“They’ve used the Venezuelan telephone company to record the president of the republic. Brother, it's the empire!" Those are the latest interesting remarks of Venezuelan President Hugo Chavez regarding his nation’s largest telephone company, CANTV (NYSE: VNT). His allusion is to the 28.5 percent stake in the company owned by VERIZON COMMUNICATIONS (NYSE: VZ), which he implies has made CANTV the stooge of the Bush administration.

Fortunately for America’s second-largest communications company--which has a market cap of more than $110 billion and rising quarterly sales of $23 billion-plus--the roughly $425 million current market value of its stake in CANTV is insignificant to its overall fortunes. But with Chavez announcing the nationalization of CANTV as well as his nation’s electric utilities, the fate of Verizon’s investment in that company doesn’t look good, despite the assurances of Venezuelan officials and Chavez himself that compensation will be fair.

AES CORP (NYSE: AES) is also a loser from Mr. Chavez’ efforts to, in his words, “reclaim national assets.” The company owns 87 percent of Electricidad de Caracas, by far the most efficient utility in Venezuela. Ironically, AES has a five-year history of cooperating with the government, making a sizeable investment in the utility over the last seven years despite Chavez’ increasingly bellicose behavior.

Happily for AES, even losing its entire Venezuelan investment is no back-breaker. In 2005, for example, Venezuelan revenue was just 5.6 percent of its global total. Assets in the country of $1.5 billion were a roughly equal percentage.

The unit’s debt is entirely non-recourse to the parent or its shareholders. That accounts for the absence of a reaction to events by the major credit raters--all of three of which give AES overall a stable outlook. Also, the company expanded rapidly elsewhere in 2006, particularly in renewable energy in the US. Consequently, the relative importance of the Venezuelan assets is actually less than the numbers from 2005--drawn from its most recent 10-K report--would indicate.

Understandably, the nationalization news hit both AES and Verizon shares initially. But in the days since, both have recovered as analysts have run the numbers and jittery investors have calmed their nerves.

Had this nationalization drive occurred just two or three years ago, it could have been the final push over the cliff for AES, which was then coping with the fallout from two decades of rapid, unfocused growth under its founders Roger Sant and Dennis Baake. Today, under the leadership of extremely well-connected Chairman Richard Darman and CEO Paul Hanrahan, it’s just a bump in the road for a company that’s emerged as a leader in alternative energy and is on track for powerful growth.

At this juncture, investors shouldn’t count on either company to realize much from its Venezuelan investments. This week, for example, the Venezuelan National Assembly gave the initial thumbs up to a measure enabling Mr. Chavez to enact laws by decree to mid-2008. Whatever check there was on his power in formerly democratic Venezuela is out the window.

Further, falling oil prices are no doubt taking their toll on the country’s treasury. So even taking his assurances of fair compensation at face value, there’s no assurance of what kind of money will be there to make good on his promises.

In a worst case, both companies will have to write off their investment sometime in 2007, taking a hit to earnings. Even that, however, would be only a one-time hit and would in no way threaten either their financial strength or growth prospects.

Both are solid, well-diversified companies. Like all essential service providers, both are subject to regulatory rulings in the various jurisdictions where they operate. That’s the price of dominance in any market. But by spreading their exposure and preventing any one jurisdiction from becoming too important to overall prospects, they’re also protected against a setback here or there. As a result, both are still worthwhile investments.

REGULATOR WATCH

The Venezuelan nationalizations are clearly an extreme example of regulatory risk. But electric, gas, pipeline, communications and water companies face regulatory risk of some nature that, if not properly handled or guarded against, can have severe negative consequences.

Late last year, Illinois and Maryland stood out as primary flash points for power companies in this country. Both were on the verge of substantial rate increases for electricity service, the result of a decade-long rate freeze and a competitive power market auction that lifted utilities’ wholesale costs.

Since then, the situation in Maryland seems to have leavened out a bit. Utilities have been able to negotiate phase-ins for the rate increases with regulators. That seems to have satisfied the incoming Democratic governor--who used the rate issue to unseat his Republican predecessor--at least for the time being.

In contrast, Illinois remains in flux. As in Maryland, the utilities have negotiated phased-in rates and regulators have signed off on them. The lower house of the state legislature, however, passed legislation to extend the state’s rate freeze through 2009. That effort failed when the upper house failed to follow suit before state lawmakers recessed. But proponents and opponents alike predict the measure will come up again in the next session. And as history shows, it’s mighty hard for politicians to reject lower utility rates for their constituents, no matter what the long-term cost.

Extending the rate freeze would have potentially devastating consequences for the state’s electric distribution utilities. As in California earlier this decade, they’d literally be forced to eat the rise in market prices for wholesale power to the tune of potentially billions of dollars. And like the Golden State companies then, bankruptcy would be a real possibility.

The good news for EXELON (NYSE: EXC) is that it could put its Commonwealth Edison unit into Chapter 11 protection to force the state’s hand, without damaging either its credit rating or dividend.

In fact, its wholesale power division in Illinois alone stands to make far more money this year than it would lose from a temporary interruption in income from Commonwealth Edison. Exelon’s strong position was underscored today by Fitch’s affirmation of its credit rating at BBB+.

The other major affected utility in the state, AMEREN (NYSE: AEE)--also stands to gain from higher wholesale power prices at its generation arm. Unfortunately, it’s much less diversified than Exelon, and a bankruptcy of its power distribution unit will almost surely pressure the dividend, which was not covered by earnings during the last 12 months.

It’s still quite possible that phased-in rates will pacify enough members of the upper house to at least table this legislation for the time being. In that case, even Ameren will come out of this in good shape. The key, however, is that Exelon--the more diversified company--is in much better shape than Ameren, which is more concentrated.

Assessing individual companies’ regulatory exposure is a good part of what I do in Utility Forecaster (http://www.utilityforecaster.com). Over the past several years, we’ve seen states generally grant utilities what they’ve needed in rates in order to shore up financial strength. That’s been a marked contrast with the 1980s and ’90s, when the focus was always to beat up on the utility in the name of lower rates.

As we enter the next few years, many US utilities--particularly in the power sector--will face higher capital costs than has been the case for a long time. Some of the pressure is removed by the fact that much electricity is now produced competitively, mostly by unregulated units of major utilities like Exelon and FPL (NYSE:FPL). But there will still be hefty bills ahead for emissions control from power plants, particularly as global warming becomes more of an issue nationwide.

In addition, some companies face expenditures for bringing their transmission systems up to speed. CONSOLIDATED EDISON (NYSE: ED) in New York, for example, is under fire for outages this summer in Queens, which a recent regulator report blamed squarely on management negligence.

As utilities make these expenditures, they’ll be increasingly depending on regulators to allow recovery through rates. As a result, it will be ever-more important to monitor the cases that do come down the pike, not just for their immediate impact on affected companies but for implications about future rate cases.

The good news is in early 2007 the spirit of compromise continues to prevail nationwide. Not every utility is getting everything it wants. But despite spiking natural gas and coal prices--which have been passed through to customers--regulators in most states are taking into consideration the long-term financial health of companies when they make their decisions.

The pressure to deny companies what they need may grow if costs continue to rise or the US economy enters a prolonged slowdown. And some states like Illinois are showing some worrisome signs of slipping back into the bad old days. But the positive examples are still far outweighing the bad and even formerly harsh climates like California, Missouri and Nevada are now poster children for what utility/regulator cooperation can accomplish.

Looking ahead, my approach will be to focus on the better regulatory climates as much as possible, and to avoid companies operating in places that appear to be deteriorating. The exceptions are utilities that are diversified and powerful enough to withstand setbacks, just as AES and Verizon will do in Venezuela and Exelon will do in Illinois.

THE BIG PICTURE

The lesson here for investors is you can’t avoid regulatory risk entirely with utilities. And even if you completely avoid utilities, you’re still going to have regulatory risk with virtually any industry you invest in, from pharmaceuticals to Super Oil companies.

There are a lot of things you can do, however, to minimize the impact of regulatory risk on your overall portfolio, just as AES, Exelon and Verizon do with their businesses. That includes being on the alert for trouble spots. But more importantly, it means not putting yourself in a position where a single adverse development can have an inordinate adverse impact on your financial well being.

Those who put their entire savings into Canadian income trusts this year took a hard knock when that country’s government issued its proposal to begin taxing trusts as corporations beginning in 2011.

Energy producer trusts are still bleeding. But the damage from taxation proposals is done--it’s baked into prices and the individual trusts are now trading on their business prospects again.

There’s also a good chance the ultimate legislation will be tweaked further in investors’ favor, particularly with hearings now being held in parliament.

Those who held trusts as part of a diversified portfolio of income investments last year likely came out ahead in the trust decline, as the money moved into utilities and other investments and pushed up prices. Those who heavily weighted trusts before this event, however, are likely to sit with red ink for a while--even if they’ve been buying only the strongest trusts.

The point is to keep a lookout for weakening situations and to focus on the strongest regulatory climates. But protect yourself from those inevitable anomalous situations with diversification. That’s a sound philosophy for any market environment.