[BETA] Fortnightly

Many years ago when utilities were small and local control areas themselves, electric supply-side investing was relatively risk free. Growth was steady and predictable, as was regulatory recovery of investment to meet supply-side expansion. However, the recessions of the late 1970s and early 1980s, combined with inaccurate long-run load forecasts, led to overbuilding. In addition, changes in nuclear plant design mandated by the government after the Three Mile Island accident led to schedule delays and cost overruns. The regulatory response resulted in protracted prudence reviews and various approaches to mitigate rate shocks in rate proceedings.

Today, supply-side investing in the face of uncertainty is incredibly daunting. The investment drivers are no longer the same as replacement of aging infrastructure and compliance with environmental or public policy reforms have replaced growth and increasing demand. Furthermore, while the development of wholesale markets over the past 20 years has improved overall economic efficiency for the industry, it has also made investment choices increasingly complex. Government intervention in the marketplace via state-mandated renewable portfolio standards, ratepayer-subsidized clean coal plants, and, in certain cases, mandated wholesale bidding practices (i.e., bidding new capacity at zero cost), can have a dramatic effect on valuation of existing and potential new merchant supply-side investment. In addition, new supply-side capacity is significantly more expensive than the existing portfolio, even when adjusted for inflation (see Figure 1). Therefore, the replacement of existing supply will not only significantly affect the investment profile of the utility, but also will trigger significant rate impacts to consumers.

While the cost of new generation technologies has outpaced inflation, very few new mechanisms have been introduced to mitigate rate shock as these more costly investments have entered service. A survey performed by Navigant on behalf of the Ontario Energy Board in 2011 indicates that most mechanisms used to mitigate the rate shock from the introduction of large generating units existed, or were introduced or emphasized, during the last generation cycle of the 1980s.

Alternative ratemaking proposals—such as pre-investment funding—mitigate both the rate impact and financial implications for the utility.

Traditional Regulation vs. Pre-funding

In traditional vertically integrated states, regulatory treatments for capital-intensive investments that can trigger significant financial implications for both utility and ratepayer have been addressed using recovery methods such as construction work in progress (CWIP) or allowance for funds used during construction (AFUDC). In today’s uncertain risk environment, these traditional methods might not provide the financial certainty needed to see projects move forward. For example, the Federal Energy Regulatory Commission (FERC) recently added incentives for qualifying transmission projects—such as 1) increased rate of return; 100 percent recovery of CWIP; and recovery of all prudently incurred development and construction costs if any of the projects are abandoned or cancelled, in whole or in part, for reasons beyond the utility’s control. While the provision of these incentives hasn’t been