How to benchmark return on equity (ROE) and depreciation expense in utility rate cases.
The Reliability Spending Conundrum
What is the right and prudent level of spending on service?
Times have changed for electric utilities. The combination of deregulation, mergers, major storms, and widespread outages has shifted the industry's emphasis to reliability. That wasn't always true. Even 20 years ago, the growth of load was adding so much to ratebases and driving such large rate increases that regulators spent a lot of time reviewing plans for capacity additions-and challenging utilities for over-spending. Because of these "prudency reviews," excessive costs sometimes were disallowed as additions to ratebase.
Generation today is deregulated in many states, while many states have excess supply. And concerns about reliability are escalating. Consequently, regulators are focused on whether utilities are spending enough money to ensure quality of service.
Trending, benchmarking, and modeling are three good tests utilities and regulators can use to determine the right amount of spending for the desired quality of service.
One of the most commonly used tests for spending prudency examines the trend of spending and service levels. Looking back over a specific time period, what has the utility spent on reliability, service, or system integrity? How does that compare to service level and performance over the same time?
Take five years of spending on reliability, service, or system integrity, and compare that with five years of service level performance. If the results look like Figure 1, where spending and service are both going down, there is a problem. The utility either is not spending enough or not spending it prudently.
Some utility executives may consider trending a backward-looking, late-emerging test. If trending is known to be part of the utility's review process, it can cause forward-looking decision makers to take action in advance to avoid the situation. If a utility is decreasing its spending on service-related categories, it would do well to ensure that service levels are trending up. When the curves slope in opposite directions, the case that spending is inadequate or imprudent is less compelling.
When there is more than one indicator of spending or service level, the test is more complicated. For some utilities, "inconclusive" results may be considered good enough. However, for more progressive organizations, the objective (and challenge) is to ensure that the results tell the same positive story: spending is going down and service problems are going down too. This will help stabilize rates, continue service improvements, and beef up return on investment.
The results of benchmarking to determine whether the spending level is right and prudent also can be either ambivalent or compelling. Presumably, a company that spends less than its peers on service-related problems, and which has a better service level, has no problem. But is that all there is to it?
Many companies want all their benchmarks to be in the first quartile or even the first decile-where "first" applies to the end of the scale with low costs and high levels of service. Other utilities may have a compact with their customers and regulators to find the right point along some tradeoff curve between cost and service.
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