Sticker Shock!


Increasing prices for materials, equipment and services are driving utility infrastructure costs into uncharted territory.

Increasing prices for materials, equipment and services are driving utility infrastructure costs into uncharted territory.

Fortnightly Magazine - December 2007

By now, the evidence is overwhelming. Utility-industry construction costs have risen and will remain elevated for some time.

Some of the factors underlying these trends are straightforward. For example, costs for steel, copper and concrete have risen sharply due to high global demand, as well as production and transportation costs (in part owing to high fuel prices), and a weakening U.S. dollar. Other drivers are less transparent. Labor costs generally have tracked inflation rates, but shortages in skilled workers have driven costs higher for utility equipment and construction services.

Moreover, constraints in component-manufacturing capacity as well as engineering, procurement and construction (EPC) services exacerbate cost pressures. In January 2007, for example, OG&E executives reported that the cost estimate for EPC services for building the company’s proposed Red Rock coal-fired power plant increased by more than 50 percent in just nine months, from $223 per kilowatt to $340/kW. 1

Although customers will not see the full rate impact associated with construction cost increases until infrastructure projects are completed, these increases now are affecting industry investment plans and presenting new challenges to regulators.

The recent rise in many utility construction cost components follows roughly a decade of relatively stable (or even declining) real construction costs, adding to a growing sense of sticker shock among power companies and state regulators.

Moreover, these increased costs are largely absent from the capital costs specified in the Energy Information Administration’s (EIA) 2007 Annual Energy Outlook (AEO), leading to a substantial divergence between EIA’s data assumptions and market evidence. For example, the AEO estimates construction costs for advanced nuclear plants at just over $2,000/kW, but a recent report from Moody’s Investors Service forecasts costs between $5,000 and $6,000/kW—three times the EIA figures. 2

To provide reliable indicators of current or future capital costs, the Edison Foundation commissioned the Brattle Group to study recent increases in the costs of building utility infrastructure—including generation, transmission and distribution facilities. The study also identified the causes of these increases and explained how these increased costs will translate into higher consumer rates. 3

The overall effects will be borne out in various ways, depending on how utilities, markets and regulators respond to these cost increases.

Predicting the Wave

Construction-cost inflation during the past several years has reached every corner of the electric utility industry.

Infrastructure costs were relatively stable during the 1990s. But between January 2004 and January 2007, prices increased rapidly. Costs for steam-generation boilers, transmission facilities and distribution-grid equipment rose by 25 percent to 35 percent, compared to an 8 percent increase in inflation, expressed by the GDP deflator 4(see Figure 1, “National Average Utility Infrastructure Cost Indices”).

The cost of gas turbines increased by 17 percent during 2006. Similarly, prices for line transformers and pad transformers increased by 68 percent and 79 percent, respectively, between