At Utility Forecaster, we’ve always taken an expansive view of our sector, with coverage of diverse businesses ranging from traditional utilities, including power generators, water companies and telecommunication firms, to less traditional operators, such as midstream master limited partnerships (MLP) and even some technology firms.

Despite such an inclusionary approach, we do have certain biases. For starters, as income investors, we want a sizable dividend with ample coverage by earnings.

But the current yield on a stock only tells part of the income story–the other part is dividend growth and the ability of earnings to sustain that growth. Ideally, we don’t just want to lock in a nice yield, we want our paychecks to grow fatter with each passing year.

At the same time, we want to feel reasonably confident that our initial income stream is stable, with minimum possibility of disruption. While some income investors have the luxury of reinvesting their dividends, many others must live off the income generated by their portfolios.

That brings us to our other bias, which is the fact that we tend to favor regulated utilities over competitive ones. Indeed, the one thing that most of our recommended portfolio holdings have in common is that a majority of their returns are regulated at the local, state or federal level.

Although the regulatory reach of government is understandably viewed warily by investors in other sectors, that oversight is what allows utilities with huge capital costs to earn a steady, predictable return on their investments. And that ultimately flows through to the dividend, as well as share-price appreciation.

Unfortunately, the potential for higher growth from some of these firms turned sour when low natural gas prices resulting from the Shale Revolution led to falling prices in the wholesale power market.

That forced some unregulated power generators to cut their dividends. For instance, former Growth Portfolio Core Holding Exelon Corp. (NYSE: EXC) cut its quarterly dividend by 41% in 2013. And FirstEnergy Corp. (NYSE: FE) cut its quarterly dividend by 35% last year.

While retail investors typically punish stocks for dividend cuts, a lower or suspended payout is often the first step toward regaining favor from Wall Street, which views such a move as an opportunity for a troubled company to reallocate capital toward more pressing needs.

Though institutional investors have the ability to analyze these actions dispassionately, when you depend on dividends for current income, it’s hard to trust a company after it’s made a cut.

With a few noteworthy exceptions, we largely avoid firms that derive a majority of their earnings from unregulated operations.

And many utilities are pursuing a similar strategy, by shedding or spinning off unregulated assets or by acquiring regulated assets to lower their exposure to their competitive businesses.

The Merchants of PJM

But if you’re still stuck holding an underperforming merchant generator in your portfolio, the government may have just given you a partial reprieve, at least if the company sells power via the PJM Interconnection–the grid that underpins the largest competitive wholesale electricity market in the U.S., spanning parts of 13 states from the Midwest to the Mid-Atlantic.

Earlier this week, the Federal Energy Regulatory Commission (FERC) approved a pay-for-performance model that it hopes will help mitigate the widespread outages that can occur during extreme weather conditions, such as the polar vortex in January 2014.

In one day during that frigid event, the PJM lost 22% of its generation capacity. The constraints of the natural gas market and the resulting spike in fuel prices were widely cited as major factors that crippled power generation in the Northeast.

But another big factor may have been utilities’ failure to winterize coal units, a cost-saving decision that was based on the fact that they were underutilized during the prior two winters.

The fear was that, under the existing pricing system, long-term reliability could worsen in the coming years as more and more aging coal plants are mothballed to comply with federal emissions regulations.

To address the situation, FERC’s ruling will essentially implement a pricing feature that’s somewhat akin to one of our favorite aspects of the midstream MLP business: take-or-pay contracts, which allow pipeline companies to get paid for their contracted capacity even if customers fail to fully utilize it.

Similarly, merchant generators are being paid a premium to provide excess capacity that may not always be called upon, particularly in years that have mild winters.

In exchange, these companies would have to pay stiff penalties if they failed to perform.

Interestingly, the lone nay in the FERC’s 4-1 vote was the agency’s chairman, Norman Bay, who’s been at the helm for a little less than a year.

He sees the plan as essentially paying an exorbitant amount of money for an approach that may not necessarily improve reliability.

That may be a valid concern for policymakers and bill payers, but not so much for investors in the firms expected to be beneficiaries of the new scheme.

Among the biggest merchant generators in the PJM grid are independent power producers such as Dynegy Inc. (NYSE: DYN), recent PPL Corp. spinoff Talen Energy Corp. (NYSE: TLN), and NRG Energy Inc. (NYSE: NRG) and hybrid utilities American Electric Power Co. Inc. (NYSE: AEP), Public Service Enterprise Group Inc. (NYSE: PEG), Exelon and FirstEnergy.

Under the new regime, Bloomberg says that pricing in annual capacity auctions could jump by as much as $50 per megawatt-day, an increase that would add about $180 million in revenue for a company with a mid-sized fleet of 10,000 megawatts.

Based on company guidance, Bloomberg estimates that a $50 per megawatt-day increase would give NRG an additional $325 million in revenue and American Electric Power an additional $145 million in revenue. Yes, please!

Naturally, these firms enjoyed gains in share price following the news.

Of course, companies that agree to the higher standard will also have to make the necessary expenditures and contract adjustments to ensure they can provide power during periods of peak demand amid emergency conditions.

And the price of failure?

“A rational profit-maximizing resource could simply seek a capacity award in the auction, fail to perform during each performance assessment hour and likely pay a penalty less than the carrot it has received,” the dissenting FERC chairman said.

Sounds like it will be manageable.