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New Day for Prudence

Pre-approvals demand a new approach to managing risks and costs.

Fortnightly Magazine - December 2009

that utilities have been gun shy to embark on major nuclear power plant construction without some certainty as to the regulatory path forward.

While trends in the power market call for new plant construction, utilities and commissions both recognize that new construction costs will require the demonstration of prudence before these projects are approved and the actual costs are passed on to ratepayers. Toward that end, Georgia Power has received approval from the Georgia commission for the construction of two new nuclear units. The filing included a request that the construction of nuclear plants be deemed the “prudent” new generation alternative and that the estimated costs be deemed prudent.

And prudency now extends well beyond nuclear plant construction and encompasses all new build, whether nuclear, fossil or renewable. One example is Kansas City Power & Light’s (KCP&L) filing on the costs of environmental upgrades to Unit 1 at its Iatan I coal-fired unit. The Kansas and Missouri commissions, both of which have jurisdiction, required a showing of prudence in construction prior to allowing into rate base the pre-approved environmental upgrades to this coal facility. 13

Unlike the rate cases of the 1970s-1980s, where the utility had to prove that the actual costs expended were prudent, many of today’s rate cases are requiring the utility to prove up its costs before they are incurred. Much of the proof will center on contracting strategies and the contractors’ commitments, especially how change will be managed, costed and reimbursed. For these prudence-of-future-costs cases, both the utility and the contractor must provide a means of estimating project price and separating the fixed-price portion from the variable portion and allocating risks in a form that can be approved by the commission.

In short, utilities will need to take some steps they might not have considered 20 years ago.

In a recent presentation before the House Energy Committee, David K. Owens of the Edison Electric Institute pointed to four difficult issues that complicate the prudency analysis: 1) high capital expenses for upgrades of existing facilities; 2) rising cost environment for all commodities and manufactured goods; 3) constraints on GHG emissions; and 4) energy efficiency mandates and expectations. Additionally, Owens said there’s a cloud looming over the industry due to the aging workforce and a shortage of skilled labor.

To address these uncertainties, Owens advocated establishing a process where project costs can be visited early, reviewed continually and acted upon as necessary. In prior years, investments were made and then second-guessed. This model isn’t recommended. Instead, there needs to be an on-going dialogue between key decision-makers and utilities.

At the same hearing, Caren Byrd of Morgan Stanley noted that the major investment needed throughout the entire energy industry—an estimated $900 billion over the next 15 years—might result in some large rate increases across the board. To manage these costs effectively, collaboration will be needed between regulators and the industry, with long-term plans presented and pre-approvals given for rate recovery. 14

As part of this process, commissions are becoming actively involved in the on-going audit process. They’re examining utilities’ internal controls