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ERMUSR HANDOUT #3 10-13-2009~ ~~e __ ,, '~ a e ~~, ~; n a in n a ce a~ n e es Renewable energy, a sagging economy, aging infrastructure and other trials put pressure on utility finances. __ Today, many public power utilities face common challenges operating in the chaotic utility environment. How do you compare to the issues and solutions adopted by our utility? As a city-owned electric utility serving a community with a population of approxr mately 75,000, the Municipal Utility is a theoretical but typical mid-sized municipal utility. It has a peak demand of 200 MW and annual energy sales of 1 million kWh. Its customers are mostly residential and commercial with some light industry and one large manufacturing facility, which accounts for 25 percent of the annual energy sales. The Municipal Utility meets its wholesale requirements through a combination of owned generation and market purchases. It owns a portion of a large coal-fired base load plant and has local peaking resources, and it is planning to add additional local peaking resources in the near future. The utility is governed by an autonomous Utility Board whose members are appointed by the City Council. Looking forward, the Municipal Utility recognizes that there are many important is- sues it will need to address. These issues often have a component that directly impacts the utility's rates and charges to its customers. At a basic level, the Municipal Utility is in the business of providing electric service to its customers. The revenue side of this business is driven by the utility's rates and charges, which in turn can be de- signed to affect customer usage behavior that can impact the cost side of the business. The Municipal Utility has identified the following issues that will require rate- related tactics as part of the utility's broad business strategy: • Special rate programs, including conservation and demand response • Net metering and backup power tariffs • Renewable portfolio standards and carbon legislation • arge customer/local employer incentives • Municipal government cash requirements • Infrastructure needs: debt vs. cash flow funding • Overall rate strategy ~8 SEPTEMBER 2009 PUBLIC POWER The Municipal Utility's current rate structures have been in place for many years. The rates include customer charges and single block energy charges for residential and small commercial cus- tomers. Large commercial customers have a demand and energy rate, and the industrial customers have a demand rate with on- and off-peak energy rates. The utility realizes that more special- ized rates are needed to influence customers' use of electricity. There has been a recent emphasis on conservation programs to reduce overall electricity usage and demand response efforts to reduce peak consumption.The Municipal Utility is also beginning to consider advanced metering infrastructure (AMI) devices to support smart grid programs. JLUTIC The Municipal Utility has implemented a broad array of rebates for energy efficiency efforts, such as efficient appliances, compact fluo- rescent lighting and insulation programs. It also works directly with larger customers to reduce consumption through more efficient motors, lighting and other uses. Recognizing that successful conser- vation programs reduce sales, which reduce revenues, has resulted in a renewed effort to monitor revenues and costs through the util- ity's financial plan. The conservation programs also have a cost associated with the rebates and other program costs. As consump- tion goes down, the utility may need to raise rates or implement some form of decoupled rates (revenues not tied to consumption). As future rate increases are required, it is considering a move to in- verted energy rates, where higher levels of usage get more expensive. This would further discourage higher levels of energy use, but the higher usage rates help offset the lower revenue due to reduced sales. For rate-related demand response efforts, it is con- sidering both carrot and stick approaches. The carrot approach includes giving customers a credit on a $/kW basis for reducing peak load consumption when requested by the utility. The stick ap- proach includes more time-of--use rates for more customer classes and even higher rates for on-peak usage. The utility is also contem- plating critical peak pricing with significantly higher rates during a small number of peak hours during the year. Critical peak pricing will require some kind of two-way communication with customers to alert them that a critical peak period has been declared. Ulti- mately, the Municipal Utility will be moving into automated metering infrastructure (AMI) systems and will need to consider all the costs associated with the programs along with the savings real- ized to determine how overall rate levels will be impacted. AMI systems also allow for more innovative rates to further influence customer usage. The state legislature and public utility commission have imple mented requirements for utilities to begin implementing net metering and backup power tariffs. The net metering tariffs are intended for smaller renewable generation installations at resi- dential and commercial locations. Under this tariff, the customer is required to receive full retail rate credit for any surplus energy injected into the Municipal Utility system. The backup power tar- iffs are required for larger customers who self generate all or a portion of their own requirements and who need backup power from the Municipal Utility when their own generation is not avail- able or is insufficient to meet their requirements. ' SOLUTION 2 ` The state has issued net metering rules that will dictate much of the utility's new net metering tariff: The utility has also collected tariffs from other area utilities that are designed to comply with the same rules. The utility will require metering upgrades at customer loca- tionswhere net metering service is requested. The new meters will measure flow of energy both into and out of the customer facility. The state rules allow for collection. of additional meter expenses. The Municipal Utility will implement a higher monthly customer charge for net metering customers based on the difference iri capi- tal cost, including installation cost for the new meter amortized over the expected life of the meter. For the backup power tariff; the Mu- nicipal Utility needs to consider the requirements of the backup customer in an unbundled way. For the generation and transmis- sion portions of the backup tariff, it has opted to rely on the market. The unknown nature of timing and amounts of backup generation required make it difficult for the Municipal Utility to include provi- sion of backup generation in its generation asset plans. The Municipal Utility is a participant in the regional independent sys- tem operator, which will provide real-time market power delivered to the Municipal Utility for any backup generation and transmission requirements. The utility will do a straight pass-through, with an adder for local system losses, to any backup customer requiring en- ergy. For local disMbution services (substations, feeders, service transformers and drops, meters, etc.) the Municipal Utility will rely on its unbundled cost of service analysis to set fixed monthly rates on a $/kW basis for the maximum backup amount requested by the customers. It has adopted a philosophy that it must plan and build its local system to be able to serve the backup customers at any time, just like any other customer. www.APPAnet.org SEPTEMBER 2OOJ 'I7 7 Rate and Finance Challenges ~3 ~~~~ ~~ ~ sl ~ - The Municipal Utility is concerned about the rate impact of potential environmental legislation. Implementation of re- newable portfolio standards (RPS) and potential legislation or regulation to limit carbon dioxide emissions are of partic- ular concern.The Municipal Utility has added wind resources to its generation portfolio and currently provides 4 percent of its energy sales from wind. However, it also rec- ognizes that there has been a net cost to add these resources. The utility is concerned that if RPS mandates 20 percent to 30 percent of energy requirements from renew- ables, there may be a significant cost impact. This cost impact could be driven by numerous factors including higher capital costs due to increased demand, increased transmis- sion requirements, and expanded operating challenges. Potential carbon dioxide legislation is a source of rate impact anxiety for the Municipal Utility. Any proposal to limit carbon dioxide emissions will likely increase costs to the Municipal Utility and its customers. This cost increase could be sub- stantial. The challenge for the Municipal Utility is how to prepare when the outcome is largely unknown. The Municipal Utility has already implemented steps to manage its power supply program to minimize negative cost impact from pend- ing environmental regulations. Relative to the rate side of the business, it has decided to increase its customer awareness programs ~to prepare customers for change, whatever that change may be. The utility has decided to implement an "environmental adjustment" to its ate schedules. This adder will be similar to a fuel or purchased power adjustment. The environmental adjustment will begin appearing on bills immediately, but the initial amount of the adjustment will be zero. The new bills will include information about the rationale for the adjustment (it will reflect increased costs to meet new environmental regulations). The adjustment will be a straight pass-through on a per- kWh basis, applied equally to all customer classes. As costs are incurred, the adjustment will begin to impact bill amounts, and the bills will include specific information about the justification and calcu- lation of the adjustment. The Municipal Utility will also add information to its normal communicafion outlets such as its Web site, e-mail, media outlets and community organization presentations. In addition, it has begun to investigate more contemporary communica- tions such as a blog, a Facebook page and Twitter. Finley Engineering has been a leader in design, engineering and construction of electrical power systems for over fifty • ~ • • ~ years. Our planning and design for electric power systems includes all phases of distribution, transmission and substations, from initial stages and site selection to • • construction management and startup. For more information visit www.fecinc.com or contact us at: Finley Engineering Company 104 East 11th Street P.O. Box 148 Lamar, MO 64759 471-682-5531 Phil Carroll P.E. Vice President p.carroll®fecinc.com ~in~ ENGINEERING INNOVATION TO THE NE%T POWER www.fecinc.com 7$ SEPTEMBER LOOJ PUBLIC POWER The Municipal Utility has a large manufacturing facility located in its community that accounts for 25 percent of the utility's en- ergy sales. It is also a significant employer and is a critical piece of the local economy. The manufacturing facility is fo- cused on controlling its operating costs and has made direct requests for electric rate relief. The manufacturing facility oper- ates three shifts and takes advantage of the time-of-use rates available from the Municipal Utility. The Municipal Utility knows it will be implementing overall rate increases going for- ward. The primary issue has become the willingness of the Municipal Utility to grant rate concessions to the manufactur- ing facility and pass additional costs onto the remaining customers. The Municipal Utility acknowledges the importance of the manufac- turing facility to the local economy and to the utility. Loss of this customer could have a devastating impact on the community and on all utility ratepayers. On a philosophical basis, the Municipal Utility is willing to consider rate considerations for this customer, particu- larly as it relates to the levels of future rate increases. The critical issue for the utility is that it makes informed decisions related to rates and costs to provide service. This will require a detailed cost-of- service analysis to estimate the true cost to serve all its customers. The Utility Board has agreed in principle to accept a smaller overall margin for this customer and a higher margin for remaining cus- tomers. However, the board will not put its remaining customers in the position of subsidizing energy sales to the manufacturing facility. By varying the margins by rate class in the cost-of-service analysis, the utility can arrive at a rational approach for providing rate relief to an important local facility. The Utility Board has agreed in principle; to accept a smaller overall margin for this customer and a higher margin for remaining customers. www.APPAnet.org SEPTEMBER 2009 19 7 Rate and Finance Challenges The Municipal Utility is owned by the city and the citizens it serves. As such, the city is entitled to a reasonable return on its investment. The Municipal Utility makes a payment in lieu of tax (PILOT) contribution to the city every year. Historically, the amount of the PILOT has been more or less negotiated between the Municipal Utility and the city. The Municipal Utility believes the historical PILOT amount has been reasonable. Recently, the city has come under economic pressure to increase funding and • The Municipal Utility has ongoing capital needs to fund infrastruc- ture improvements and additions to its system. It has outstanding debt related to past capital additions, and it maintains a favorable and stable rating from the rating agencies. The utility is projecting a steady increase in capital needs in the future for renewable re- sources, AMI systems, peaking generation and other local system additions. The Utility Board is not debt-averse, but it prefers to pay for capital needs out of reserves and cash flow as much as possi- has requested a sigrnf~cant temporary increase in the PILOT pay- ble. As increasing costs and opposition to rate increases combine ment from the utility. The Municipal Utility is concerned that the to diminish available margins, the board is concerned about its new PILOT amount is unreasonable, the increase will not be tem- ability to maintain the utility's bond rating white relying more on porary, and the utility may be viewed as a source for future debt financing of capital items. The Municipal Utility needs to increased funding needs. strike the right balance concerning funding of capital. V ~ ~~n~~~'~ ~~ ` ~Z ~V _,,..,,w..._.. ..,,...... _ ~ ~+M~xn ..,- . xf5 'W 7 ~~a. ~1 {q'~ The Municipal Utility determined that its goals related to the The Municipal Utility currently funds depreciation through its PILOT are fairness, predictability and transparency. Fairness will rates. It has decided to establish a policy to use the cash flow avail- be resolved through direct discussions with the city. The Municipal able from funding non-cash flow depreciation to fund normal Utility will collect information regarding other municipally owned ongoing capital needs. If capital needs in a given year are less than utilities and their PILOT payments as well as franchise and prop- depreciation, the excess funds will be added to a capital reserve ac- erty tax information for communities served by investor-owned count. If capital needs exceed depreciation funding available, utilities and rural electric cooperatives. Once a fair contribution is capital reserve funds will be utilized as well. If these funds are not determined, the issue of predictability can be addressed. Pre- sufficient, the Utility will rely on issuing additional debt. It will in- dictable levels of PILOT payments are advantageous to both the crease its interaction with its financial adviser and the rating city and the Municipal Utility. There are numerous methods avail- agencies to ensure it maintains or improves its current rating. The able for devising a predictable calculation of PILOT, including as a utility also plans to work with its governing body to make sure board ~~~ percentage of revenue, an amount per energy sold, a percentage of members understand the need to maintain a favorable rating and plank in service, a fixed amount with an escalator and others. Each the steps necessary to achieve that goal. method has advantages and disadvantages, but if fairness can be corr~bined with predictability, the Municipal Utility will have arrived at an outcome that best serves its ratepayers. The issue of trans- parency can be a more difficult political challenge. There are many advocates of placing a separate line item on the utility bill to identify the PILOT payment, so the Municipal Utility has decided that it will adopt this practice. As utility bills get more complicated and costs increase for a variety of reasons, the Municipal Utility has de- i<ermined that it wants its customers to have as much information as possible to understand the individual components that make up their bills. The utility also feels that if the PILOT payment is de- fendable, there is no reason not to list it separately. ~p-s, utility bills get more complicated and costs increase for a variety of reasons, the ,Municipal Utility has determined that it wants its customers to have as much . information as possible to understand the individual components that makeup their bills. ZO SEPTEMBER 2OOJ PUBLIC POWEF ,. The Municipal Utility has many issues to deal with relative to its fiscal and operational health. Most decisions impact the utility's '~ finances, which ultimately affect rates. The Municipal Utility is ~ concerned about how it will manage its rates and pricing pro- gram to keep up with the changes in its operating environment, send the correct price signals and be fair to customers. ~~ a SC)LUTI.OI~ ~~~; The Municipal Utility has decided it needs an overall rate strategy to help guide its decision-making process going forward. The rate strategy will provide direction for rate-related decisions. Both the utility management and governing body will be involved in develop- ing this strategy. The strategy is envisioned to be a list of core rate-related principles including: • Developing and maintaining afive-year financial plan • Setting minimum financial ratios (i.e., debt service coverage, debt/equity ratio, margins) • Anticipating rate needs and developing appropriate rate change transitions • Developing an effective public rela- tions program that supports conservation, demand response and other pricing approaches • Addressing fee structure (i.e., new connects, special services) • Stating policy regarding competitive pricing (i.e., goals compared to neighbor- ingutilities) • Defining methodology related to re- liance on cost-based pricing • Setting reserve fund policies • Establishing rate rider guidelines (i.e., fuel adjustments, regulatory re- quirements) • The strategy will be in writing and adopted by the board to serve as an on- going guide for the board and utility management and as an educational tool for new board members. By tackling is- sues aspart of a rate strategy before they arise, the Municipal Utility will be better prepared to deal with its rate-related challenges. Finance Group of R.W. Bock, an SAIC company. www.APPAnet.org SEPTEMBER 2009 27 David Berg, P.E., is a principal in the St. Paul, Minn., office of R.W. Beck, a SAIC company. He is national director of the Rates, Valuation and G~ti ENGINEERS