Ratemaking Mechanisms to Facilitate Major Additions to Rate Base Presented to the Sixth Annual National Conference on Today s Utility Rate Cases: Current Issues and Strategies February 11 & 12, 2010 John J. Reed, Chairman and CEO, Concentric Energy Advisors, Inc.
Overview of Concentric Energy Advisors Concentric is a management consulting and economic advisory firm focused on the North American energy industry. Concentric specializes in energy market and regulatory strategies, market assessments, regulatory and litigation support, transactionrelated financial advisory services, energy commodity contracting and procurement, economic feasibility studies, and capital market analyses and negotiations. The firm s staff members have held executive positions with management consulting firms, utility companies, regulatory agencies, competitive energy suppliers and investment banks. Concentric s regulatory experts address public utility regulation challenges throughout North America s energy industry. We are closely attuned to the latest rate-setting practices, policies and trends, including decoupling, cost tracking mechanisms, the interface of integrated resource planning with ratemaking, and alternative regulation mechanisms. Our experts routinely participate in rate-related proceedings and forums at the municipal, state, provincial and federal levels, and provide clients with a complete menu of ratemaking and regulatory advisory services. 1
The Regulatory Landscape for Non-Base Rate Recovery Expense Adjustment Clauses (fuel, purchased power, DSM, pension fund, PBOPs, gas supply costs, emission allowances, hedging costs, etc.) Revenue Adjustment Clauses (interruptible sales, wholesale sales, decoupling mechanisms, ISO transactions, etc.) Narrowly Targeted CapEx Trackers DSM programs Environmental retrofits* Hurricanes, ice storm costs* Stranded costs* Smart Grid/Advanced Metering Cast iron/bare steel mains Manufactured gas plant remediation Economic development/brownfield redevelopment * Candidates for securitization 2
Major Rate Base Trackers (MRBT) Are Special Cases Most trackers cover costs that are volatile or unpredictable, beyond management s control, and often policy-based Major rate base trackers cover costs that can be all of these, and: Are incurred over a five to twelve year development period Represent total costs at COD that are a large portion of current rate base (e.g., 50% or more) Represent needed and least cost resources under a defined set of assumptions, which can change from year to year Are beyond the utility s ability to fund (at a reasonably cost) through current cash flow 3
Why Do Large Rate Base Projects Need Special Treatment? Reduce Rate Shock Offset Earnings Quality Reduction Ensure that Long Lead Projects are Still Needed and Least Cost Timely Prudence Reviews Avoid Major Mistakes Incent Investment in Selected Technologies Reduce Frequency of Full Rate Cases 4
Common Characteristics of MRBTs Up front determination of need; product of full IRP Defined Periodic Post-CPCN Reviews of Past and Projected Costs Deferred Cost Accounting Dfi Defined dperiodic idi Review of fleast Cost Plan Development Cost Amortization Construction Cost Carrying Charge Recovery Strict Adherence to NRRI Prudence Standard Pre-Determined Treatment (amortization) of Cancelled Project Costs 5
Regulators and Legislators Have Focused on Alignment of Interests The Objectives Are Simple Fund necessary long lead capex on a cost-effective basis Avoid big mistakes by focusing on prudence, not the used and useful standard MRBTs Are Born Out of Necessity No utility is prepared to bet the company New base load generation will require lots of capital Resource planning has become more uncertain than ever Enough CEOs (and consultants) remember what happened 25 years ago that it isn t likely to be repeated 6
Case Study #1: Texas Transmission Cost Recovery Factor (TCRF) Public Utility Commission Texas Substantive Rule 25.193 Effective Date: July 17, 2003 Application: Rates are collected from electric distribution service providers (DSPs) located within the ERCOT region once the transmission cost of service rate applied for by the transmission service provider (TSP) is approved by the PUCT. The TSP is allowed to revise its transmission service rates annually based on its invested capital. This rate will reflect the addition and retirement of transmission facilities, depreciation, federal income taxes and a commission-allowed ROR. Authorization: Eligible DSPs may include the Transmission Cost Recovery Factor (TCRF) as a clause in their tariff. The TCRF enables each DSP to charge or credit its customers for variation in its wholesale transmission costs from those used to calculate its rates. Frequency: The TCRF may only be updated d on March 1 st and dseptember 1 st of each calendar year, unless as a part of a larger rate proceeding. 7
Case Study #1: Texas TCRF(cont ) Examples of costs recovered through the TCRF Xcel Energy (Southwestern Public Service Company - SPS) On June 23, 2009, SPS submitted a request to the Public Utility Commission of Texas (PUCT) to implement a TCRF with proposed revenues of $7.4 million annually. The filing was based on changes in transmission investment for a period of Jan. 1, 2008 through April 30, 2009 and increases in FERC approved transmission costs for 2008. This was SPS first filing under the TCRF. All parties have agreed to a Stipulation that allows SPS to recover $4.5 million on an annual basis. These rates will be set forth in the TCRF tariff for usage occurring on or after January 1, 2010. 2 1 Source: Xcel Energy release dated June 23, 2009 2 Source: Public Utility Commission of Texas, Proposed order, Docket No. 37135, December 8, 2009. 8
Case Study #1: Texas TCRF(cont ) Examples of costs recovered through the TCRF (cont.) ) ONCOR In January 2009, ONCOR filed to increase its rates through the TCRF. This was approved administratively in February, 2009 and rates became effective in March 2009. The rate change is expected to increase annualized revenues by $16 million. Again in August 2009, the PUCT approved ONCOR s application to readjust its TCRF. The adjustment became effective in September. At the time, it was estimated that the adjustment would increase annualized revenues by $14 million. Similar mechanisms exist for other utilities PSCO s Transmission Cost Adjustment Rider allows recovery of ongoing capital expenditures not already recovered through rate base. Northern States Power Company has a Transmission Cost Recovery Adjustment that allows for the revised annual recovery of transmission i costs not included in the determination of NSP-Minnesota s electric retail rates. ERCOT: $8.2 billion in potential transmission projects to be built over the next five years, mostly for wind generation in west Texas 9
Case Study #1: Texas TCRF(cont ) Analyst Response In a Fitch Ratings report released in July 2009, it is noted with respect to SPS, that SPS has made some regulatory progress with the May 2009 approval of its most recent Texas retail rate case settlement which increases rates by $57.4 million and implements a transmission cost recovery factor, which Fitch views as a credit positive given SPS's need for additional transmission investment. 3 3 Source: Fitch Ratings report dated July 22, 2009. 10
Case Study #2: Florida Capacity Cost Recovery Factor (CCRF) Florida Code Rule 25-6.0423 Effective Date: The Florida legislature s section 366.93, F.S. mandated that the Commission establish a cost recovery mechanism within six months of its 2006 enactment. After several revisions, the Rule was amended and made effective in 2008. Application: All electric utilities within Florida s jurisdiction seeking to build nuclear or integrated gasification combined cycle power plants. Authorization: Any utility seeking cost recovery through the Capacity Cost Recovery Factor (CCRF) through a Generation Base Rate Adjustment (GBRA) or a Nuclear Cost Recovery Clause (NCRC) must first seek a determination of need from the Commission. Utilities recovering costs through the CCRF must submit annual reports to the Commission containing historical and projected true-up data, as well as projected costs. Under the NCRC, the utility may petition for recovery of certain pre-construction expenses. Under the GBRA, the utility must wait to collect costs through rates until the units have entered commercial operation. Frequency: The Commission will make a determination on the reasonableness of recovered costs on October 1 st of every year the CCRF is in effect. Utilities must submit reports on the long-term feasibility of completing construction annually on May 1 st. 11
Case Study #2: Florida CCRF(cont cont ) Examples of costs recovered through the CCRF Progress Energy Florida (PEF), Inc. & Florida Power and Light (FPL) Both utilities petitioned to recover their nuclear power plant costs through the CCRF. PEF sought to recover costs incurred from the up-rate of Crystal River Unit 3 and pre-construction costs for Levy Units 1 and 2. FPL sought to recover costs incurred from the extended power update projects at Turkey Point 3&4 and St. Lucie Units 1&2 and the pre-construction costs for Turkey Point 6&7. The Florida PSC approved rate recovery of FPLs West County Energy Center through a generation base rate adjustment upon commercial operation of the facility; the GBRA has just been terminated by the FPSC in favor of rate case treatment. The importance of prudent cost recovery Annual prudence and need ddeterminations, i with pre-determined drecovery for cancelled plant costs, are essential for the new nuclear program to move forward for both FPL and Progress. 12
Case Study #3: South Carolina Base Load Review Act (BLRA) South Carolina Article 4 Section 58-33-210 Effective Date: April 26, 2007 Application: Electric utilities within the state of South Carolina serving customers in South Carolina. The Purpose of BLRA is to provide for the recovery of prudently incurred costs associated with new base load nuclear or coal units larger than 350 MW with a capacity factor greater than 70%. Authorization: The utility must file an application or a combined application under the Act related to a specific plant. The application must include the description of the plant, information establishing the need for generation capacity, information establishing the reasonableness and prudence of potential fuel sources for the plant and provide other information as may be required to establish that the decision to incur preconstruction costs related to the nuclear plant is prudent. Frequency: BLRA allows for an annual adjustment to rates during construction of a new nuclear facility as a means of recovering financing costs associated with the project. For a nuclear plant under construction, until it enters commercial operation the rate adjustments related to the plant shall include recovery of the weighted average cost of capital applied to the outstanding balance of capital costs of that plant. 13
Case Study #3: South Carolina BLRA (cont ) Example of costs recovered through the BLRA September 30, 2009 the South Carolina Public Service Commission approved an increase to South Carolina Electric & Gas Company s (SCE&G) rates of $22 million for costs incurred by SCE&G for the development of two nuclear units to be built at the site of the V.C. Summer nuclear station. The first of the two units is set to come on-line in 2016 and the second in 2019. Total construction work in progress spent totaled approximately $200 million to date. Adjustment clause is a win-win for both customers and shareholders. SCE&G President has said that the BLRA could lower the cost of building the new nuclear units by $1 billion. BLRA reduces the risk for the utility while increasing regulatory oversight of construction. 14
Case Study #4: Texas Gas Reliability Infrastructure Program (GRIP) Texas Utilities Code 104.301 Interim Adjustment for Changes in Investment Effective Date: September 1, 2003 Application: GRIP allows a gas utility to adjust its monthly customer charge or initial block rate to recover the cost of new investment placed in service for gas utility investment. This adjustment mechanism allows for the recovery of new infrastructure investment as well as the recovery of costs associated with replacement investments without filing a full rate case if the utility has filed a rate case within the prior two years. New costs are allocated to customers in the same manner as the cost of service was allocated from the most recent rate case. Authorization: Costs that can be included are return on investment, depreciation expense and certain taxes. After implementation, the gas utility must file the following information annually: 1) reports describing the new investment and retired plant costs, need and customers benefited by the new investment; 2) annual earnings monitoring report showing earnings in the past year; and 3) if earnings are more than 75 basis points above currently approved rate of return, utility must explain why the rates are not unreasonable. Frequency: Adjustments are recalculated annually. 15
Case Study #4: Texas GRIP (cont ) Example of costs recovered through the GRIP Atmos filed amended 2007 GRIP adjustment with the City of Dallas on August 1, 2008. The City sought to the GRIP adjustment November 10, 2008. The Railroad Commission refused to hear the City s case and Atmos implemented the GRIP increase in rates on January 23, 2009 without regulatory approval. GRIP is a balanced law that provides gas utilities an opportunity to earn a regulated rate of return by reducing regulatory lag on invested capital while at the same time providing several protections for gas customers. 16
MRBTs Are Working In Several Jurisdictions Regulators and Utilities Have Achieved a Balance That Both Find Workable Major investment commitments are being made for transmission and nuclear projects The investments have withstood prudence challenges and need reviews, so far The MRBTs have successfully dealt with significant schedule and budget changes No cancelled plant costs have had to be flowed through the clauses, but there seems to be confidence that these mechanisms can work if these circumstances arise Perhaps most importantly, the financial community is convinced that these clauses have durability and certainty that has effectively reduced the risk of long-lead time, major capex programs 17
For More Information, Please Contact: S ETTING HIGHER STANDARDS FOR CONSULTING COMMITMENT AND CLIENT CONFIDENCE. Concentric Energy Advisors 293 Boston Post Road West Marlborough, MA 01752 Tel: 508.263.6200 Fax: 508.303.3290 18