by other sources.

REASON

Many attribute the declining use of outside financing to growth in earnings and tax savings due to adjustments for depreciation (i.e., accelerated depreciation, investment credit and guidelines). These people overlook the fact that while cash flow has increased, annual plant additions have shown little growth; in fact, since 1957 construction has gone down. This condition is the prime cause for the decline in the use of outside funds. As for the impact of tax adjustments, little of the increased cash flow results from deferred taxes and the investment credit. Normalization of taxes has been providing a declining portion due to the feedback of accelerated amortization. The bulk of the increase simply reflects the

1 William F. Craig, assistant vice president. Irving Trust Co., New York, is a member of the public utility department. He was graduated with a B.S. in economics from Villanova University in 1953, and an M.B.A. degree from Drexel Institute of Technology in 1960. Previously he was associated with the finance and accounting department of the Philadelphia Electric Co. from 1956 to 1960.

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