In several recent utility rate cases, regulators have disallowed portions of utility compensation expenses, on the basis that difficult local economic conditions justify pay cuts. However, when...
The Reliability Spending Conundrum
example, the model should show how tree trimming affects one aspect of electric reliability, as well as how adding new lines and substations affects another aspect of reliability. Ideally, the model should have a dual function of optimization and prioritization. That is, it should help determine not only the right level of spending, but also which programs should be funded and in what order.
Typically, this type of model can be represented in a funding curve like that shown in Figure 2. On the horizontal axis, the curve shows the level of funding, starting from a basic minimum and increasing as additional discretionary programs are added. On the vertical axis, various measures might be used, from a simple point-scoring method to an appropriate valuation method that computes the incremental benefits associated with the incremental cost of each program.
The trouble with the point-scoring approach is that it can prioritize but not optimize. It can tell you which projects to do in what order, but it cannot tell you what the right level of spending should be. To accomplish that, the model must be able to predict the impact on service indicators and to value that service in such a way that when the incremental value/cost ratio equals 1.0, the right level of spending has been achieved. This method has been shown to be a good test of prudency, and it can subsume the other two measures. In fact, a good model can explain the trend in spending and performance and make the benchmarking moot.
One of the advantages of such a model is that it only gets better with time. As the relationships are proven out and refined, the confidence in the model's predictions grow, and the conclusions become even more compelling and credible. The model's elaborate detail will allow you to fine-tune optimization and prioritization.
Boards Care Too
Utility executives will find that their boards of directors are equally concerned about achieving the right and prudent level of spending. Board members know that one of the key risks in utility finance can be the disallowance of costs for rate recovery. They also recognize that they may be forced to significantly increase spending to address a perceived or real service quality problem. Knowing that spending levels are right and prudent for ensuring service helps directors feel good about approving business plans.
So, what is the right and prudent level of spending? To make your case and make it firmly, apply all three tests. If the first two support your case, that's good. If the two tests are inconclusive, be prepared to explain why you think they are not relevant. In either event, rely on the third approach, modeling, to provide not only a conclusive answer but also a way to achieve the promised results, to monitor progress, and adjust if necessary. To do anything else would not be prudent. And that means it would not be right.
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