Annual ROE Survey: Capitalizing On Grid Concerns

Deck: 

Regulators use rate cases to craft incentives for capital spending.

Fortnightly Magazine - November 2007

A new trend has evolved in utility rate cases. In the past year, state utility regulators have begun tailoring return-on-equity (ROE) rate allowance to encourage utilities to build infrastructure.

Traditional ROE analysis focuses on the utility’s ability to attract sufficient capital to make the investments necessary for providing adequate service. Generally speaking, rate regulators leave the timing and choice of such investment to utility managers. But some current cases show an increasing willingness to give managers an earnings incentive to pursue preferred investments.

Federal regulators have made some high-profile moves in this direction in recent years. FERC recently ruled an investment by an electric utility in a transmission expansion project for Western Pennsylvania is eligible for significant levels of ROE incentives.1 In that case, the commission found Duquesne Light Co. was under no absolute mandate to make the upgrades and had voluntarily chosen to invest in an important reliability project that would benefit consumers.

The ruling allows Duquesne to earn returns as high as 13.8 percent on the investment. A look at the company’s returns reported this year indicates what a good deal this is for investors.

The idea the ROE allowance might be adjusted to make sure utilities can attract adequate capital is not new to state regulators. This year, however, several states have looked beyond the traditional base-rate proceeding to exploit the ROE component of regulated rates as a tool to improve energy system reliability and efficiency. A recent resource-planning case involving Nevada’s electric utilities provides an example.2 (The proceeding wasn’t a rate case [and therefore does not appear in the accompanying chart], but rather an integrated resource planning (IRP) proceeding.)

According to the Nevada Public Service Commission (PSC), the state faces a number of challenges in meeting its long-term electricity needs. The PSC says the state’s major utilities have forecasted a need for significant new power supply, with a real possibility of shortages in the near term. Additionally, the utilities rely on purchased power to meet a large part of their load requirements. After reviewing the utilities’ preferred resource plans, the commission concluded the public would gain maximum benefit if the utilities build and own a new large power plant.

The Nevada PSC also identified a clean-coal option as the best choice for the state’s consumers, rather than relying on a gas-fired power plant that would be cheaper to build, but often more expensive to run. The commission said the utilities should be encouraged to invest in more renewable energy to add needed diversity to the generation mix.

To make this happen, the PSC granted Nevada Power Co. and Sierra Pacific Power Co. several “equity adders” ranging from 0.125 percent to 0.25 percent for hitting or exceeding solar and non-solar renewable targets, as well as for completing the requested clean-coal plant by 2012.

Decoupling Dance

Estimating an appropriate rate of return on equity for utility investors is a fundamental component of the cost-of-service rate case conducted across the nation by state energy utility regulators. The following survey (see chart) demonstrates the results of those proceedings over the past year. As usual, current interest rate trends and a discussion of business risk dominate the debate; market restructuring efforts either wind down or mature; and discussion of the effect of such programs on ROE in traditional rate proceedings seems to be on the wane. In addition to the idea the ROE rate component is an appropriate tool to signal investment preferences as discussed above, regulators at the state level also are beginning to focus on the effect their own more traditional regulatory methods and procedures might have on a utility’s risk profile.

One example of this is seen in an electric rate case decided by the Idaho PUC.3 In that case, the PUC authorized Idaho Power Co. to implement a three-year, fixed-cost decoupling pilot program. The mechanism adjusts rates upward or downward to recover the company’s fixed cost of service independent from the volume of the utility’s energy sales. With such a plan, a utility collects a stable revenue stream whether or not its customers respond to conservation incentives in a positive way. (For example, if sales go down due to efficiency improvements or conservations, rates will go up within a 3 percent cap under the approved plan.)

After setting a revenue requirement and a new ROE for the coming rate period, the commission put the utility on notice that it would address in a future rate case whether it should reduce the company’s authorized ROE to reflect reduced risk of cost recovery under the new adjustment mechanism.

 

Endnotes:

1. Re Duquesne Light Co., FERC Docket Nos. EL06-109-000 et al., Feb. 6, 2007.

2. Re Nevada Power Co., 253 PUR4th 252 (Nev. P.S.C. 2006).

3. Re Idaho Power Co., 256 PUR4th 322 (Idaho PUC 2007).

 

Table Endnotes:

* Settlement agreement. No ROE figure stated.

1. Figure reflects finding by commission that utility collects 40 percent of retail revenues through adjustment clause, making it less risky than other comparable utility companies.

2. Revenue settlement reflects cost of equity as shown.

3. Revenue shown is after LNG mitigation.

4. Revenue settlement includes earnings-sharing mechanism, which provides for allocation to ratepayers of 100 percent of all earnings above figure shown.

5. Settlement stated ROE. Previous case was settled with no stated ROE.

6. Order on periodic earnings review under existing rate-stabilization plan. Figure shown is threshold for earnings sharing.

7. The last case involving this utility where the cost of equity is noted resulted in a final order issued May 1991. Four rate cases filed since that date were determined by settlement agreements that did not specify any element of the cost of capital.

8. The last case involving this utility where the cost of equity was noted resulted in a final order issued December 1984. Six rate investigations filed since that date were determined by settlements, which did not specify any element of the cost of capital.

9. An additional $1 million increase to become effective Nov. 1, 2007.

10. In addition to revenue increase shown, utility is authorized to make permanent a two-year $58.1 million increase approved by order dated Oct. 14, 2004.

11. Partial settlement agreement includes ROE + Revenue figures.

12. Figures shown is total system-wide increase for L&P operating division is $45.1 million. Increase for MPS operating division is $13.6 million.

13. ROE figure shown reflects downward adjustment of 32.5 basis points for reduced risk associated with approved a straight fixed-variable rate design.

14. An additional $358,853 increase effective Nov. 1, 2006; additional $107,475 effective May 1, 2007.

15. First year of three-year revenue settlement agreement.

16. Earnings sharing component of rate plan triggered if utility achieves 11 percent ROE, reduced to 10.8 percent if company fails to earn “retail customer choice education incentive.”

17. Earnings sharing component of rate plan triggered if utility achieves 10.6 percent ROE.

18. Rate orders address two filings. The first, a general rate increase application resulted in rate decrease shown. The second, a request to recover costs of a new generating plant, produced an increase of $42.1 million, effective when plant comes on line.

19. Order set a range of 11.25 to 11.75 percent with rates set using 11.70 percent figure.

20. Settlement Agreement includes ROE as shown.

21. On 9/16/05 the Consumer Advocate Division petitioned the Tennessee Regulatory Authority (TRA) to open an investigation to determine whether Atmos Energy Corp. was overearning.

22. Final order pending.

23. After an investigation by TRA staff and then a contested case proceeding, the TRA determined on 10/26/06 that Atmos had a revenue surplus of $6.1 million for the 12 months ending 9/30/07.

24. ncrease shown is subject to a $30 million rate credit. Net of credit, rates increase by $85 million effective 12/11/06 and by an additional $30 million on 6/1/07.

25. Revenue settlement reflects ROE as shown.

26. Application to adjust capped rates to recover prudently incurred incremental environmental and reliability costs.

27. Base period for calculating incremental investment.

28. Figure shown reflects current financial conditions. Applicable only as “carry charge” on incremental costs determined in current case.

29. Commission adopts stipulated performance-based rate plan. Rates frozen of current levels for 5 years beginning Jan. 1, 2006.

30. Stipulated performance-based rate plan provides that utility will share earnings over figure shown 75 percent to ratepayers 25 percent to shareholders.

31. Final revenue figure subject to adjustment for calculation of power costs.

32. Joint application. Both companies constitute a single utility system with the same rates and power supply source.

33. Figure shown is total of electric, gas & water operations:

$.797 million approved electric increase.

$.347 million approved gas incraese.

$.548 million approved water increase.

34. ROE award applied to 55 percent common equity finance ratio.

35. Revenue award includes cost of fuel.