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Global Utility White Paper
CONFIDENTIAL

the broader market. Following the policy errors, Japanese utilities staged exceptionally strong outperformance rallies lasting over 1.5 years, on average, and outperforming the Topix by 30-40% (graph below).

[Chart Title: Japan's Two Major Policy Mistakes (Nomura)]
[Chart Text Top: Koizumi reform included: 1. general spending cut 2. capping new bond sales This moderate fiscal consolidation sent the economy back into recession]
[Chart Text Bottom: Hashimoto fiscal tightening included: 1. hiking the consumption tax to 5% from 3% 2. scrapping the special rebate on income and residential tax 3. reducing the budget deficit to 3% of GDP by FY2003 4. cutting bond issuance and reducing public works spending]
[Chart Axis: 01/1990 - 01/2012]
[Chart Caption: Price ratio: TPELEC Index (Japan utility index)/TPX Index]
Source: Nomura Research Institute, Bloomberg

During the Jan 97–Nov 98 policy error period, fundamental investors bid up the better prospects (Tokyo Electric Power and Osaka Gas each rose 34%) while the Topix declined by -19. During this same period, some Japanese utilities also posted sharp absolute declines, such as Hokkaido Gas -49%, Saibu Gas -30% and Okinawa Electric -27%. During the May 01-May 03 policy error period, Okinawa Electric and Hokkaido Gas rallied +40% and +23%, respectively, while the Topix declined -44% and Tokyo Electric Power and Osaka Gas declined -13% and -7%, respectively.

The Japanese utility experience is very interesting as several economists question whether the US is currently committing similar policy errors while deleveraging is still occurring in the private sector (e.g. the US just increased income and payroll taxes and is implementing austerity measures). The Japanese experience demonstrates the potential for strong outperformance rallies during periods of deleveraging, demonstrating the alpha opportunity arising from an influx of fundamental investors into the sector after periods of limited interest.

o Potential for Yield Catch-up

Unlike other income-oriented investments such as Treasuries, German bunds, UK gilts, investment-grade bonds, high-yield bonds, emerging market bonds and MLPs, all of which have rallied strongly – some believe as the result of a yield bubble – the global utility sector has been left behind; yet certain parts offer a compelling investment yield opportunity today. If some fixed income cross-over investors become more concerned about inflation (because of economic growth), yet continue to be squeezed by the QE programs of the Fed, BOE, BOJ, etc., then they could begin shifting into global utilities. This seems logical, as such investors would look for the closest bond proxies in the equity market, the utility sector, rather than bypass utilities for high-beta broad market stocks. Given the enormous amounts of capital controlled by fixed income cross-over investors, even a small reweighting could have a significant effect in bidding utility stock prices up and yields down.

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Electron Capital Partners, LLC
For exclusive of Jeffrey Epstein
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