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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.
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
task. This condition will continue for most utilities. However, there are and will continue to be many companies in the position of generating internal funds in excess of construction needs. When a company is able to meet cash requirements internally, annual retained earnings will tend to enrich the equity portion of the company's capitalization and reduce leverage. If rate base is not growing. earnings growth will slow down. Utilities adding plant at a rate equivalent to or greater than the rate of annual increase in depreciation will not face this problem.
In most instances this will be a temporary condition resulting from a lull in construction. Factors contributing to this condition include: first, the broad electric industry effort to reduce reserve capacity from the present average December peak reserve of 30 percent to something under 15 percent; second, rapid technological development in extra high voltage transmission making it no longer necessary to maintain reserves equivalent to a system's largest unit; third, interconnections and power pooling agreements which allow installation delays and the construction of larger units.
A power company might temporarily be a net purchaser of power under a pooling arrangement in order to insure a high plant load factor when a large unit is added to the company's system. Electric companies adding units every other year might now add larger units every third or fourth year. A pipeline might elect to delay moving into new market areas, looping lines or expanding collection facilities. In either case, during the construction lull funds in excess of immediate needs might be generated.
When construction demands and sinking fund requirements are met, how can a utility best put excess internally generated funds to use? First, we should consider the long-range outlook. While a company might have a 1- to 5-year slowdown in construction, in almost every instance, demand will catch up with capacity, necessitating expanded construction. Management must determine whether the cash-flow surplus is a temporary or static condition. This is an important benchmark from which to evaluate the alternative uses for the excESS funds. Some of the alternative uses for such funds are as follows:
A. Revise dividend policy
Such a solution would have application only when it was decided that the condition was long term. Investors in utility equities expect little and in frequent deviations from established dividend policy. Declaring dividend extras is also uncommon, but such a move might be considered if the company is unable to select investments which are to the financial benefit of the shareholders.
B. Highly liquid short-term investments
The use of Government securities, certificates of deposit, or commercial paper is practical if there will be a need for these funds in the near future. If this need is 3, 4, or 5 years off, these funds will act as a weight on the overall return of the company. Regulation might not allow a return on working capital or might give only partial recognition of these investments at the expense of the equity holders.
C. Purchase outstanding securities
If a company has high coupon bonds or high paying preferreds outstanding it might consider refunding the issue. This would be done independent of cashflow conditions. Using excess cash for the purpose of purchasing securities should be approached with caution. The capitalization balance is a long-term financial policy matter. If management wanted to improve an overcapitalization situation, it might be wise to retire some higher priced bonds. But, if cash excesses were to be a long-term condition, retirement of debt securities would only accelerate growth of the equity portion of the company's capitalization. If the long-term outlook promised a steady buildup of equity, it might at some point be wise to consider retirement of preferred. Some analysts have proposed the acquisition and retirement of common stock by the company. Such purchases at above book value might be damaging to the stockholders.
D. Investment in the company's future
When a utility finds itself generating internally more funds than it needs for construction purposes, the first thing it should do is to analyze its operation in depth. This should be done with the aim of improving operations to upgrade
service and/or reduce costs. Secondly the company should consider promotional expenditures which will result in load building.
1. Electric companies might consider a program such as extending utility property to include the fuse box or circuit breaker. Rather than stand by and wait for the consumer to step up to full 200-ampere service, the power companies could go out and offer to bring in three-wire service and at the same time directly promote load-building appliances. If residential sales are leveling off in a metropolitan area this is an excellent way to spark a promotional drive while adding rate base.
2. Companies might consider entering more directly into area development. A utility would be in a better position to promote its service territory if it had several desirable sites immediately available for industrial occupancy. Companies might invest in well-located land and bring in the utilities necessary for development. The advisability of investment in speculative buildings would depend on past experience in the area and the nature of the industry the location is likely to attract.
3. Increase budgets for the promotion of appliances which are heavy users of product.
4. Consideration might be given to upgrading service by increasing the reliability of distribution facilities. Further efforts to put overhead wiring underground seems timely.
5. The promotion of major appliances would get a boost if the sales package included broad credit terms. Both gas and electric companies might consider providing credit if working capital is an allowable rate base item. In the event that this item would not be allowed to earn a return, a separate subsidiary might be set up outside regulation. Bank borrowings or commercial paper could be used to supplement internally generated cash.
6. Under similar conditions as were mentioned above, the utilities might look into the purchase and lease of major load builders.
Employment of funds generated in excess of immediate construction needs should be subjected to standard investment tests (i.e., will the investment provide a return commensurate with the risk involved?) If the investment has merit for a company with cash excesses it would more than likely have value for all companies in the industry. The above suggestions are only a few of the many challenging ways a utility might take advantage of the unique condition of generating funds in excess of construction needs. This condition might well be a temporary phenomenon. It might be that we have underestimated the obsolescence factor. Technological breakthroughs such as EHV have made mine-mouth generation and distant hydro economically feasible. The cost gap between nuclear and conventional energy is being closed. ilar advancements are being experienced with transmission equipment in the gas industry. The significance of this topic is certainly thought provoking and well deserving of broader consideration.
Senator METCALF. I favor continuance of the 2-percent REA loan program. I think Congress should increase the appropriation for these loans and give the administration the strongest advice it has ever gotten about putting that money to work out where it is needed. These annual episodes of asking the Budget Bureau to put out the money which Congress has voted are ridiculous.
I recognize, too, that supplemental financing is necessary. I question whether the relatively small co-ops in sparsely settled areas such as my State should be required to pay more than the conventional 2 percent at this time. Some of these co-ops, especially the newer telephone co-ops, can barely meet their commitments now. This is simply because of what the economists and sociologists call the economic cost of space. Or, as an old homesteader put it, it costs more to see the least. Mr. Chairman, here are some comparisons between urban populations and these sparsely populated areas.
Nationally, the IOU's get $7,820 revenue per mile of line; nationally, the cooperatives get $516 revenue per mile of line.
In Montana, the IOU's get $3,868 revenue per mile of line, and in Montana the cooperatives get $286 revenue per mile of line.
Nationally, the IOU's density is 34 persons per mile of line, and the cooperatives 3.5 persons per mile of line.
In Montana, the IOU density is 17.4 persons per mile of line, and the cooperatives is 1.5 persons per mile of line.
In other words, the cooperative density in Montana is less than onehalf the national average, and the revenue per mile of line in Montana is a little more than one-half the national average.
The cooperatives have about 10 percent of the revenue nationally, and about 10 percent of the customers per mile of line.
You members of this committee can write, better than I could, legislation to provide supplemental financing for those midwestern and other large cooperative systems that do not desperately need the 2-percent program. My only request is that the co-ops which serve the sparsely settled areas, whose revenue per mile is below the national average and whose interest costs are therefore already high in proportion to their revenue, be permitted whatever 2-percent loans they can justify to the REA Administrator.
This is important to city persons as well as rural families in a State such as Montana. The rural electrics are the only "yardstick" in the retail power business there. If their costs and consequently their rates are forced upward, you can be sure that the customer overcharges in the cities will be increased. I contend that competition is a better brake on customer overcharges than regulation ever will be, and it is in the national interest to maintain strong competition in our largest industry.
I appreciate the chance to come back over here, and I am especially appreciative to Chairman Cooley, responsive, as always to a colleague's request.
I would, in closing, like permission to place in the hearing record several letters and a wire which I received during the past few days from rural cooperative officials in Montana. They underscore_and elaborate on some of the points which I have made. They are from J. L. McInerney, manager of 3 Rivers Telephone Co-op of Fairfield, Ray J. Smith, manager of Blackfoot Telephone Cooperative at Missoula, Jim Turnland, manager of Valley Electric Co-op and Valley Rural Telephone Co-op at Glasgow, Bill Van Fleet, manager of MidRivers Telephone Cooperative at Circle, Mrs. Barbara B. Kruger of Grass Range and the board and management of Flathead Electric Cooperative at Kalispell.
Mr. POAGE. Without objection, they will be placed in the record at this point.
(The communications referred to follow :)
3 RIVERS TELEPHONE CO-OP, Fairfield, Mont., June 8, 1966.
Hon. LEE METCALF,
U.S. Senate Office Building,
DEAR SENATOR METCALF: Our organization is a rural Telephone Cooperative serving some 2,600 members in the rural areas around Great Falls. We do provide telephone service to some of the smaller towns in our area, but even considering this, our overall density is in the neighborhood of one subscriber per mile of line.
Our rural service is based on eight parties per line and with the accelerated use of the telephone this service has degraded itself considerably during the past few years.
Just recently our engineers completed a study to determine costs and feasibility of upgrading the service in the Fairfield exchange to a maximum of 4-parties per line, with an alternate design of 1-party service. The demand is definitely for fewer parties on each line with an ultimate of single party service on the entire system.
We feel that improved service is a necessity to our rural people, in view of this we will certainly appreciate your support of Senate Bill 3337 to provide supplemental financing for the REA telephone program in the form of intermediate financing and a separate Telephone Bank.
Thanking you in advance for your consideration in this matter.
J. L. MCINERNEY, Manager.
BLACKFOOT TELEPHONE COOPERATIVE, INC.,
Hon. LEE METCALF,
Senate Office Building,
DEAR SENATOR Metcalf: With regard to the numerous bills for financing, pending in Congress at the present time, I should like to plead with you for all the help your powers can provide in making loan funds available to us and the other REA borrowers who are providing service to the rural areas.
The Blackfoot Telephone Cooperative provides telephone service in five western counties of Montana and has a total of about eleven hundred (1100) patron users. We are experiencing a steady growth in all parts of our service areas and we feel that we have good reason for a great deal of concern toward present and future in the financing of communications to rural people.
Since the first of the year, due to the complete exhaustion of loan funds, we have created a "hold order" file which will have to wait along with many others until such time as additional funds can be made available to us.
In May of 1966, we requested additional loan funds in the amount of six hundred and twenty-five thousand dollars ($625,000.00) for which we expect to rebuild our system that has become over-crowded in nearly all parts of the service
Also due to the demand for better service and the high cost of maintenance because of terrain and joint use with power companies, it is imperative that we move a good portion of our facilities which we hope to place underground and at the same time upgrade service in the rural areas from eight parties to four on a line.
With all sincerity we ask for your help, as we supply this service to our people and yours.
RAY J. SMITH, Manager.
VALLEY ELECTRIC COOPERATIVE, INC.,
Senator LEE METCALF,
DEAR SENATOR METCALF: As a manager of a Rural Electric Cooperative, I am requesting your support on establishing a Federal Bank for rural electric and telephone systems.
Rural electric systems have no more completed their job to date than the County Commissioners had when they completed their first graded roads for the old Model T. Due to the ever increasing use of electricity in the rural areas, distribution lines, substations, transformers and services must be heavied up on this project. The average monthly use of electricity on the farm has increased from 440 kwh in 1955 to 740 kwh in 1965. The original systems were not built with the capacity for this kind of consumption of kwh.
Montana has very few cooperatives that could stand the high interest money; we know that there are many electric cooperatives east of the Mississippi River that can stand the increased interest cost. The Federal Banks would take care of them and leave the 2% money for the electric systems that have a low density.
Rural telephone cooperatives are in the same boat as the electric cooperatives. They started out with 8 party service, now due to the increased calling habits,