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DEPRECIATION, DEFERRAL, DENIAL. I have often discussed in Public Utilities Fortnightly the tendency for regulation to defer the recording and recovery of depreciation expenses. Therefore, Mr. William C. Schaeffer's discussion of this subject in the February 1, 1998 issue (see "Mail," p. 11) attracted my attention, especially his quoted claim of the Delaware public advocate that investors should be neutral to depreciation deferral on a present value basis.
My experience has been that present value arguments in regulatory proceedings relative to depreciation are in support of deferral. Regulators set tariffs based on nominal (undiscounted) amounts, so customers pay nominal amounts for service. Therefore, discounting does not provide a reasonable basis for determining the effect of depreciation deferral on customers.
Rate base regulation causes the effect of depreciation changes to reverse in the long-term, and to have more impact on return and related tax component of revenue requirements than on the depreciation expense component. Therefore, deferral of depreciation will provide a small near-term tariff decrease and a large long-term increase. It is clear that discounting serving as the basis for depreciation deferrals is detrimental to the long-term interests of customers, to the long-term competitiveness of the utility, and to the economy of the service territory.
Even the argument from the standpoint of investors should be questioned. It assumes the investor's cost of capital is actually earned, which may not happen. An even more significant concern is that deferral may become denial. The potential for denial and inability to earn cost of capital is demonstrated by the large asset impairment write-offs of telecommunication companies as a result of inadequate depreciable lives for regulatory purposes, starting with US West in 1994, and by the recent electric company write-offs in Illinois and Pennsylvania as a result of legislation affecting recovery of stranded costs.
John S. Ferguson
Principal, Ferguson Associates
Editor's Note: As "Showdown in Latin America" (April 1, 1998) went to press, one of the key companies profiled in the piece (em Chilgener, Chile's second largest generation utility (em changed its name to Gener to reflect its growing international interests. The company administers about 5,000 megawatts of power in Chile, Argentina and Colombia and is eyeing opportunities in Brazil. In 1998, Gener plans investments of about $400 million.
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