Why Utility Profits Could Be the Next Target

Rising inflation and higher interest rates are squeezing electric utilities, and regulators may respond by lowering the allowed return on equity. That shift could reduce utility earnings and prompt a reassessment of utility stock valuations, the article argues.

By AI Newsroom· Reviewed by Pranav, Founder & Editor-in-ChiefPublished 1 minute agoUpdated 1 minute ago0 views

Why It Matters

If state regulators move to trim allowed equity returns to ease consumer bills, utility shareholders could see meaningful earnings losses and the sector may face a broad valuation re-rating. The debate links macro moves in Treasury yields and Fed policy to sector-level regulatory decisions.

Key Facts

Treasury yield: 10-year Treasury about 5%
Equity risk premium (average stock): About 6% (NYU numbers), range roughly 5%-7% over past two decades
Utility equity risk: Utilities ~half as risky as overall equity market (beta perspective)
Implied utility equity premium: Estimated 2%-3% for utilities
Implied cost of equity for utilities: About 7%-8% per year (5% risk-free + 2%-3% premium)

Electricity prices, operating costs and input expenses for utilities are rising alongside broader inflationary pressures, the authors note, and higher Treasury yields and Fed rate moves are increasing capital costs. A utility’s cost of equity is determined by a risk-free rate plus an equity risk premium; with 10-year Treasuries near 5%, the risk-free component has clearly risen. Regulators set allowed returns based on these inputs, but they can influence the equity risk premium portion of the calculation.

Using historical and market metrics, the piece argues that utilities should require a much smaller equity risk premium than the average stock because their measured market risk is roughly half that of the broader market. With an average-stock equity premium around 6%, utilities’ lower risk implies a premium near 2%–3%, producing an estimated cost of equity near 7%–8% given current risk-free rates.

By contrast, recent reported returns for many investor-owned utilities have exceeded those levels. The authors cite Edison Electric Institute member firms as having earned about 10% on equity over the past two years, and point to industry market-to-book ratios in the 180%–200% range as consistent with earnings above the cost of equity. They calculate that each one percentage-point cut in allowed return on equity would reduce common-stock earnings by roughly 10%, which would be felt directly by shareholders.

The article outlines a potential regulatory response: confronted with rising costs, affordability concerns, and political pressure, state regulators could lower allowed equity risk premiums toward historical lower bounds. That policy choice, together with higher costs and higher capital intensity in equity, could lead investors to assign lower price/earnings multiples to utilities — the authors suggest a possible 20%–30% rerating of the group — and could also prompt utilities to scale back investment if regulators tighten returns on equity.