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ANOTHER PERSPECTIVE
 THE IMPORTANCE OF BEING CERTAIN
By Norman Jenks, manager of Edison Electic Institute's State Regulation Service.
One of the huge challenges of the 2000-01 energy crisis has been the loss of investor confidence and reduced access to capital markets—even for regulated electric utility operating companies that were not in the energy trading or merchant power businesses. The results have been higher financing costs for the industry generally and delayed infrastructure investments.
Among state policymakers, there is growing recognition of how those results lead to longer-term problems for the energy sector and the economy. They also see the importance of being certain—that is, how providing certainty strengthens investor confidence—and policymakers in several states have provided clear frameworks that increase the certainty of a utility's ability to recover costs of essential power procurement and resource planning. These are two of the most risky, costly, and important areas for utilities to manage effectively during these times of economic uncertainty.
Pre-Approved Generation Costs
There are several examples of confidence boosting cost-recovery and advance-approval processes. For example, after considering restructuring legislation for several years and deciding against it, Iowa's lawmakers saw that utilities would need greater cost-recovery assurance to build generation—generation that nonregulated merchant companies would have otherwise provided in a deregulated market. So, in July 2001 legislators authorized regulators to determine the ratemaking treatment of costs of projects before construction begins. It is a unique law still: In advance, the capped costs for building a specific generation or transmission project would be deemed prudently incurred and thus fully recoverable. Plus, to avoid second-guessing, the law prohibits the rate determination from being revisited once it's been made.
Some commissions also recognize that risk management strategies—once approved and prudently implemented—should have cost recovery assurance because they reduce the chance of customers facing potentially much greater costs. Due to the havoc wreaked by volatile energy prices in the West in 2000-01, the Idaho Public Utilities Commission (PUC) approved Idaho Power's strategy for hedging its exposure to wholesale market prices. Having this assurance is important for Idaho Power: Its exposure is large because difficult-to-predict hydro is the greatest part of its generation portfolio. Moreover, when the company must purchase wholesale power, market prices are most likely to be high; and when the company has excess hydropower to sell, prices are likely to be low. So, the approved risk management strategy protects customers and the utility in hydro surplus and deficit months.
Good Regulation at Crisis Epicenter
Another noteworthy example is California's new power procurement and resource planning law and its implementation for the state's three main shareholder-owned utilities by the California PUC. The law responds directly to the California energy crisis by acknowledging utilities' need for flexible and timely cost recovery mechanisms and sets clear guidelines on how their decisions will be judged for cost-recovery purposes.
Utilities file power procurement plans and receive pre-approval of purchased power contracts. The PUC and a stakeholder procurement review group examine the contracts before they are finally approved. Costs of contracts consistent with the procurement plan are deemed reasonable and recoverable in rates. The law also requires "balancing accounts" to record purchased power expenses and requires rates to be adjusted before these costs and related revenues become unbalanced.
The Certainty Principle
Other states also are working to provide greater certainty in cost recovery. Regulatory certainty is an essential pre-condition for needed new investment in energy infrastructure at reasonable cost—and the essence of that certainty is support for the timely recovery of prudently incurred costs.
The corollary is that the reasonableness of utility decisions must be judged on the circumstances at the time the decisions were made, not on the basis of hindsight. In the current economic climate, financial institutions and investors have become acutely aware of the risks second-guessing can pose and therefore ratchet up their lending requirements. The reasonableness of actions taken to implement commission-approved resource plans is best judged on what the utility knew or should have known at the time, not on the ultimate outcome of such actions.
To the extent that power procurement or resource planning programs are second-guessed, uncertainty increases. Our hope is that, in light of the effects of the last energy crisis, more states follow the example of Iowa, Idaho, and California; provide pre-approval frameworks for cost recovery; and recognize the importance of being certain.
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