Analysts: Down on utilities. Is the party over? That’s the tough question posed in a research note by Wachovia equity research analyst Samuel Brothwell.
Fossil Plant Decommissioning: Tracking Deferred Costs in a Competitive Market
and periodically summarize them in terms of unit costs and net salvage factors:
Gas & Coal
Oil Units Units
1993 Cost Level $30/Kw $ 40/Kw
Removal Date Cost Level $62/Kw $174/Kw
Net Salvage Factor (37)% (49)%
While I find net salvage factors less meaningful than unit costs, the two measures do tend to correlate for the steam units of several of my clients. Thus, I find it reasonable to assume fossil station decommissioning cost levels of about 30 to 50 percent of the current depreciable investment. However, these costs are somewhat conservative, because escalation is applied to salvage amounts and removal is assumed to occur in the year in which the last unit at each station is retired.
Charts 1 and 2 show data derived from my site-specific estimate collection. Chart 1 covers coal units and Chart 2 gas and oil units; both show cost estimates expressed as amounts per Kw of capacity in relation to the average size of the generating unit or units. Charts 1A and 2A show amounts at the 1993 price level and Charts lB and 2B show amounts at the price level at the estimated date of retirement. The correlation to size for the 1993 amounts gets a bit fuzzy when cost escalation is introduced, especially for coal units.
The estimates on Charts 1 and 2 vary widely from station to station, as do the net salvage factors on Chart 3. Several reasons undoubtedly explain these variations. For instance, about a dozen different estimators are involved. And estimators are understandably reluctant to share their secrets, especially demolition contractors.
Regulatory Cost Deferral
Regulators generally do not like the negative net salvage produced by decommissioning, because it leads to higher depreciation rates and, in the short term, to higher tariffs. Therefore, they commonly defer recognition of decommissioning costs in utility depreciation rates. This task is easier at fossil stations because not much historical experience exists to be explained away.
Query: Can we determine whether regulators are in fact deferring fossil plant decommissioning costs?
If one excludes Florida and Pennsylvania (these two states do not include fossil station decommissioning costs in depreciation rates), industry data shows that state public utility commissions (PUCs) generally are approving decommissioning cost (negative net salvages) factors for fossil-fired steam generating plants in a range of 5 to 10 percent. That range clearly demonstrates the degree of deferral that exists, since, as noted earlier, fossil station decommissioning cost estimates range between 30 to 50 percent of the current depreciable investment.
The most common deferral practice sets depreciation rates on the basis of decommissioning costs at the current price level, which causes the depreciation rates to increase when the utility periodically recalculates future decommissioning costs as generating units grow older. But under my interpretation of the AICPA definition of depreciation accounting, these increasing depreciation rates will not comply with GAAP. I believe that GAAP will permit such increases in depreciation rates only if the usage of the underlying assets also increases. However, usage of fossil-fired generating units will likely stay relatively constant or decrease over