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Transition cost estimates detailed in Oak Ridge report

Issue 4 and Volume 100.

Transition cost estimates detailed in Oak Ridge report

By Ann Chambers, Assistant Editor

Transition costs are a hot subject in these days of impending deregulation, with wildly disparate estimates and demands flying from various interested parties. Oak Ridge National Laboratory in Tennessee recently released a cool-headed analysis of the subject called “Different approaches to estimating transition costs in the electric-utility industry.”

Author Lester W. Baxter notes four major cost categories which are candidates for inclusion in transition costs estimates: utility-owned generation, long-term contractual obligations for fuel and power, regulatory assets and public policy programs.

“Regulators and many analysts appear to be reaching agreement that certain costs arising from utility-owned generation and all costs from long-term contractual obligations are appropriately included as transition costs,” Baxter states. Many believe utilities should be allowed to recover their net generating plant in service below market value and that the appropriate way to quantify net plant in service is by the net change in asset value of a utility`s entire generating portfolio, according to the report.

Above-market costs of long-term obligations for firm purchases, particularly power-purchase and fuel-supply contracts, should also be included as transition costs. This is especially true for those contracts which were made in response to the Public Utilities Regulatory Policy Act.

Regulatory assets result from regulations permitting utilities to recover certain costs in the future, and they require continued regulation of a retail monopoly franchise to maintain their value. “Because the potential costs are large, regulatory assets have assumed an increasingly important role in the debate on transition costs. The estimation issues center on determining which regulatory assets to include as transition costs and then determining the appropriate account balances for these assets,” the report states.

During the compilation of the report, based primarily on the records of the Federal Energy Regulatory Commission and the California Public Utilities Commission, eight general options for estimating the costs, including administrative and market valuation, were analyzed.

The report recommends regulators consider several issues when assessing the various options, including: implementation requirements; relative administrative ease of implementation; base transition cost estimates; estimation of relevant assets and liabilities; relevant time period for transition cost estimates; estimation approach to market price; and comparable structure for regulated and competitive market prices.

The various estimation methods lead to vastly different transition cost totals. “Based on our analysis, the most plausible estimates of transition costs range from $69 billion to $99 billion, but we found estimates in the literature that ranged from about $20 billion to upward of $500 billion,” according to the report, which was sponsored by Competitive Resource Strategies Program of the Office of Energy Efficiency and Renewable Energy in the U.S. Department of Energy.

Deregulation proposals tend to focus on generation, which is the highest-cost area for utilities (see figure). In 1993, investor-owned electric utilities spent 67 percent of total revenue on generation, 15 percent on distribution, 9 percent on administrative and general, 6 percent on transmission and 4 percent on customer service. In addition, fixed costs represented approximately 63 percent of the total utility costs, with fixed generation costs alone accounting for approximately 47 percent of the total utility generation costs, according to the report.

Utilities and regulators can influence the final determination of transition costs, with utilities mitigating their transition costs by reducing total costs and pursuing markets where they can offer competitive service. Regulators can provide comparable price signals to consumers by unbundling rates or designing appropriate exit fees.

“These restructuring decisions, whether made piecemeal or in a comprehensive fashion, will determine when customers get access to alternative suppliers and what policies regulators develop to encourage productive efficiency,” Baxter writes. “Restructuring will also affect the utility`s cost structure and the market price for power.” Another important factor is time. The faster deregulation happens, the higher the transition costs carried by the utilities. Slower deregulation moves more of the costs onto the consumers.

The report is available from Oak Ridge National Laboratory at (423) 576-8084.