Will investors support 10 million Arizonans?

By Jeffrey Coles and Dennis Hoffman What will an Arizona of 10 million people look like? And how will we support them all? Today, Arizona has about 6 million residents. For 30 years, we have experienced robust growth fueled by an attractive climate, affordable housing and opportunities for employment. Obviously, in the current recession, growth has slowed. However, when it resumes, as expected, our state will be well on its way to becoming one of the largest in the U.S. All these new people will create new and unprecedented demands on our desert-based infrastructure on water, energy, education, healthcare, and transportation. Delivering on the promise of tomorrow is an extraordinary challenge requiring the collective will and coordinated decision-making of the public and private sectors today. At the federal level, infrastructure seems to be in-play as a public investment. But what about private investors? Looking ahead to 2030, with a youthful state and opportunities for new industries like solar energy, Arizona would appear to be incredibly lucrative. If unimpeded by regulation, private capital will flow to these opportunities with attractive risk-adjusted returns. So, with Arizonas growth trajectory, why arent we overrun with private investment? Could it be that our collective aversion to infrastructure investment is leading potential investors to question their likelihood of getting repaid? Many would agree it is imprudent for taxpayers to invest when returns accrue primarily to private parties. But goods that confer benefits on the larger public can deserve support. National defense is not supplied on a private basis. Energy infrastructure, also essential to our future, wont be put into place without a rate structure that enables it. Consider Arizona Public Service, whose investment in Palo Verde provided affordable energy over the past 20 years. Electricity prices have been essentially fixed ever since, declining 20 percent after adjusting for inflation. Meanwhile the cost of APS investments in new energy infrastructure continues to rise. APS must attract capital to finance these investments. But potential debt and equity investors look at the risk of an investment in APS and choose to invest only when the potential return compensates them appropriately. Financial markets dont paint a pretty picture for APS. The debt of the company is rated BBB-, not far above junk. The dividend yield (compensation to investors for holding risky equity) is among the highest in the industry. This means the cost of capital for APS is high relative to competitors. Compare APS with Detroit Edison or Consolidated Edison, which serves New York City. With the ability to issue A-rated debt, these companies are viewed more favorably than is the debt of APS. New Yorks economic outlook is dismal and well-documented. And Detroit? One would think that the outlook for Arizona is far better. But investors are sending ominous signals. And slipping another notch with the rating agencies would mean significant increases in costs. Consider the rate hikes that would be necessary to cover the costs of a 15 percent interest rate on energy infrastructure. Arizonans may have to adjust to either skyrocketing future costs or erosion in standards of living due to a declining energy infrastructure base. Of course this dire scenario need not play out. Unlike Detroit, we can control our destiny. A few bold moves by legislators and regulators could signal the financial markets that Arizona is still open for business. And yes, it may cost a little bit more today, but these actions will save a lot in terms of debt expense and reasonable utility rates in the future. Jeffrey Coles is a professor of finance and chairman of the department of finance and Dennis Hoffman is professor of economics and director of the L. Wm. Seidman Research Institute at Arizona State Universitys W.P. Carey School of Business.