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Rate-Base Cleansings: Rolling Over Ratepayers

State PUCs should recognize a refundable regulatory liability for past charges to ratepayers.

Fortnightly Magazine - November 2005

have increased public utility depreciation rates. The marked-up rates produced depreciation charges far in excess of the amount necessary to return capital to investors over the lives of utility assets.

As a rate regulator, a state PUC can impose a refundable obligation. For example, it may increase a public utility's current service rates to recover costs expected to be incurred in the future, with the understanding that if those costs are not incurred, the utility's future rates will be reduced by corresponding amounts. This obligation to pay future costs or refund the excess is a "regulatory liability." 1

The Difference Between Legal And Non-Legal AROs

FASB's SFAS No. 143 addresses asset retirement obligations (AROs) associated with long-lived plant. It applies to both regulated and unregulated companies. Legal AROs are "legal obligations that a party is required to settle as a result of an existing or enacted law, statute, ordinance, or written or oral contract or by legal construction of a contract under the doctrine of promissory estoppel." 2

When a company has a legal ARO, the discounted fair value of the related asset retirement cost (ARC) is capitalized and depreciated. A legal ARO results in an increased charge to depreciation expense by virtue of the higher asset cost, as long as there is a legal requirement to incur the future cost.

Many utilities do have legal AROs. The obligation associated with the retirement of nuclear plants whereby the company is legally required to perform decontamination activities when the plant ceases operations is a legal ARO. If a utility determines that it has collected too much for a legal ARO decontamination expense, it is required to report the excess collections as regulatory liabilities.

Moreover, SFAS No. 143 also addresses "non-legal" AROs. A non-legal ARO is an estimated future retirement cost for which there is no actual legal obligation or liability. 3 SFAS No. 143 requires reporting of non-legal AROs as regulatory liabilities to ratepayers because there is no legal obligation to incur these costs. 4 Thus, if a utility either collected too much for a legal ARO or has collected money for non-legal AROs, SFAS No. 143 requires it to report them as regulatory liabilities.

Since the doctrine of promissory estoppel provides substantial leeway in qualifying an ARO as legal, the threshold tests are low. The fact that an ARO is not legal under that doctrine suggests that the obligation is doubtful. By definition, non-legal AROs are not "liabilities"; they are not "probable" future sacrifices of economic benefits. 5 Non-legal AROs are ambiguous and they are not even conditional obligations. 6 Any conditional obligations, or even promises to spend the money for cost of removal, would qualify as legal AROs.

Yet, regardless of the low threshold, the utility industry still reports billions of dollars of regulatory liabilities resulting from non-legal AROs. The industry acknowledges that it does not have any obligation to remove its plant or to spend the money it has collected from ratepayers for that presumed purpose. Explicitly, it has not promised to spend the money for its intended purpose, and