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Paradox of Thrift

Economic barriers complicate T&D modernization.

Fortnightly Magazine - July 2009

total modernization program. The reason for this prominent role lies in the fundamental technical attributes of modernization and other smart-grid investments.

For the past half-century, the electric utility industry has been characterized by very long-lived, mature, and technically stable assets that are evidenced by very steady ASLs (see Figure 5) . This stability exists in substantially all classes of T&D assets. What’s new and different about many smart-grid and modernization investments is that they may not economically fit into the industry’s prevailing depreciation patterns. For example, existing metering methods are mostly based on mature electro-mechanical technologies that in today’s regulatory and tax framework have an average service life of twenty years or longer (see Figure 7) .

In contrast to these historic patterns, the latest modernization and AMI investments are based on advanced electronic technologies used in conjunction with automating software. Such technologies in other venues have a practical life of five to 10 years and occasionally shorter. These substantially shorter real or engineering lives in the context of the much longer regulatory and tax lives pose a genuine economic barrier to investment.

The industry’s solution to this problem lies in the proven path followed by the telecommunications industry and especially in its rapidly changing cellular segment. Like today’s electric industry, for more than a decade the telecommunications industry has faced rapidly changing (and thus obsolescing) technologies. The result has been to progressively challenge and increase depreciation rates ( i.e., reduce service lives) in numerous jurisdictions and across the affected asset classes.

Signs of progress are emerging in the electricity industry, albeit slowly. The Emergency Economic Stabilization Act of 2008 was signed into law in October 2008 and it called for specific provisions for investments related to smart grid. Although it is relatively narrow and proscriptive in scope, it reduced the service life of AMI-related investments from 20 years to 10 years for tax purposes. A bolder initiative is needed to include substantially all T&D modernization investments. More important, state regulatory agencies need to follow this initial lead and make parallel changes in T&D asset service lives for rate-making purposes.

Accelerating Depreciation

Utility investments and rate-making trends have clear implications for electric utility executives and regulatory policy makers. Absent mandates, the level of T&D modernization investment will be linked closely to the capital resources available to utilities through depreciation in rates. Utilities and regulators alike need a full understanding of these factors in relation to their modernization needs.

Selected companies and some entire jurisdictions suffer from having very high ASLs of their T&D assets and thus very low depreciation rates. These utilities will be exceptionally challenged in their effort to modernize their systems.

Regulators and utilities likely will need to increase depreciation rates to create both a funding and a recovery mechanism, and also for modernization, especially in problematic jurisdictions and companies. Accelerated depreciation rates have been proven time and again as an effective means to encourage rapid and targeted investment.

Regulators and utilities alike need to acknowledge their roles in creating the current challenge of low depreciation rates that exist