When microgrids are optimized in a smart grid, they’ll usher in a new era of utility resilience and flexibility. Get ready for dynamic microgrids.
Banking on the Big Build
The need for many hundreds of billions of dollars in capital expenditures creates huge opportunities and challenges, especially in a more challenging credit environment.
benefited from below-market prices for many years, and even though the structure for the generation auctions had been approved by FERC and by the Illinois Commerce Commission, the one-time shock of a step-up to market prices created a dynamic where politicians extracted a $1 billion settlement from Exelon and Ameren (with relatively modest contributions from Dynegy and Edison Mission) under the threat of retroactively extending the rate freeze and/or imposing additional taxes on generators.
Precedents from the previous cycle of nuclear-plant construction are not encouraging with respect to allowing utilities a fair return on their invested capital. The ability of regulators to conduct after-the-fact reviews of prudence allows them to apply the perfect wisdom of hindsight. Therefore, the more that utilities are able to obtain cost recovery during construction, through construction cost riders and other mechanisms, the more financeable their projects will become. Where real-time recovery of construction costs is not possible, keeping regulatory lag to a minimum will become all the more important. On this front, there was an unfortunate example in Arizona recently where Arizona Public Service (APS) was denied relief from its under-earnings situation (the company expects 2007 ROE to be around 7.5 percent versus its allowed ROE of 10.75 percent) that arose because of growth-oriented capital expenditure requirements and regulatory lag in recovery. The ACC rejected APS’s request for accelerated depreciation, inclusion of construction work in progress (CWIP) in rate base, and the earnings “attrition adjustment” (to bring actual ROE toward allowed levels). As a result, APS is put in a position to require routine rate case filings and may need to cut back its planned capital expenditures. The rating agencies have concluded that the inability of APS to receive timely recovery of its large capital expenditures could pressure its future credit profile.
Regulatory certainty is important in other ways. Investor appetite to fund new generating capacity in deregulated markets will depend on market signals being provided by capacity markets. Once in place, it is important that markets be allowed to function freely. Any indication that regulators would seek to limit investor upside through the imposition of price caps, or through changes in the level of such caps once they had been established, while leaving investors fully exposed to the downside, would create an asymmetrical risk profile and would result in an increase in the cost of capital or—in extreme cases—in capital not being available at all on reasonable terms. It is interesting to note in this context that only a relatively small amount of new capacity has been added in California since the last power crisis, so it is likely only a matter of time before the state experiences another supply squeeze.
Market structures also need to accommodate the potential for long-term contracts in deregulated markets. Given their bad experience in the early years of this decade, it is unlikely that investors will fund large new investments in generation purely on a merchant basis. In this context, it is helpful to see the Illinois Senate’s recent passage of House Bill 3388, allowing utilities to enter into long-term