Results of the annual Survey of Energy Utility Rate Proceedings.
The results of our annual survey of authorized rates of return on common equity for state-regulated energy utilities show a continued reliance on traditional cost-of-service ratemaking in many states. At the same time the results also show that rate case filings do not dominate the field of economic regulation the way they might have in times of higher rates of inflation and prior to the advent of price cap regulation and market restructuring programs.
Nevertheless, the issue of the appropriate level of "profit" to include in the rates of a regulated electric and natural gas companies continues to figure prominently for those engaged in the task of retail ratemaking.
A reading of this year's rate orders indicates that the Discounted Cash Flow analysis (DCF Method) continues as a staple for estimating the cost of equity capital sought by energy utilities. Issues such as current trends in overall cost of capital available to large industries, as well as business and regulatory risks facing utilities, are also discussed at some length in numerous cases. The debate also continues over the effect that the divestiture of generation assets by electric utilities under state-run industry restructuring plans might have on utility risk and investor expectations. Similarly regulators are also considering the change in risk for natural gas utilities when moving to a competitive market model for pricing of gas supply.
Montana Power: Divestiture Lowers Risk
In a case involving the Montana Power Co., a combined electric and gas utility, the Montana Public Service Commission has concluded that the utility faces less risk as a consequence of its divestiture of electric generation assets. While acknowledging company concerns about regulatory risk as the electric industry is restructured the PSC adjusted future electric rates downward by reducing the utility's equity ratio from 44.12 percent common equity used in the utility's prior rate case to 43 percent. According to the commission, debt credit rating agencies, both Moody's and Standard and Poor's, have stated that delivery-only utility operations are seen as less risky, and expected to be capitalized with more debt and less equity than fully integrated companies.
In the same case, the Montana PSC set natural gas rates to reflect reduced risk to the utility following the deregulations of natural gas supply and the implementation of a natural gas cost tracker that allows changes in commodity costs to be passed through to ratepayers without a full rate case. The PSC noted that with the risk of fluctuations in profit diminished as a result of the gas cost tracker mechanism, the LDC no longer has greater risk than the company's electric utility operations. Accordingly, it set the ROE for both energy divisions at 10.75 percent, down from the 11 percent ROE and 11.25 percent ROE allowed for the electric and gas divisions respectively in the company's prior rate hearing. The PSC permitted the gas utility to calculate future rates based on an capital structure with 45 percent equity, however, two points higher than the figure used for electric operations. .
While the pace of "full-blown" rate filings for review by public utility commissions (PUCs) remains slow the complexity of the ROE component of ratemaking may be on the rise. The Oregon Public Utility Commission brought attention to this point while setting rates for Portland General Electric Co., an electric utility faced with unprecedented increases in the cost of wholesale power in the region. It pointed out that even though the increase in wholesale power costs had been largely responsible for the unprecedented 35 percent increase in rates approved in the case, a large part of the total time it spent hearing the evidence was devoted to arguments over the proper ROE. The PUC said that given the inherent complexity of the issue it "may be impossible to devise a method to make the process of determining a reasonable ROE an agreeable one." Nevertheless, it offered a generalized set of guidelines for witnesses provided cost of capital recommendations in future rate cases. The commission set ROE for the utility at 10.50 percent which includes a 25 basis downward adjustment for reduced risk associated with the utility's above average equity ratio of 52.16 percent. .
How the Survey Was Conducted
This year's survey covers cost of equity capital determinations by state public utility commissions (PUCs) during the period Oct. 1, 2000 through Sept. 31, 2001. Survey methodology remains similar to past years with requests for information on the results of recent rate proceedings sent to both regulators and utility financial officials. In addition, direct examination of the commission rate orders, when available, provides additional information.
Performance-based rate plans, merger-related rate agreements, generic industry-wide ROE investigations, and special proceedings to determine revenue requirements for restructured electric "delivery-only" utility operations also contain findings about the appropriate ROE for utilities and are reported herein. Explanatory notes accompany most entries, and citations are provided for orders published in Public Utilities Reports, Fourth Series (PUR4th). Many of the unpublished orders are available on PURbase CD ROM, WESTLAW, and LEXIS.
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