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Rate Unbundling: Are We There Yet?

Fortnightly Magazine - February 15 1996

the FERC's jurisdiction, the FERC must rethink the manner in which it requires utilities to calculate rates. Doing so will help maintain proper price signals and promote fair competition among power generators. t

Susan Stratton Morse, CFA, is a financial analyst/advisor and a co-founder of the firm of Morse, Richard, Weisenmiller & Associates, Inc., Oakland, CA. Her testimony and this article were developed jointly with Meg Meal, CFA, also a financial analyst and a principal at MRW. Melissa Lavinson is an associate at MRW.

The Case for Unbundling Cost of Capital

Despite moves toward electric deregulation, state regulators typically do not distinguish between the generation and T&D functions in setting capital structure or ROE. The costs of capital for each segment are quire different. Failing to recognize this difference produces misleading risk profiles.

As long as utilities retamin regulated and have bundled capital structures, regulators must measure risk appropriately for unbundled services to ensure accurate pricing. Unbundling the cost of capital hand-in-hand with electric services will:

. prevent cross-subsidization between generation and T&D

. prevent cross-subsidization between full-service customers (i.e., those who buy generation, transmission, distribution, and other ancillary services) and customers buying only certain services (e.g., transmission)

. send clear and correct price signals to customers and generation providers

. allow market forces to determine the appropriate ROE and investment returns for the generation sector.*

*From Testimony of Susan Stratton Morse on Behalf of the Independent Energy Producers Association on Recommendations for Determining the Allowed Return on Equity for California's Electric Utilities in Light of Restructuring. A.94-05-009, page 6, August 15, 1994.

1. From Testimony of Susan Stratton Morse on Behalf of the Independent Energy Producers Association on Recommendations for Determining the Allowed Return on Equity for California's Electric Utilities in Light of Restructuring, A.94-05-009, August 15, 1994.

2. Re Sierra Pacific Power Co., Application 94-05-009, Decision 94-11-076, Nov. 22, 1994, 158 PUR4th 217.

3. Criteria taken from "Credit Comments," Standard and Poor's Creditweek, October 11, 1993, pages 7-12.

4. FERC Docket No. ER91-11-001.

5. From Testimony of Susan Stratton Morse on Behalf of the Independent Energy Producers Association on Recommendations for Determining the Allowed Return on Equity for California's Electric Utilities in Light of Restructuring. A. 94-05-009, page 29, August 15, 1994.

6. Id.

7. FERC Docket Nos. ER88-478-000, ER91-576-000.

8. Wagener, David P., "Letting Go of Electric Generation," PUBLIC UTILITIES FORTNIGHTLY, Feb. 15, 1995, pp. 33-35.

9. For the purposes of this article, we chose to use information from SCE to demonstrate ROE differentials since SCE offers only electric-related services, as opposed to PG&E and SDG&E which offer both electric- and gas-related services. However, applying our methods to these other utilities yields similar results.

10. From Testimony of Dr. Lawrence A. Kolbe on Behalf of Southern California Edison on Cost of Capital Restructuring Effects, CPUC A.94-05-017, May, 1994, pp. 10-12.

(FN) Represents the difference between the expected return on the market portfolio (Rm) and the risk-free rate (Rf), as presented in SEC's Open-access Transmission Tariff filing at the FERC (Dkt. ER96-222-000).

11. From CPUC D.94-11-076, page 24.

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