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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

The creation of the RBF may create a balance between the risk and reward from the customer’s perspective, but what about the responsibility of the utility to build this project on budget and operate the plant efficiently? A construction incentive could be established by setting a cost cap where the utility and consumer share in all savings below an established target.

On the operating side, if the customer gets all the benefits, the responsibility-reward paradigm is seriously unbalanced. Customers may be getting all the benefits produced by the project, but are all the benefits being produced? Based upon decades of experience with fuel-adjustment clauses that produced massive disincentives to power-plant efficiency, the answer is an unambiguous “no.” The loss of 10 percentage points in capacity factor at a 500-MW unit could increase the cost of electricity by $10 million/year. The enormous savings of RBF must be coupled with an operating incentive. The exact nature of the incentive will depend upon many factors, including the facility being discussed, the overall risk-reward balance, wholesale- and retail-market structure, and jurisdictional restrictions. Potential approaches could include establishing benchmarks for capacity factor, heat rate, fuel prices, or market management and then allowing some level of a sharing if these benchmarks are exceeded. By balancing RBF with operating incentives, great financing savings can be achieved without sacrificing operational efficiency.

Meeting Green Expectations

Renewable energy or alternative energy requirements are being mandated in a growing number of states. Utilities and other load-serving entities are being required to meet an increasing portion of the retail electricity load that they serve with renewable (e.g., wind and solar) or other alternative resources (e.g., waste products as fuels such as waste wood or culm, or specific technologies such as ICCG). Sometimes load management and conservation and other demand-side resources (DSR) are included in these portfolios. Because of the vast variety of programs and potential business structures, one type of balanced RBF may not be universally applicable to all situations. When the utility owns the renewable or alternative resource being developed and the technology is a typical boiler plant, the paradigm set forth for base-load generation may be applicable.

But what type of an RBF can be used when the resource is owned by a third party and when the facility is powered by the sun or wind? Using RBF to fund a project like a wind farm owned by someone other than a regulated utility might start by the utility entering into a long-term contract with the developer for the project’s output, even before construction has started. At completion, using the utility’s pledge as collateral, the developer could refinance the project using RBF. The purchased-power agreement could require that a certain amount of power be delivered to the utility, with a portion of the revenues being set aside to repay the bond. The power would be priced to reflect the enormous savings in financing costs.

Advocates for renewable and alternative resources often cite the importance of long-term contracts with utilities to get attractive financing. The use of RBF just takes the concept to