Guest Editorial: Debt Issue Fuels Utility Bias

By Steven Schleimer Calpine Corporation vice-president of market and regulatory affairs Across the country, utilities are bringing up debt equivalence as a reason to avoid entering into long-term power-purchase agreements (PPAs). Debt equivalence is difficult to explain, but the general concept is that credit-rating agencies (such as Moody?s, Fitch, and Standard & Poor?s) treat a certain percentage of long-term PPA costs as debt when analyzing the financial condition of a utility. Utilities claim that as a result of some PPA costs being treated as debt, their overall costs of debt and equity will rise, increasing overall rates to customers. They claim it affects their debt costs because they appear to be more highly leveraged and debt buyers will require more. In their view, there is a hidden, but nevertheless real, ratepayer cost associated with PPAs. In California, debt equivalence has been a major focus in utilities? current cost-of-capital proceedings at the CPUC. Utilities assert that their portfolios of PPAs are having an adverse effect on their cost of capital, and they want the CPUC to not only recognize this impact, but mitigate it. Mitigating the impact of imputed debt equivalence will allow utilities to either increase the amount of equity in their capital structure or increase their authorized return on equity. While either of these actions will likely increase costs to customers, if utilities? assertions about the impacts of their current portfolios of PPAs are correct, the CPUC should affirmatively address the issue. Allowing utilities to use an imputed debt equivalence cost when evaluating new generation resources, however, is a different story. In the generation resource planning rulemaking ( R 04-04-003 ), utilities are demanding that the CPUC allow them to include imputed debt equivalence costs on PPAs bid into the utilities? resource solicitations. These demands go too far. Allowing utilities to impute debt equivalence in the bid evaluation process strongly tilts the scale in favor of cost-of-service regulated utility generation during the resource selection process because a PPA bid must be significantly cheaper in order to overcome the debt equivalence penalty. Utilities? incentives for advocating such a position are obvious: cost-of-service regulated generation creates earnings; PPAs don?t. Utilities? request to penalize PPAs in the resource selection process should be rejected for numerous reasons, the most important of which are the following: It is impossible to determine whether a specific PPA or set of PPAs will have any adverse impact on a utility?s ratings. Two of the three rating agencies, Fitch and Moody?s, don?t specify how debt equivalence affects their analysis. The third agency, Standard & Poor?s (S&P), appears to use a ?quantitative approach? that is really a ?black box.? The key driver in S&P?s analysis is a ?risk factor,? which is S&P?s guess as to how likely it is the utility will recover PPA costs from ratepayers. The lower the risk factor, the less debt equivalence is imputed to PPAs. How the risk factor is determined is unclear at best. Furthermore, because none of the rating agencies has participated in proceedings addressing debt equivalence before the CPUC, the discussion at the commission has revolved around what utilities say the ratings agencies mean. The fact is, no one except the analysts at these companies really knows the impact of debt equivalence on the utility, and they?re not making it clear to the rest of us. The second reason why utilities? requests should be rejected is that they are deliberately ignoring offsetting factors. Under cost-of-service ratemaking, utilities are allowed to recover ?reasonable? cost overruns from their ratepayers. On the other hand, under a PPA, the nonutility developer is on the hook for cost overruns. Historically, utilities have not been able to develop and construct new utility-owned resources on budget; thus, it follows that it is much more likely that ratepayers will pay more than originally expected with a cost-of-service regulated utility plant than with a PPA. Utilities, however, refuse to include this potential ratepayer risk in evaluating the cost-of-service regulated generation options. So, when an adverse impact to ratepayers is ?possible? as a result of the debt equivalence of PPAs, utilities demand it be included in bid evaluation, but when an adverse ratepayer impact is ?possible? as the result of cost-of-service ratemaking, they ignore it. If PPAs are to be penalized for the debt equivalence risks they place on ratepayers, so too must cost-of-service regulated utility plants. Failure to do so is clearly self-serving. Prior to adopting a policy that clearly gives cost-of-service regulated generation a competitive advantage in the resource selection process, California must undertake a discussion on how to comprehensively evaluate the risks and benefits of all procurement alternatives. Otherwise, utility ratepayers could be stuck with generation resources that are not the best deal, but are instead selected to meet the utilities? objective of growing earnings.

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Guest Editorial: Debt Issue Fuels Utility Bias

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