[BETA] Fortnightly

These are challenging times for the electric and gas utilities. Reliability projects, renewable portfolio standards, greenhouse-gas emissions control, AMI, smart-grid investments, and conservation programs—all these things add to costs, but might bring in no additional revenue. Moreover, there will be unprecedented capital investment in transmission, renewable generation projects, and replacement of old facilities from the 1950s and 1960s. Thus, earnings likely will be more closely watched and traditional general rate cases might not be able to keep up.

Removal cost is the expenditure involved with physical removal or safe abandonment of an asset, and is not a trivial matter, because it is not unusual for such expenditures for long-lived property to exceed the related depreciable investment amounts. Various treatments of removal costs have various effects on utility ratepayers. Of all the approaches the industry uses, ratable treatment through depreciation minimizes the costs borne by ratepayers.

While enthusiastic equipment vendors and zealous environmentalists push for the comfort of mandated modernization requirements, more thoughtful industry stakeholders are seeking to develop a technically and economically rational approach to modernize the T&D network. The core of this challenge lies in making modernization a financially attractive investment and it has two essential ingredients.

A large regional utility forfeited significant operating revenues after it replaced pulverizers at several of its coal-fired power plants. Because the replacement pulverizers were sized to operate at 100-percent capacity during operations using the coal typically procured by the utility, upgraded plants had to be derated following a change to lower BTU-rated fuel. If utility decision makers had used a total cost of ownership (TCO) framework, they could have avoided this situation.

The SEC is taking steps toward substituting International Financial Reporting Standards for U.S. Generally Accepted Accounting Principles. Having certainty surrounding existing utility asset and depreciation accounting practices enhances the ability to use financial statements to accurately depict the results of operations and financial status of reporting entities.

The credit crisis has split U.S. utility companies into the haves and have-nots. Companies that planned ahead are enjoying the benefits of liquidity, while the rest are struggling to manage their financial risks in a volatile market. Nevertheless, companies across the sector are cutting spending and deferring projects as they weather the storm.

Adoption of IFRS (International Financial Reporting Standards) in the United States undoubtedly will mark a significant change for many U.S. companies. But this change should not be feared. Moving to an entirely new accounting structure ultimately might enable companies to streamline reporting processes and reduce compliance costs.

The time has come to revisit where the accumulated provision for depreciation belongs. Utilities objected—some 50 years ago—when it was moved from the right side of the balance sheet to the left side, with good reason. Consistency, comparability, reliability and relevance all demand an end to this strange accounting practice.

When an advisory committee of the SEC voted recently to phase out special accounting treatment for various industries, it signaled the end may be near for power plant depreciation deferral mechanisms. Such mechanisms are a mainstay of regulatory accounting in many states, and their discontinuation could send plant owners and regulators back to the drawing board to find a new, GAAP-compliant way to recognize asset depreciation in financial reports.

The recent breakout of the benchmark 10-Year Treasury yield from the recent mid-4 percent yield band to approximately 5 percent (with some market expectation that it may increase further) potentially has important strategic and value implications for the power and utility industry.