Nowhere are the failings of traditional utility regulation more evident than on Long Island. The New York Public Service Commission (PSC) has raised rates for the Long Island Lighting Co. (LILCO)...
Rate Unbundling: Are We There Yet?
comparable groups do not exist for unbundled services, especially for T&D. Absent
comparable groups, the job of accurately setting unbundled ROEs requires a detailed review and breakdown of the costs and risk exposure of the various components of the utility's assets, separated by business function: generation, T&D, and (where applicable) gas services. This analysis would likely require collecting a massive amount of data, some of which is not readily available.
As for when, some utility representatives have argued that unbundling risks now would amount to nothing more than an accounting exercise, since rates are not yet unbundled, and would hinder the IOUs' abilities to compute their annual revenue requirements. Further, several jurisdictional issues between the FERC and the CPUC regarding transmission pricing, in light of the CPUC's decision regarding unbundling, complicate the implementation process.
GENERATION IS RISKIER
Both financial analysts and industry players agree that the bulk of the risk faced by IOUs today lies primarily with the generation function. First, the generation function is being opened to competition; the T&D function, at
present, remains largely a monopoly insulated from competitive risk. Second, the generation function is inherently riskier due to the variability associated with its inputs, such as fuel prices and availability, and construction risks associated with new generating capacity.
For example, the criteria Standard & Poor's (S&P) developed for its bond ratings of electric utilities demonstrate that the majority of business risks faced by utilities arise from the generation function (see Table 1 on next page).3
This is not to say that the T&D function does not carry its own risks, such as those associated with prudent use of the T&D system and recovery of capital investment in new facilities and upgrades of existing facilities. However, on balance, the risks of producing kilowatt-hours (generation) are significantly greater than the risks of delivering them (T&D).
In fact, the FERC's 1991 ruling on the Nevada Sun-Peak case,4 which allowed a ceiling of 15 percent for that EWG's ROE, indicates that exempt wholesale generators (EWGs) bear more risk than an electric utility, which provides both generation and T&D.
As a third example of relative risk, for illustrative purposes, we examined the difference in betas (as a proxy for risk) between the competitive and regulated arms of the natural gas and telephone industries, which have recently been restructured. In the natural gas industry, pipeline companies (which operate in a competitive industry) post a higher beta (em 0.92 on average (em than local distribution
companies (regulated natural monopolies), which show an average beta of approximately 0.64.5 Similarly, during the last decade, the telephone industry was deregulated and long-distance carriers were exposed to competitive risks. ROEs for long-distance carriers increased steadily due to increased competition, while ROEs for the regional Bell operating companies (the regulated arm) remained relatively constant.6
More competition, and less of a safety net once direct access has been established, will continue to increase the risks associated with the generation side of the business for integrated utilities. Therefore, unbundling of the utility's functions and the cost of capital should occur sooner