(October 2009) In his article “Paradox of Thrift, author James M. Seibert looks to be calculating his average service lives as the reciprocal of depreciation rates, whereas utility...
Letters to the Editor
Paradox of Thrift
In his article “ Paradox of Thrift ,” (July 2009), author James M. Seibert looks to be calculating his average service lives as the reciprocal of depreciation rates, whereas utility depreciation rates reflect both life and net salvage. For electric utilities, the cost of removal for most types of transmission and distribution property exceeds the salvage, resulting in the net salvage component having the effect of increasing the rate. Therefore, the reciprocal of an electric transmission or distribution depreciation rate is likely to indicate a life less than the inherent average service life. How much less will be influenced by the extent to which regulatory bodies allow net salvage to be reflected in depreciation rates, and there is considerable variation in this from state to state.
Mr. Seibert notes that the calculated lives for Pennsylvania are high, which is not surprising, given that Pennsylvania precludes net salvage from being reflected in the depreciation rates for transmission and distribution property. Therefore, the reciprocal of Pennsylvania depreciation rates is the average service life, whereas for every other state it reflects both life and net salvage. The variation in the regulatory treatment of net salvage among states is also evident in Mr. Seibert’s Figure 7, because Georgia requires a form of cash treatment that allows only enough net salvage in depreciation rates to equal the amount of current expenditures, whereas most other states (Delaware and Maryland are exceptions) allow accrual treatment of net salvage that results in higher depreciation rates and an accumulation of net removal amounts in book depreciation reserves.
The influence of net salvage on the calculated average service lives is also evident from the lives on Figure 7 for station equipment being higher than the lives for poles. Station equipment tends to exhibit positive net salvage that would cause the rate reciprocal to overstate the life, whereas poles exhibit negative net salvage that would cause the reciprocal to understate the life. I note that Figure 7 incorrectly identifies the transmission accounts (350 through 359) as being distribution accounts and the distribution accounts (361 through 373) as being being transmission accounts. [Editor’s note: The error was Fortnightly’s, not Seibert’s.] I also note that the shape of the survivor curve on Figure 4 is somewhat similar to the Iowa patterns, but is not the same as any of the 30 Iowa patterns.
Mr. Seibert makes a case for increasing depreciation rates to provide capital for system modernization. However, there is a long-term downside to higher depreciation rates, because rate base regulation causes any depreciation change to reverse in a few years as the higher accruals accumulate in the book reserve. Therefore, a depreciation increase today will decrease the total cash flow over the typically long life of electric utility property, but this would be offset to an unknown extent by the investment increasing as a consequence of modernization. The FERC has the authority to authorize accelerated depreciation to encourage transmission line construction, but I do not believe there have been any requests to do so. It would be interesting to