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Facing the Climate Challenge

Climate risks are entering the calculus for utility investment strategies.

Fortnightly Magazine - August 2006

presented as part of an overall strategy for managing energy-price risks. But the real challenge of environmental leadership is not in developing technology or promoting it to customers, but in mustering the political will to socialize some share of the investment cost.

“PUCs are willing to run utilities almost into bankruptcy to keep rates down,” says Doug Dunn, a partner with Milbank, Tweed, Hadley & McCloy in New York and chair of its utility practice. “That endangers future generation investments, but the lesson has never been learned by the PUCs.”

However, facing the complex challenges of improving supply diversity while also protecting the environment, some utilities and rate regulators are adapting the regulatory compact to support a long-term technology vision.

In April 2006, the Ohio PUC granted American Electric Power’s (AEP) request to recover nearly $24 million in pre-construction costs for the company’s proposed integrated gasification combined cycle (IGCC) project. This pay-as-you-go approach is relatively novel in the electric power industry, but AEP’s experience offers hope for power generators seeking to pioneer the next generation of power-generation solutions. In Minnesota, the state PUC is reviewing a proposed power-sales contract that would require Xcel Energy to buy power from an IGCC facility proposed by Excelsior Energy in Northeastern Minnesota. The agreement would allow Xcel to pass the technology premium through to ratepayers. And DTE is contemplating investments in nuclear and IGCC projects, while grappling with the challenge of undertaking next-generation investments without overburdening shareholders with technology risks.

“With large investments it would be advantageous if we could take our plant to the commission and have them approve cost-recovery up front,” Boyd says. “It certainly would take away some of the risk. Periodically we have that conversation with the commission, but we haven’t asked for a specific ruling.”

Utility commissions naturally are skeptical about rate-recovery requests, especially novel ones that ask ratepayers to bear R&D costs that will benefit shareholders. But the pay-as-you-go idea might gain momentum as part of state integrated resource planning (IRP) proceedings, or during project-permitting processes to obtain certificates of public convenience and necessity.

“Regulators won’t like the idea, but it has to be part of the conversation up front,” Dunn says. “Otherwise, investors won’t put money into something that must face a prudence review at the end.”