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How Could American Electric Power’s Return on Equity Improve?

Vincent Kruger

AEP: How Is It Adapting to the Changing Utility Industry?

(Continued from Prior Part)

American Electric Power’s return on equity

With its greater focus on regulated operations, American Electric Power’s (AEP) return on equity is expected to improve in the coming years. In 2015, the consolidated return on equity of its regulated operations segment stood at 9.6%. The expected return on equity of the segment is estimated to improve to 10.1% in 2016.

The regulatory return on equity is a combination of the cost of paying back debt with interest in addition to the return utilities offer to their equity shareholders. Ultimately, allowed ROE (return on equity) is the only part of the revenue requirement that utilities keep for themselves as profit.

Focus on regulated operations

AEP’s divestment of its merchant generation business is likely to provide earnings stability. Also, more predictable cash flows and stable operations may boost the return on equity. AEP’s focus on expanding its regulated operations segment could be good for future growth. The company has allocated 95% of its capital budget to regulated operations. Half of this is expected to be spent on the regulated transmission segment. Transmission operations have a higher allowed return on equity than other utility (FUTY) operations.

Moreover, American Electric Power’s operational territories have an amicable regulatory environment, which bodes well for rate cases. The widespread presence of AEP garners benefits of diverse regulatory policies and attains a healthy ROE. In March of this year, Ohio regulators approved AEP’s proposal to shift the financial burden of non-profitable power plants onto customers.

Peer ROE comparison

In comparison, WEC Energy Group (WEC) has an authorized rate of return of 12.7%, which is one of the highest in the industry. Californian utilities Edison International (EIX) and PG&E (PCG) earn returns on equity of ~10.5%. Generally, rate bases with more regulated transmissions have a higher return on equity.

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