The Utility Agenda: Trackers

Wed, 06/20/2012 - 16:52

A company in a competitive market has to compete for your business and therefore must carefully manage its costs in order to stay competitive. However, a regulated monopoly utility has no competition, and regulation of rates and services is necessary. Under regulation, a regulated monopoly utility is entitled to recover its prudently incurred costs plus a return on the capital invested by its shareholders. The utility’s costs are determined by looking at a test year – 12 consecutive months of the utility’s operations – and adjusted for known and measurable changes to costs. Regulators also determine a fair return for shareholders by looking at the utility’s risk profile compared to similar ventures. Regulators then determine a revenue requirement, or yearly income amount that would allow the utility to recover its costs plus the authorized return. The revenue requirement is then divided among the customers and the energy (amount of gas or electricity) that the utility’s customers use.

Between rate cases, the utility has to manage its costs. Because it takes time for regulators to approve new rates (called regulatory lag), the utility has an incentive to manage its operations and reduce costs. Because there can be regulatory lag in cost recovery, and there is some risk a utility may not be able to recover its costs and generate the full return authorized by regulators, the utility’s return includes a "risk premium."

Trackers allow the utility to recover expenditures on an on-going basis by adjusting rates on a quarterly or biannual basis for certain categories of costs, which means utilities do not have to wait for the next rate case to recover those costs.

An example of costs that can reasonably be tracked is fuel costs. Since the 1980s, utility companies have been able to “track” fuel costs on a quarterly basis. This was thought to be sound because fuel costs are large, not under the utility’s control and volatile (they fluctuate significantly).

An example of costs that should not be tracked is capital or construction costs of power plants. These costs are under the utility’s control to the extent the utility, as provided by law, is properly planning its resource mix and regulators enforce this provision of the law. Tracking the capital costs of power plants is called construction work in progress (CWIP). CWIP allows electric utilities to recover the capital costs of a power plant as the plant is being built, making ratepayers the financing mechanisms for the plants instead of stockholders and the utility. Duke Energy has requested the IURC to grant them this financing mechanism for the coal gasification plant they’ve proposed at Edwardsport.

The other key feature of trackers is that they tend to greatly reduce oversight of the utility’s costs. Once a particular tracker mechanism is approved, review of actual costs on an ongoing basis is typically done in an expedited or fast-tracked proceeding.

 Legislatively, electric utilities have tried to pass laws to provide trackers for:

  •  Transmission and distribution lines, which should not be tracked because utilities can properly plan for these investments and assess the costs;
  • Broadband over power lines, which has nothing to do with providing electric service;
  • Any costs that are the result of a government mandate, which, for a regulated utility, covers just about all core costs since they involve providing service.

In addition, electric utilities have imbedded sweeteners for themselves in their proposed tracking legislation. These include:

  • Deregulating revenue that is generated from trackers, which means as the number of and revenue from trackers increase the less regulatory oversight of profits.
  • Automatic, monetary incentives for trackers that have been approved. Under the proposed incentives, the IURC would have to automatically increase the utility’s rate of return if the proposed tracker were approved. The IURC would have no discretion in these cases.
  • Reduced regulatory oversight of utility investments and costs.

The issue here is that trackers, once approved, virtually guarantee, with perhaps minor adjustments, recovery of costs going forward. This reduces the company’s risk in terms of the potential of not being able to recover those costs in a future rate case. Wall Street investors and lenders then view the utility as a less risky investment, which means:

  •  That the utility will receive more favorable interest rates on any borrowed money; and
  • That their rate of return should be lowered, not increased with incentives, because there is less financial risk to the company. That is, ratepayers should not have to pay a risk premium on that investment when risk related to cost recovery for that investment is essentially nonexistent. Adding an incentive on top of the rate of return is adding insult to injury.

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