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Hybrid Finance

A solution to high electricity prices in restructured states.

Fortnightly Magazine - September 2010

New baseload generation is needed in many areas of the United States to restrain electricity price increases and to assure reliability as economic growth creates increasing demand for electric power. The financing of new plants will be particularly challenging in restructured states where generation facilities are no longer included in rate base and therefore not financed through the traditional rate-of-return paradigm associated with vertical integration.

The adoption of a market hybrid approach in which new baseload plants would be partially owned and financed by the regulated distribution company with the other portion owned and financed by the unregulated generation company would combine the advantages of lower-cost capital and regulatory oversight associated with traditional rate-of-return regulation with the cost control and efficiency associated with competitive markets. In addition, the use of rate-reduction bonds borrowed from industry restructuring would further minimize the cost to ratepayers.

Economic growth will require new baseload capacity in addition to conservation and the increased use of renewables. The environmental concerns engendered by global warming dictate that new baseload generation will be very expensive, i.e., either nuclear or clean coal power. The addition of baseload capacity to the generation mix will have a salutary impact on market prices and the construction of new baseload plants will enhance regional economic growth.

The market hybrid approach is a solution to the problem of high electricity prices. Preliminary indications are that consumers would benefit from lower priced electricity, the environment would benefit from cleaner energy production and the economy would benefit from increased employment, output and growth.

Electric Utility Restructuring

Electric rates in states that restructured their electric utility industry continue to be among the highest in the nation, creating a burden not only on residential customers but also negatively impacting economic growth. The goal of restructuring was to increase competition in both wholesale and retail markets to reduce electric rates and expand consumer choice.

Prior to restructuring, electricity was generated, transmitted and distributed to end-use customers by regulated monopolies that built, owned and operated most power plants and delivered electricity to end-users. This business model was referred to as vertical integration. A fair return on utility investment, although not guaranteed, was reasonably assured through the regulatory process. The funding of baseload generation was accomplished under rate-of-return regulation. Regulation of these monopolies was based on cost of service and was meant to produce prices that would exist in a properly functioning market.

Approximately one-half of U.S. states have adopted some level of deregulation or restructuring of the energy utility sector to enhance competition and eliminate inefficiencies in the supply market. The basic framework of restructuring includes the following:

• Retail prices were cut on the order of 10 percent; phased-in over five years to enhance the appeal of deregulation to the public;

• Utility generation was required either to

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