Rate-Base Cleansings: Rolling Over Ratepayers


State PUCs should recognize a refundable regulatory liability for past charges to ratepayers.

State PUCs should recognize a refundable regulatory liability for past charges to ratepayers.

Fortnightly Magazine - November 2005
EES North America

The Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 143 (SFAS No.143) identifies an immediate need for state public utilities commissions (PUCs) to recognize a refundable regulatory liability for past charges to ratepayers for non-legal asset retirement costs.

Although these prior charges resulted in billions of dollars of regulatory liabilities on utilities' generally accepted accounting principles (GAAP) financial statements, they are almost invisible on the regulatory financial statements of the utilities. This is because of the deference shown to state PUCs by the Federal Energy Regulatory Commission (FERC) when dealing with these liabilities. Unless the state PUCs specifically recognize the liabilities, the utilities will have the opportunity to institute a rate-base "cleansing" by transferring ratepayer-fronted money into income.

Regulated public utilities rely on ratemaking hearings rather than a competitive market to establish their prices. A utility's "revenue requirement" quantifies several components summing up to the allowed revenues it will have the opportunity to collect. The "rate base" is the shareholders' investment in utility operations. A "rate of return" applied to rate base yields the "return on investment" component of the revenue requirement. Hence the phrase "rate-base, rate-of-return regulation."

Rate base includes the investment in plant and other assets, net of accumulated depreciation, and ratepayer-provided capital. Accumulated depreciation theoretically measures the amount of "investor-supplied capital" that has been returned by ratepayers. Alternatively, "ratepayer-provided capital" includes items such as accumulated deferred taxes and investment tax credits, which are charges to ratepayers for taxes the utility did not pay. In theory, ratepayers initially "front" these amounts, and then repaid in the form of lower tax expense charges in the future. The is the subtraction of this ratepayer-provided capital from rate base.

Déjà Vu All Over Again

The telephone industry has cleansed its rate base twice. Now regulated electric and other utilities are ready to cleanse their rate bases. In fact, certain electric utilities already have demonstrated their willingness to write off these ratepayer-provided capital amounts. "Write off" is a euphemism for an increase to corporate retained earnings.

To prevent these cleansings, state PUC regulators first must recognize that the utilities have collected enormous amounts for future removal costs, and then declare those amounts to be regulatory liabilities for regulatory and ratemaking purposes.

Although all companies record depreciation expense and concomitantly increase their accumulated depreciation accounts, the process creates substantial controversy in public utility rate proceedings due to the magnitude of the numbers, stemming from the capital intensity of these regulated industries.

Depreciation rates are the vehicle for charging depreciation expense. The higher the depreciation rate, the higher the depreciation expense. Utility depreciation expense increases revenue requirements and therefore drives up utility prices. Depreciation expense is the cause, and the resulting charges to ratepayers are the effect. This article addresses regulatory liabilities resulting from depreciation-rate markups for future removal costs.

When a physical asset is no longer useful, it is retired from service. Asset-retirement costs are incidental to the retirement. Markups for estimated future retirement costs