The issue
Within the traditional regulatory framework, utilities can request that the cost of capital (financing costs and return) for a new asset be added into rate base even before construction is complete, speeding recovery even further. Once considered a somewhat far-fetched idea, inclusion of construction work in progress (CWIP) in rate base is becoming more commonly accepted among regulatory commissions.
How we got to this point
CWIP came into vogue in the 1970s when big-ticket nuclear plants were being built. It allows the utility to collect financing costs for a project prior to the plant’s completion, and before it can pass the standard “used and useful” test. This eliminates regulatory lag (the lapse of time between project completion and cost recovery), as well as regulatory uncertainty (the potential for a commission to deny cost recovery once a project is complete). By allowing return on the cost of capital during construction, CWIP reduces the overall amount needed to finance a project, thus reducing total project costs passed on to the consumer.
Some state-specific CWIP examples
| STATE | EXAMPLE OF USE |
|---|
| LA, VA, FL, CO, MD, ND, WI | Specific types of generation (often nuclear) |
|---|
| OH | IGCC |
|---|
| LA, FL | Allows CWIP for a portion of a new plant, to avoid rate shock in the future |
|---|
| CO | Transmission project |
|---|
CWIP carries with it “generational issues,” especially with capital projects that have long construction times. A small percentage of any utility’s customers close business or move away before a project is complete. Likewise, a certain group of new consumers – new businesses or those who have just moved to the area – when the project does go on line, will benefit from the asset without having helped to finance it. Although this concern is growing, both groups are relatively small compared to the entire population and, at least currently, the argument is not a loud one.
CWIP sometimes is allowed by a state utility commission for projects incorporating specific technologies the commission wishes to promote, such as renewable or nuclear generating facilities.
AEP position
AEP is a strong supporter of CWIP. It removes both regulatory lag and regulatory uncertainty from costly capital projects. Either of those elements can delay or kill a project.
CWIP addresses some very real financial challenges for utilities, while not requiring a complete overhaul of the traditional regulatory framework.
Although it’s true that CWIP carries certain generational issues, the percentage of consumers impacted is quite small and, in the overall economic picture, the benefits of lower total financing costs helps keep rates lower for all remaining customers.
What the industry says
Utilities as a whole are supportive of CWIP. Commissions are becoming more amenable to the concept although they sometimes have concerns about their ability to monitor cost prudency once CWIP is granted. However, CWIP typically comes with a review process that includes true-up, which should preserve commission authority to review costs.
Utility company bond ratings are decreasing
(Note: Rating applies to utility holding company entity)
SOURCE: EEI Q4 2008 Financial Update
Effect on bond rating
Utilities’ bond ratings as a whole have gradually eroded over time. Because a utility’s bond rating is directly linked to its cost of capital, the increased cost of borrowing is passed on to the customer. Two ways to strengthen the utilities’ bond ratings and stabilize bond ratings are reducing regulatory lag (the time between when a utility makes and investment and when the investment is recovered through rates) and regulatory uncertainty (the risk that an utility commission will disallow recovery of an expenditure). Because CWIP accomplishes both of these objectives, it is a very useful tool commissions and utilities can use to make large capital investments while maintaining bond ratings.
