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Cash & Working Capital

Utilities Lose out in Tax Reform

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January 03, 2018

Highly regulated utilities see their cash flow strategies thwarted by new tax law

IRS and dollarUtilities will see fewer dollars flowing into their coffers now that new the tax law has come to fruition. That’s because the highly regulated businesses base their fees partly on expected taxes, which now are going down, according to Moody’s Investors Service. This also means they’ve collected too much revenue over the years and now will have return some to customers. This reduction in cash flow could ultimately lead to downgrades, the credit rating agency says.

“The rate regulators allow utilities to charge customers is based on a cost-plus model, with tax expense being one of the pass-through items,” Moody’s says in a research note on tax reform. This means that regulated utilities collect their revenues from customers “based on book tax expense but typically pay much less tax in cash due to tax deferrals.”

But now, a reduced tax rate means that utilities will collect less revenue “for the purpose of tax expense compensation.”

“Going to a tax rate of 21% from 35% represents about a 40% fall in revenue collection related to tax expense,” Moody’s estimates. “Although this revenue is ultimately paid out as an expense, under the new law utilities will lose the timing benefit, thereby reducing cash that may have been carried over many years.”

This also means that since utilities have been collecting fees based on future tax obligations – at 35% - they’ve now been put in the position of having over-collected. This in turn means they will have to refund that money, which will further erode cash. “As utilities refund the excess collection to customers, it will reduce cash flows, likely spread out over 20 years,” Moody’s says. Moody’s adds that out its portfolio of 215 regulated utilities and their holding companies, it expects that “up to 20% of them will see meaningful declines in key financial metrics.” For this subset of companies, Moody’s further estimates that “the ratio of cash flow from operations pre-working capital (CFO pre-WC) to debt will on average fall about 133 basis points,” which if not addressed, “could lead to negative rating actions.”

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