Over the next year (or years), companies in Canada and the U.S. will make the transition towards adopting International Financial Reporting Standards (IFRS). These standards will have a...
Paradox of Thrift
Economic barriers complicate T&D modernization.
Industry interest in transmission and distribution (T&D) network modernization and the ubiquitous smart grid seemingly couldn’t be higher. The infrastructure security challenge that developed in the wake of September 11th, 2001 and the August 2003 blackout elevated the modernization topic, and it has more recently become a white-hot industry need that has been supercharged by the American Recovery and Reinvestment Act of 2009.
While enthusiastic equipment vendors and zealous environmentalists push for the comfort of mandated modernization requirements, more thoughtful industry stakeholders are seeking to develop a technically and economically rational approach to modernize the T&D network. The core of this challenge lies in making modernization a financially attractive investment and it has two essential ingredients. First, investment resources must be available through consumer rates to provide utilities with the capability to invest in T&D modernization. Second, future rates (and ratemaking policies) need to embody the economic relativities of new, rapidly changing (and thus obsolescing) technologies that are replacing the industry’s technically stable assets. In both of these areas, challenging the industry’s conservative investment and depreciation practices likely will be necessary to make widespread, economically rational T&D modernization occur.
T&D network modernization is fundamentally an investment decision; more specifically, network modernization is better characterized as a reinvestment decision. This refurbishment of the T&D network doesn’t add new customers, incremental load, or additional revenue to the electric system. Ironically, many of the positive elements of modernization investments will, in fact, reduce energy sales though conservation and efficiency.
Thus, predicting the likely pace of the industry’s (or any individual utility’s) T&D network-modernization efforts begins with an understanding of how the utilities make such reinvestment decisions. With the exception of those jurisdictions that simply mandate network modernization, the reinvestment decisions made by most utilities will follow logical and economically-rational patterns (see Figure 1) .
Conceptually, T&D investments can be characterized in two ways: first, investments related to new business; and second, the balance of T&D investments related to reliability needs, equipment replacement and reinforcement requirements, and mandated investments such as relocation of system assets. Traditional ratemaking is designed to make new business investment neutral to the existing customer base [through contribution-in-aid-of-construction (CIAC) policies]. The balance of system investment must be economically justified either through existing rates, potential operating cost savings, incremental energy sales, or through planned rate increases.
Although GAAP and FERC accounting practices don’t strictly characterize investments from this new business versus replacement perspective (indeed, investments are characterized by the nature of the assets themselves, not their rationale), these investment reasons are very much a part of the typical T&D investment planning processes and decision criteria.
The level of any utility’s reinvestment activity can be estimated by examining its total investment but excluding the predominately new business-related investments in meters, services, and customer installations. Figure 1 presents a 20-year industry-wide analysis of the estimated electric