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A Prescription for Regulatory Lag

Depreciation accounting methods can trim revenue shortfalls.

Fortnightly Magazine - April 2011

rising revenues and rising expenses will combine to reduce earnings volatility.

Pretax capital depreciation between rate cases is a systematic and straight-forward approach to deal with a utility’s inflation-induced inability to earn its allowed ROE. Pretax capital depreciation offers simplicity and cost effectiveness to help utilities and regulators deliver the allowed ROE.

 

Endnotes:

1. This article discusses rate making issues surrounding the return “of” and the return “on” rate base fixed assets. Examples included herein hold other rate making components (O&M, volumes, etc…) and fuel costs constant. By being held constant they don’t influence example comparisons and therefore aren’t made a part of the examples. To further help facilitate discussion, any deferred taxes, salvage values or working capital needs are netted with fixed asset costs on a net present-value basis.

2. The 67 ROE basis points calculation is relative. It’s applicable for utilities with 30,000 or 3,000,000 customers.

3. Author’s analysis: Visit www.pretaxcapitaldepreciation.com for source calculations.

4. Inflation in this respect encompasses a host of economic elements—including general price increases, industry technological innovation and obsolescence, environmental, deferred tax and safety regulations, productivity gains, etc. The examples in this article use an illustrative 3.1 percent inflation rate. A reference point is the Labor Department’s Bureau of Labor Statistics 3.2 percent November 1980-2010 CPI-U.

5. Municipal sinking funds have been in use for over a century.

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