From Wikipedia: The three Rs (as in the letter R) are the foundations of a basic skills-orientated education program within schools: Reading, wRiting and aRithmetic.

The phrase is attributed to a toast given by Sir William Curtis around 1825.Since its original creation, many others have created new words for what the Rs stand for.

There is an earlier reference to "reading, writing, and arithmetic." It comes from Saint Augustine's "The Confessions of Saint Augustine" AD 401, Book I -- Translated by Edward Bouverie Pusey. "For those first lessons, reading, writing and arithmetic, I thought as great a burden and penalty as any Greek."

To many of us involved in the financial world there is another definition of the three R's - Risk Requires Returns.

It has been proposed that allowed Returns on Equity (ROE) should be reduced to reflect lower risks as a result of declining returns available on so-called risk free investments such as US Treasuries.

While true that US Treasury securities are currently priced at historically low levels, the operating risks of utilities have had no concurrent decline and, in fact, can be shown to actually have increased in recent years.

A variety of mechanisms have been permitted in rate setting procedures which tend to permit earlier recovery of specific expenses, such as purchased fuel expenses, pension expenses, environmental controls, demand side management (DSM), and delinquent payments by customers, etc.

While adjustments for specific conditions make it somewhat easier and earlier for recovery, the dollars involved likely would have been allowed and recovered in a traditional rate proceeding, so it is not that risk is reduced, perhaps rather that regulatory lag is reduced, thus allowing a given company to come closer to actually earning the ROE determined by the Commission to be fair and reasonable.

An example of a mechanism that allows a company to recover costs that might have otherwise gone unrecovered and unrecoverable is decoupling, where actual usage is lower than that which is projected when rates are fixed. While such a mechanism might make a company whole for energy efficiency efforts by its customers, or economic and weather variations, some risk may, in fact, be transferred from shareholders to customers, but it escapes me as to how one might measure the basis points of ROE that such a transfer represents -- specially at a time when allowed returns are at historically low levels to begin with. (According to Regulatory Research Associates, the average ROE determined in 30 electric utility cases decided in the first nine months of 2011 was 10.18%, some 0.16% less than had in 59 determinations in 2010 (10.34%) and 0.30% lower than those in 39 determinations made in 2009(10.48%).During the decade 2000-2009 allowed ROEs declined from 11.43% to 10.48%, and in the ensuing year and nine months to September 2011 to 10.0%. The trend is not favorable to equity investors.

Numerous research reports by members of the financial community in the early days of 2012 suggest that ROEs to be awarded in cases decided this year may well decline by as much as another 50 basis points, however one detailed study suggests that while such a decline is possible if risk premia are to decline by 100 basis point, however they "do not expect the average allowed ROE set in utility rate cases in 2012 to decline from recent levels..."

Rating Agency Comments

One agency recently noted that electricity sales growth will slow in 2012 with state and federal energy efficiency plans possibly exacerbating this trend, and noted that sales growth below consensus forecasts would pressure unit costs as environmental, growth capex and higher operating costs are spread out over fewer units of sales, leading to conservation and still lower unit sales, perpetuating a downward spiral in electricity usage.

The credit implications of reduced electricity sales growth is noted to vary widely for individual utilities given the variation in consumption at the state level and different regulatory recovery mechanisms with efficiency programs by large commercial users presenting the greatest risk of lost sales, thus suggesting utilities in high- consumption, high-priced states as the most vulnerable with regulatory response being a significant determinant of the ultimate effect.

Another agency, in considering "Credit Concerns", posed what they called "The Top Ten Investors Questions for U.S Regulated Electric Utilities in 2012:

• What impact will the EPA rules (Mercury and Air Toxic Standards and Cross-State Air Pollution Rule) have on regulated utility credit quality?

• Are there credit implications for electric utilities in a slow growth environment?

• How much capital spending will occur during 2012?

• Do you expect electric utilities to continue to have access to capital markets?

• Is the global financial turmoil affecting U.S. utilities liquidity positions?

• Will the closing of some generating plants compromise electricity reliability?

• What impact will the expiration of bonus depreciation have on credit metrics?

• Will merger activity continue in 2012?

• Are Federal Energy Regulatory Commission (FERC) incentive rates required to build out the transmission system?

• How much solar power will companies install in 2012?

Another agency states that their outlook for the investor-owned US regulated electric and gas utility sector is stable, reflecting their expectations for the fundamental business conditions in the industry over the next 12 to 18 months. They note that financing large capital investment programs is a "key risk factor" in their outlook and that utilities need to continue to strong access to capital markets, but that volatility in the financial institutions sector, and especially European banks, is rising so that should access to capital become limited it could present a material negative risk to their outlook. They also note that the 2012 election cycle will likely bring campaign rhetoric touching on energy policy, infrastructure investment and environmental regulation in the US, though they do not expect this to impact credit ratings as their focus on the political and regulatory environment is primarily at the state and local level. They believe that utilities own and operate critical infrastructure assets, a key ingredient for a functioning economy , and they are major employers in their communities, with this role not being lost on utility management teams whose constituency outreach efforts generally lead to positive regulatory outcomes.

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