The impact of customer mix on the cost of capital for electric utilities

Abstract

This dissertation investigates the perceived riskiness of electric utilities based on their mix of residential and industrial customers. While previous studies have attempted to develop a simple measure of the total riskiness of individual customer classes, this study examines the relative riskiness of the total utility as impacted by customer mix. Because the cost of risk is an element in the determination of the utility's revenue requirement, it impacts the set of optimal tariffs derived from a constrained welfare-maximization problem.

The null hypothesis that investors do not base their perception of the riskiness of a utility on the customer mix is tested against the alternatives that residential customers decrease and that industrial customers increase the perceived riskiness of a utility. The hypothesis is examined using cross-sectional data for 1981. The weighted-average, after-tax cost of capital is used to measure the relative riskiness of the utility. In addition to the customer mix variables, the explanatory variables include operational and regulatory variables. The analysis provides support for the hypothesis that investors do not differentiate the riskiness of a utility based on the size of the residential class. Further, the analysis permits rejection of the alternative hypothesis that investors perceive a utility to be more risky when its customer mix is heavily industrial. The results suggest that, in fact, investors may associate greater risk with an absence of industrial customers.