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Power Plant Financing in Senate Bill 3
Shifts Risks to Customers
By John
Blackburn and John Runkle
CONSTRUCTION
Senate
WHAT IS CWIP?
CWIP is the accounting scheme used by the electric utilities to pay for the
cost of capital assets, i.e. power plants or transmission lines, which need to
be constructed over a period of years.
The issue before the General Assembly is whether the utilities can make
a profit on the costs of construction (and financing charges) before the power
plant is placed in service.
HOW DO THE ELECTRIC UTILITIES CURRENTLY PAY FOR THEIR POWER PLANTS?
Electric utilities frequently have projects that take several years to
complete, so that CWIP accounting is of special significance. Currently, the construction costs and
financing costs associated for each project are accumulated. When the project
is completed, the power plant is placed in service and becomes "used and
useful." Like the construction
costs, the financing costs are not treated as expenses year by year and cannot
be recovered until the plant is producing.
Utilities
may use some of their own funds but often borrow funds during the construction
period. They add interest on borrowed funds and a “profit” on their own funds
(allowance for funds used during construction, or AFUDC) to the cost of
construction, and then recover all of these sums through rates when the plant
begins operating. All these calculated
"profits" are reported in financial statements year by year during
construction even though they have not been earned in production nor collected
in cash.
The power plant will have a total booked cost composed of the sum of
construction outlays, accumulated interest, and AFUDC "profits." When the asset is finished and is producing,
depreciation begins and earnings begin from the use of the asset. For the utilities, all of this goes into the
rate base on which allowable returns, i.e. profits, are allowed by N.C.
Utilities Commission.
WHAT WAS THE IMPACT OF THE “EARLY” CWIP PROVISIONS IN THE 1970’s and
1980’s?
In the
1970’s and 1980’s, a utility was allowed to place all of the construction and
financing costs in the rate base annually, and then begin to generate profit on
those costs. By allowing the utilities to
make a profit on all construction costs and financing charges prior to the
completion of the power plants, the utilities had a direct incentive to build
as many plants as they could justify. This style of accounting and treatment of
interest during construction proved to be nearly fatal to utilities in the late
1970's and 1980's. Vast power plant
construction projects across the country were underway, project costs were
rising well above budgets and long delays were common. The costs of new construction, primarily of
nuclear plants, almost bankrupted the system. As a result, electric bills
increased from overbuilding and canceled plants.
Utilities were, in effect, borrowing money for project costs, borrowing more
for accumulating interest cost, and since much of their "profits" was
AFUDC, they were borrowing money to pay dividends as well. Many projects were canceled, and their costs
never recovered.
WHAT
HAPPENED IN
The anticipated growth in the demand for electricity did not materialize. Cost
estimates for new power plants escalated rapidly, especially the nuclear power
plants. (The initial estimate for the
Shearon Harris plant was $1 billion for four units, and the cost of one that
was actually completed came in over $4 billion). The annual cost recovery and profits from
building these baseload plants caused utility rates to increase
significantly. Duke Power and Progress
Energy canceled nine nuclear plants after expending almost $1.5 billion. The utilities went to the N.C. Utilities
Commission to decide who would pay for those canceled plants and the Commission
split the costs between the stockholders and the rate payers.
In 1982,
the General Assembly significantly modified this early recovery of CWIP and
adopted the current regulatory rate system.
Since then, there has been no construction of the costly baseload power
plants.
WHY DO
THE UTILITIES WANT TO CHANGE THE WAY THAT CONSTRUCTION IS PAID FOR?
The Utilities see another wave of big construction coming and they were
resolved not to get caught with any of the massive costs of the nuclear plants
this time. Nuclear plants are inherently
risky, especially with the long construction time required. Historically, the
construction delays,
risks of accidents and the unknown cost of the long-term handling of
radioactive waste have made nuclear plants an unviable alternative. Hence, there is a push in state legislatures
to change the regulatory accounting rules now that new plants are being
considered.
In North Carolina, the utilities wish to be reimbursed year by year for
interest on construction, rather than adding these costs to projects and then
recovering them later as the assets go into service. Moreover, they seek to insure against losing
their partial investments in new plants should they be canceled. They want to shift as much risk for plant
construction onto the ratepayers as possible.
WOULD THE CWIP PROVISIONS IN SENATE BILL 3 RETURN RISKS TO THE CUSTOMERS?
The CWIP provisions in Senate
The CWIP provisions in Senate
WHAT HAPPENS WHEN A POWER PLANT IS CANCELED?
Another major change sought by utilities in Senate
HOW MUCH NEW BASELOAD CONSTRUCTION
Duke Energy is planning to construct the 800 MW Cliffside coal plant in
Rutherford County by 2011 and two 1170 MW nuclear units at its Lee Station site
in Cherokee County, South Carolina. Progress Energy is considering construction
of two 1117 MW units at its Shearon Harris site in Wake County, and two more
nuclear plants in its Florida service area.
Both utilities have plans for natural gas and combined cycle plants,
although these are generally used for intermediate and peak loads. These plants are less expensive to construct
and have far shorter construction times than coal and nuclear units.
HOW MUCH WOULD THESE NEW PLANTS
It is difficult to guess at this time.
The latest cost projection for Duke's Cliffside unit are $1.8 billion
with another $600 million for the AFUDC financing charges. The utilities have not presented any reliable
estimates for the nuclear units, although given the $3000/kW for the Cliffside
unit, the nuclear units would cost at a minimum $3.5 billion each. Given the
long construction time for the nuclear units they could easily be $4.5 billion
each. As a result, the total cost for
the four nuclear units, and the Cliffside coal unit easily approaches $20 billion. And this would be over the next decade.
WOULD THE
No. Because the service areas of both Duke and Progress include parts of
HOW MUCH WOULD THIS
Averaged over the next decade, the new plant construction would be an increase
in bills of $1.4 billion per year, more than 10 percent of the current gross
revenues of the utilities annually.
Under the
baseload financing provisions in Senate Bill 3, the utilities get our money for
construction costs, financing costs and profits and our rates would go up to
cover all of these costs.
WHAT IS THE BASIC PROBLEM WITH THE CWIP PROVISIONS IN SENATE BILL 3?
For electricity customers, the changes proposed in Senate Bill 3 mean that
rates would go up sooner than would be the case under the current rate
structure, since interest charges on construction projects would be allowed as
a current expense in determining rates immediately rather than later when the
plants are completed and become used and useful. Moreover, profits would be allowed in rates
right away on CWIP and AFUDC.
Once the costs went into the rate base, the utility would get its current 12%
rate of return on the money. If the
utilities get the opportunity to recover all of the costs for constructing
baseload plants, it would become much easier and economical for utilities to
build new plants. The utilities would
bear very little of the risk. The costs to ratepayers would increase
considerably while the plants were being built and even if the plants were
abandoned, we would still pay for them.
John O. Blackburn, Ph.D. is former Chair of the Economics Department and
Professor Emeritus, Duke University.
John
Runkle is General Counsel of the Conservation Council of North Carolina and
attorney for NC WARN.