[BETA] Fortnightly

A coordinated approach helps control costs.

Historically, transmission and distribution assets have been quiet utility stepchildren- generally ignored by both regulators and senior utility management while, their generating asset relations remained in the limelight. But as restructuring of the electric industry evolved in the 1990s, a looming competitive environment created strong pressures within utilities to reduce spending.

Many utility distribution engineers will tell you that under-investment has been occurring since that time. Rate freezes, the removal of regulatory protections for generating assets, and management of transmission and distribution (T D) assets by holding companies with significant unregulated operations also have contributed to pressures to reduce spending on T D assets and infrastructure.

The problems created by reduced infrastructure spending are evident when one considers the highly capital-intensive cost structure of the T D business. Electric utilities are roughly three to four times more capital-intensive than other capital intensive industries in the United States, requiring roughly four dollars of physical capital for every dollar of annual revenue The ratio of capital requirements per dollar of annual revenue indicates the value-added of the production process; it measures the willingness of the market to pay for capital recovery. Whereas companies like Intel can recover the cost of a multi-billion dollar investment in four or five years, the electric power industry requires 15 to 20 years to recover investments.

With 40 to 50 percent of total electric system investment historically allocated to the T D sector, reductions in spending are bound to affect the performance of the system. This became very clear on Aug. 14, 2003, when a blackout affected millions of customers and caused perhaps billions of dollars in economic damages. ¹ Belatedly, regulators are realizing that the once placid purview of utility engineers is an important arbiter of costs to customers, potentially more so than generating assets whose costs they have historically focused on.

This new focus on T D assets raises several critical questions for utilities and regulators alike. First, what does prudent management of a utility's T D system require? A utility can defer routine maintenance and save money in the short run, but it risks unanticipated costs in the long run. Reducing budgets for tree trimming, for example, is a simple way to cut costs, at least until a power line sags onto a beckoning branch and causes a catastrophic outage.

On the other hand, replacing perfectly functioning assets simply because they have reached a given age can lead to unnecessary increases in costs. Of course, prudence should not require perfection: unanticipated events can and will happen, regardless of how extensive a utility plans for unexpected events. Moreover, attempting to reduce the likelihood of equipment failures to zero is simply uneconomic.

This raises a second question: What is an appropriate economic approach to manage T D assets? How should a utility allocate scarce capital and expense dollars to maintain its T D system in a way that correctly accounts for the trade-off between higher costs and better reliability? Too often, utilities (and regulators) have adopted simple rules-of-thumb or flawed analytical approaches that misallocate scarce resources, to the detriment of