When the New Orleans City Council threatened to cut Entergy New Orleans’ high profit margins last year, the utility company responded aggressively: it said that such a move would not only be illegal, but also would be “an untenable proposition for any investor.” That lack of investment would make it impossible for Entergy to “make the investments in the future of New Orleans,” the monopoly utility said.
But Entergy’s own financial filings and reactions from Wall Street analysts indicate that the utility’s claims may have been self-serving bluffs.
Profit cut set off fight between Entergy and City Council
Up through last year, Entergy New Orleans’ return on equity (ROE), a measure of profitability, was 11.1%, one of the highest in the Southeast region. ROE measures the percentage that a utility is allowed by regulators to collect in profits on the capital investments it spends on infrastructure.
The City of New Orleans, which regulates Entergy New Orleans, voted to reduce Entergy New Orleans’s ROE to 9.35% on November 7, 2019. The City Council also fined Entergy $1 million in the same meeting for “inaction and omissions” as a penalty for the unabated power outages plaguing the city.
Entergy had warned that an ROE cut below 10% would result in “lengthy and costly litigation” since it would be “arbitrary and not supported by law.” A last-ditch effort by Entergy to smear clean energy intervenors and scare the Council into voting against the proposed reduction in profit failed; City Council President Helena Moreno called Entergy’s bluff and accused the utility of “bullying and threats,” in a sharply worded letter to Entergy New Orleans CEO David Ellis.
Entergy sued the City of New Orleans in response on December 6, 2019, seeking to overturn the Council’s ROE cut.
Entergy New Orleans’ claims notwithstanding, a 9.35% ROE is not outside the spectrum of what other utilities are allowed by regulators to earn. Dominion Energy’s Virginia utility requested to increase its ROE from 9.2% to 10.75%, but regulators rejected the request in November 2019. Virginia regulators found the 9.2% ROE was “consistent with the public interest” and “reasonably balances the interests” of Dominion, customers, and investors. Electric utilities filed 54 new rate reviews in 2018, according to a review by the Edison Electric Institute, the trade association and lobbying group for electric utilities. The review found that, “average awarded return on equity (ROE) was 9.51%, the lowest annual average in our 30 years of data.”
In its briefings to a Louisiana court, Entergy said that without permanent relief from the recent City Council decision, the company would “suffer irreparable harm”. Entergy estimated the cumulative effect of New Orleans City Council’s decision would cost the company $25 million per year.
Even if Entergy New Orleans’ estimate is correct, it would equate to less than three percent of the parent company Entergy’s net income in 2018, which was $863 million, according to the company’s Integrated Report.
Wall Street seems unconcerned, some see renewables as potential profit driver
Wall Street seems to have shrugged off Entergy’s claims of impending financial disaster from the ROE cut. Entergy’s share price has risen from $116 on Nov. 6, the day before the City Council cut the New Orleans’ subsidiary’s ROE, to $132 on Jan. 31, broadly tracking other utilities. Some analysts have been bullish on Entergy’s long-term outlook, noting the company’s coal-heavy fleet leaves ample opportunity for renewable energy development to increase Entergy’s deployed capital while saving customers money.
Big Cajun 2, an unscrubbed coal plant in which Entergy is a part owner, presents a case study lending evidence to that theory from investors. The coal plant registered $137 million in three-year cumulative market losses according to an analysis from the Union of Concerned Scientists. Entergy ratepayers soaked up those losses.
Financial analysts at Morgan Stanley and Moody’s Investors Service released reports in December 2019 announcing their expectation that more electric utilities will accelerate their transition away from coal, with major financial benefits for both ratepayers and shareholders. Morgan Stanley reported that replacing coal specifically with lower-cost renewable energy could save electricity customers as much as $8 billion each year nationwide. Analysts posed questions that seemed to point in that direction on Entergy’s 2019 third-quarter earnings call, with one asking if Entergy might pursue more wind energy development.
But Entergy seems to be pursuing an approach that’s at least as reliant on investment in new gas-fired power as renewable energy. On Entergy’s 2019 third-quarter earnings call, CEO Leo Denault signaled a large gas buildout of up to 4 gigawatts was in the works. Denault said, “We still see the need to replace the significant amount of our aging generation and that a portion of that will be gas, a portion of that could be renewables. We outlined a 7,000 to 8,000-megawatt need and a roughly 50-50 gas to renewables standpoint there.”