(November 2008) Economic uncertainties are raising doubts over utility returns. Will regulators feel the need to consider broader economic effects when engaging in ratemaking? While...
Return on Equity: Gen Sector Issues
Ratemaking Special: A survey of recent retail rate cases for electric and gas utilities.
The results of annual survey of rates of return on equity authorized for major electric and natural-gas utilities-based on a sample of the retail rate cases conducted by state public utility commissions (PUCs)—show a vibrant and perhaps growing interest in traditional rate-of-return regulation.
This year's survey contains several rate-case entries that mark the first rate changes in 10 years or more. These entries show how traditional rate cases can smooth out consumer prices in the face of short-term spikes in wholesale power costs. Rate cases also allow state regulators to reconcile monopoly regulation with the radical shifts in policy that have followed from some implementation of competitive markets.
Importantly, the results reveal an ongoing debate on whether and how PUCs should tailor return on equity (ROE) determinations to take account of new, extrinsic, industry-wide risks. Such extrinsic risks conceivably could include such factors as resource adequacy, fuel-price trends, quality of service, establishment of regional markets and grid system operators, ratepayer price elasticity, or general macroeconomic ups and downs.
Consider, for example, certain recent ROE determinations from Arizona, California, and New Hampshire. They pose questions on how PUCs should respond to restructuring in the generation sector, which has led to plant divestitures, a greater reliance on wholesale purchased power to assemble a resource portfolio, and predictions of future savings in wholesale power costs, driven by competition.
Gen-Specific Risk: Higher or Lower?
A recent rate order from New England sheds new light on utility risks associated specifically with the operation of generation assets-usually considered to exceed the level of risk inherent in electric transmission and distribution activities. But in the case in question, involving Public Service Co. of New Hampshire (PSNH), the PUC came to a perhaps unexpected result. In the special rate case for gen-specific assets (decided in June, after the PUC had completed a rate review of distribution-only service), the PUC set a new, allowed gen-specific ROE of only 9.63 percent, which includes a gen-risk premium of only 21 basis points. The final rate of 9.63 percent fell below both the utility's previously approved overall ROE (11 percent on gen, transmission, and distribution, set eight years earlier), and its request as proposed in the special gen-sector case (11.34 percent). ()
Understand, however, that PSNH stands as the only electric utility in New Hampshire required by law to retain ownership of its fossil and hydro-powered generation assets. The company also enjoys added state-law protections, such as guaranteed recovery of gen-plant upgrade costs to meet environmental requirements. In practice, PSNH sells the output of its gen fleet into the wholesale market, buys back the supply needed to satisfy its own default load (to serve standard-offer ratepayers), and then credits back to default customers any net gain it earns from market transactions.
Given this unique situation, the state commission concluded that PSNH faced a relatively low risk, and set ROE for generation at the lower end of the scale indicated by various financial models. But the PUC gave