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
time. This conclusion is based on my interpretation of the word "salvage," in the AICPA definition, to mean net salvage. Some contend otherwise (that "salvage" means "salvage"), thereby allowing cost of removal to be excluded from depreciation and recorded as a liability on a discounted basis.
State PUCs might also defer fossil decommissioning costs by 1) sinking fund depreciation, 2) purposely underestimating costs or future cost escalation, or 3) using a cash basis instead of accrual. Other deferral practices include:
Missouri. No recovery for fossil stations.
Pennsylvania. Recovery over 5 years following expenditure (all facilities but nuclear stations).
Texas. No current recovery of fossil plant net removal costs above 5 percent of current depreciable investment.
The Coming Competition
Deferrals of decommissioning costs for fossil-fired steam generating plants carry important implications for electric utilities during the transition from a regulated to a competitive environment.
Power-supply activities in a competitive environment may involve any one or all of a number of corrective actions, including 1) a writedown of "impaired assets," 2) a write-off of "regulatory assets" (paper assets representing regulatory promises of future cost recovery), or 3) increases in the rate of depreciation made mandatory under a switch from regulatory to nonregulatory GAAP accounting to compensate for past depreciation deferral and to preclude future deferrals.
Collectively, these corrective actions fall under the rubric of stranded investment. An active debate exists about whether investors or customers should bear costs associated with stranded investment. Since each of these possible actions arises from regulatory promises of future cost recovery, logic suggests that customers should pay. Nevertheless, this conclusion may not hold for impaired assets or depreciation rate increases if regulators have never before been apprised of the extent of the decommissioning obligations.
Impaired Assets. In March 1995, the Financial Accounting Standards Board (FASB) published new rules in Financial Accounting Standard (FAS) 121. Under those rules, asset impairment occurs when undiscounted future cash flows from asset use and eventual disposition fall below the asset carrying amount (plant in service less future net salvage and depreciation reserve).
In such a case, decommissioning costs incurred at the end of plant life will create significant differences between discounted and undiscounted cash flows. Thus, under the FASB definition, the deferred depreciation methods in common use for fossil-fired plants will increase both the chance and the magnitude of asset impairment.
Switching to GAAP. If competitive electric prices emerge, set by the market rather than by cost regulation, then electric utility accounting must move out from under FAS 71 (Accounting for the Effects of Certain Types of Regulation), and switch to GAAP, as directed by FAS 101 (Regulated Enterprises (em Accounting for the Discontinuation of FAS 71).
In the switch to GAAP, the depreciation rate increases that would be needed to recover from past depreciation deferrals can be determined from the periodic studies typically conducted to test the continued validity of depreciation rates. If my sample is any indication, the process of eliminating past deferrals and precluding future deferrals would force up fossil station depreciation rates by about 50 percent.
Remedies. Many electric utilities