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Mortgaging Your Conservation: A Way Out for Stranded Investment?Andrea L. Kelly and Donald E. Gaines

Fortnightly Magazine - October 15 1995

company, its customers, and the region.

The DSM program also effectively suppressed the kilowatt-hour sales from which the company normally derived its revenues. The disincentive associated with lost margins was recognized by the UTC, which in 1991 approved an annual adjustment mechanism that permitted dollar-for-dollar recovery for approved DSM investment in addition to recovery of fluctuations in power costs. The periodic rate adjustment mechanism (PRAM) replaced kilowatt-hour-based revenues with revenues based on the number of customers served. This decoupling was critical since Puget Power was spending $50 million and more annually on conservation.

Blue Book Fallout

As annual investment in DSM grew, so did Puget Power's regulatory asset (em an asset that could not be pledged as collateral for the issuance of securities. In principle at least, one could say that the company's DSM program had been funded entirely with equity. However, under traditional cost-of-service regulation, DSM was included in rate base and recovered through rates as if financed at the utility's authorized weighted average cost of capital.

When the California Public Utilities Commission issued its "Blue Book" in early 1994, proposing to allow customers to choose their electricity provider, major credit rating agencies and equities analysts changed their views about the pace of increasing competition and deregulation. As Moody's

Investors Service noted in an April 1994 special research report:


"Beyond California, we anticipate that industrial customers, in anticipation of the spread of retail wheeling, will increase their leverage in their negotiations with their own electricity providers for lower prices. In addition, other state regulators may feel pressured by the increased pace of deregulation."Because independent power producers, wholesale power marketers, and other nonutility providers do not bear costs associated with public-policy objectives, utility regulatory assets quickly attracted the scrutiny of the capital market. Puget Power as quickly turned a weather eye to its credit rating.

Puget Power's solution was to secure legislation that would provide a statutory basis for recovery of its largest regulatory asset, easing financial community concerns regarding ultimate recovery of its DSM investment. In turn, the cost to customers of financing the outstanding DSM investment was dramatically reduced.

The book on Puget Power's ability to recover rate-based DSM investment is thus closed. But, for other utilities with regulatory assets or more serious stranded-investment concerns, a new chapter may be unfolding. t

Andrea L. Kelly is a policy research specialist on the staff of the Washington Utilities and Transportation Commission in Olympia, WA. Donald E. Gaines is the treasurer for Puget Sound Power & Light Co. in its Bellevue, WA, headquarters.From the Legislature The 1994 Washington state law creates new classes of property known as "conservation investment assets," "bondable conservation investment" (BCI) and "conservation bonds." When an electric, gas, or water utility incurs specific expenditures under a "conservation service tariff," the law provides a statutory guarantee of rate-base inclusion (investment and carrying costs) and revenue recovery ("sufficient to recover BCI and the costs of equity and debt capital associated with it"). BCI includes all expenditures for conservation measures that improve efficiency of energy or water consumption if:

(1) the