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An Indicator of Fairness

Ratable treatment of removal costs through depreciation should be favored.

Fortnightly Magazine - August 2009

sinking fund will be different than for modified sinking fund, and both will vary depending upon the relationship between the allowed cost of capital and the selected annuity rate and whether the annual annuity amounts are constant. The costs imposed on ratepayers by forms of present value other than SFAS 143 likely would fall in the range defined by the Liability and External scenarios, and so would be the equivalent of charging for removal costs two or three times.

Deferral scenarios damage financial viability to varying degrees by denying the entity an internal source of capital during the lifetime of removed assets, thereby increasing the entity's borrowing and the cost of capital that regulation dictates should be borne by ratepayers. These calculations ignore this additional cost, which, if recognized, would cause the extra cost of service imposed by the six deferral scenarios to increase.

An additional adverse aspect of removal cost deferral is a consequence of the fairness of regulation being a leading indicator of the business climate. Such deferrals are characteristics of regulatory decisions that emphasize near-term political considerations over long-term economic considerations. The financial community and large energy users can be expected to interpret the resulting unfairness as signaling deterioration of the business climate. The financial community might react by downgrading the securities of the entities subject to the jurisdiction of the state and of the state itself. Large energy users typically have multiple locations, and so can shift production between locations in reaction to regulatory decisions. The participation of large energy users in regulatory proceedings historically has emphasized the long-term by addressing cost-allocation (fairness) issues, rather than magnitude of cost-of-service issues. However, in recent years some large users have shifted to emphasizing the near-term in their participation in regulatory proceedings, suggesting that they may not be planning on being long-term customers.

Deferral Mechanisms

Examine what happens over the life of a single asset (see Figure 3) . In practice, depreciable property groups are ongoing, so continual additions and retirements cause the position of the age of current retirements on the frequency curves depicted by Figure 1 to become relatively static at an age less than the average service life. This situation causes a deferral to become permanent, thereby allowing only a portion of removal costs to be accrued over the life of the property. The portion of the removal-cost expenditure allowed to be accrued offsets the accumulated amount in the reserve, and the remainder decreases the reserve, which has the same impact on ratepayers as if the shortfall is treated as a construction cost of the replacement asset. Therefore, a weighting calculation using the Ratable and Capitalize scenarios can be used to determine the extra costs to be borne by ratepayers when the property is ongoing.

If the deferral mechanism causes only half of the expected removal cost to be accrued, the remainder will be as de-scribed by the Capitalize scenario, so the combination (50-percent weight to Ratable and 50-percent weight to Capitalize) would result in the extra cost being the same as for the Expense scenario. Less than