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Mitigating "Mandated" Rate Hikes

How to develop balanced revenue-backed financing to manage the impacts of governmental mandates.

Fortnightly Magazine - May 2007

fashionable in the 1990s.

Unfortunately, these examples have at times produced imbalances between risk, reward, and responsibility. Municipal utilities frequently are accused of not having enough profit incentive to encourage efficient operations. Some fuel clauses made some utilities indifferent to power-plant performance, leading to capacity factors of base-load plants that were far lower than found achievable when performance incentives exist. Some stranded-cost recovery plans were based upon long-term forecasts without reconciliation between actual and forecasted stranded costs causing inequities. This experience demonstrates that there is a need to bundle RBF with either regulatory or market-based incentives to keep the risk-reward-responsibility paradigm in balance.

Will of the State

Governmental mandates on electric utilities are being focused upon because such utility action already has been required. Sometimes an RBF takes legislative enablement to allow the regulatory commission to irrevocably pledge certain assets. Given the need for legislative support, or just the serious step a commission must take to pledge resources irrevocably for an RBF, the existence of a mandate makes the application of RBF more applicable and palatable. Some of the recent mandates by state or federal governments that can be delivered more cost-effectively through the application of a balanced RBF include:

• Base-load power-plant development;
• Default-service responsibilities;
• Transmission and distribution reliability;
• Renewable or alternative energy portfolio requirements;
• Environmental-compliance mandates; and
• Demand-side resources.

This extraordinarily diverse list is not meant to be all-inclusive, rather a sampling of how balanced RBF can address some of the many existing mandates facing electric utilities. Each of these mandates can exert enormous upward pressure on a utility’s rates. The suggested solutions are designed to mitigate this pressure through a combination of upfront financial savings and ongoing cost-effectiveness incentives, which may be applicable in jurisdictions with or without retail choice. It is important to screen and rank the many opportunities to which a balanced RBF may be applied, as there may be a limited will by regulators, legislators, and the financial market to accept these programs.

Base-Load Mandates

Developing new base-load generation has been encouraged or mandated in certain jurisdictions. For simplicity, assume that the utility will own and build this plant. Some of these mandates have been supported by upfront guarantees of revenues, similar to the assurances necessary to support an RBF. The decision already has been made by the appropriate governmental authorities that this is the type of plant that should be constructed. The challenge is to get this asset built as inexpensively as possible while having that plant operated efficiently.

As noted above, financing a $500 million base-load generating plant at 100 percent debt of “AAA” RBF can produce first-year savings of $30 million (a reduction in revenue requirement associated with financing costs from $65 million to $35 million) and a 40-year life-cycle savings of $600 million compared with traditional utility financing. As there is no equity component in this example or any opportunity to revisit prudence in the future, the risks associated with the plant’s construction have been placed on the utility’s customers in exchange for the significant cost savings.