JPS president and chief executive officer Charles Matthews. - FILE
THE JAMAICA Public Service Company third quarter results (as at September 30) were recently released, revealing a year-to-date net profit attributable to shareholders of $1.1 billion.
This translates into a 6.6 per cent annualised return on equity (ROE), given the $22.6 billion in shareholder's equity, the company said in a statement.
This is significantly below the regulatory permitted ROE and is primarily the result of fuel penalties and the lower than expected energy sales, which are both exacerbated by the effect of the high world oil fuel prices.
CAPITAL INTENSIVE
The electric utility industry is an extremely capital intensive business, requiring (in the case of JPS) annual capital expenditures in excess of $3 billion on average (and annual operating costs in excess of $9 billion, excluding fuel and IPP costs), to provide reliable service to customers.
The recovery of capital is typically over a 20 to 30 year period and the utility must be funded by a combination of equity investment and long-term loan financing. In order for any utility to be able to raise this necessary equity or loan funding it must be operating a viable business.
Governments world-wide have moved away from operating such capital intensive businesses because the Government typically lacks the expertise to operate such operations efficiently and choose to avoid the high level of long-term financing required to operate such businesses (JPS currently operates with approximately $14 billion worth of long-term debt).
LISCENSING MODELS
Additionally, the privatised models utilised today are much more transparent in their application, and usually operate within an established regulatory environment.
Many countries in the world have adopted a model which provides an operating licence for a particular utility to operate within a specific geographic boundary (free of competition or with limited competition) either as an independent power producer (IPP), or as a fully-integrated utility.
This economic model is necessary to provide a predictable source of revenue to investors who are typically being asked to build power plants and operate businesses under economic models where they obtain their return over a very long period of time (20 to 30 years).
This licensing model allows utility operators to function using much lower returns than would otherwise be possible and to be able to attract necessary equity and loan funding.
The regulatory framework is described in detail in the JPS All-Island Electricity Licence 2001.
This sets out the operational terms and conditions for JPS which are monitored by the OUR.
FAIR RETURN
The OUR's broad objectives include promoting efficiency, improved customer service and service reliability; protecting the interests of customers; and providing a reasonable opportunity (and not a guarantee) for JPS to earn a fair return on its investment.
The OUR determined the fair return for JPS to be 14.85 per cent, being the allowed return on equity (ROE). This ROE was determined after giving due consideration to ROE's of comparable regulated utility companies in the United States, the risk free rate of return, the country risk premium, the business risk premium and various methods used to estimate the cost of capital (the average ROE of a U.S. regulated utility at the time was approximately 12 per cent).
At the time of the determination, JPS had a weighted average cost of debt of 12.56 per cent, which means the approved ROE allows investors to earn 2.29 per cent points more than the debt financiers.
