Brattle Consultants Find that Strong Utility Earnings in Q2 2020 Mask Longer-Term Vulnerability to COVID-19
Published by The Brattle Group, Inc.
Brattle Principal Robert Mudge and Senior Research Analyst Tess Counts have examined the first earnings season that fully reflects the impact on electric utilities of sales lost to COVID-19. The report—focused on the second quarter of 2020 (“Q2 2020”) —highlights potential drivers of future impact should pandemic conditions persist.
At first glance, relatively strong earnings results in Q2 2020 might suggest that ongoing utility financial burdens from COVID-19 are proving modest and can be readily managed, but it also raises the question of sustainability. The historically high correlation between quarterly electricity sales and utility financial results suggests that utility managers should not be sanguine about future outcomes. There remain more possible effects beyond just persistent load reduction due to “lockdowns.” In particular, the small commercial and residential exposure to acute financial distress has been buffered by federal income replacement policies that may not persist, potentially leading to increased rates of bankruptcy well beyond levels observed to date, thereby eroding (and not just deferring) customers’ ability to pay.
Q2 2020 GDP was down by an unprecedented 33% (annualized) and commercial and industrial electricity usage was 10% lower than in the same period in 2019 (more than double the impact of the financial crisis in 2009). Notwithstanding higher residential usage and high temperatures, overall load was down 4% and revenues followed (albeit not on a 1-to-1 basis). Despite this, however, utility earnings were higher in Q2 2020 than in Q2 2019, showing greater insulation from general economic conditions than other sectors of the economy.
Change in Q2 Earnings
2020 vs. 2019
Source: Butters, John, “S&P 500 Earnings Season Update: August 7, 2020,” August 7, 2020, https://insight.factset.com/sp-500-earnings-season-update-august-7-2020.
By contrast to earnings, however, electric revenues in Q2 2020 followed electricity sales in a downward direction on average:
Change in Regulated Revenues vs. Retail Load
Q2 2020 vs. Q2 2019
Source: Company 10Qs and earnings announcements.
Additionally, historically on an aggregate basis, utility revenues and earnings have been highly correlated to changes in load, quarter-by-quarter. Here that pattern is broken by COVID-19 – revenues have been cushioned from the full potential impact of reduced load (but have fallen) while earnings have actually increased. This suggests that utilities found ways to cut or defer costs in the interests of helping to manage customer bills and of conservatively sustaining their financial health. Utility earnings reports and industry analysts have noted the extraordinary efforts made to reduce costs in Q2 2020.1 However, it is intuitive that this strategy cannot be maintained indefinitely.
Additionally, the review of Q2 2020 data suggests that the revenue reduction in Q2 2020 was itself muted due to revenue recovery mechanisms and other “buffers” specific to pandemic conditions, such as an increase in residential load. Therefore, revenue outcomes to date may understate the eventual impact on electric utilities of persistent low load levels, unpaid bills, and customer defaults.
1 See for example “Utilities, responding to COVID-19, reduce O&M expense in Q2’20”, SNL, September 17, 2020