Prepayment of Power Plans and Other Investments

Background

Traditionally, investor-owned utilities did not include the costs of major capital investments in utility rates until they were put into service (i.e., until they were “used and useful”). Utility investors assumed the risk of investing in capital projects and capacity, and after determining that the investments were prudently incurred, state regulators set rates to include recovery of the investment plus a reasonable rate of return for investors. However, during the construction of nuclear power plants in the 1970s, some utilities were granted a cost recovery mechanism called Construction Work in Progress (CWIP). CWIP allows utilities to charge ratepayers for the cost of financing new power plants during construction, resulting in rate increases before the power plant or other investment is completed and providing electricity.

In recent years, utilities have sought broader applications of CWIP (now often referred to as prepayment or advanced payment) for multi-billion-dollar investments in nuclear and coal plants, and in other high dollar infrastructure upgrades. Proponents of advanced payment for these investments claim it will save money for ratepayers by spreading payments out over more time.

Opponents argue that advanced payment attracts investors who are reluctant to finance the construction because of the risk involved. Advanced payment shifts that risk to ratepayers, while still allowing investors to earn a return. For example, a report by the National Regulatory Research Institute states that CWIP “involves some upfront shifting, from regulated utilities to ratepayers, of the economic and timing risks associated with implementing a major capital project.”

Further, advanced payment alters a utility’s incentive to be efficient and complete the plant on time. Because the utility will receive financing payments upfront, it reduces the pressure to put the plant in service on schedule; the longer the delay, the higher the costs of construction that are ultimately borne by ratepayers.

Experience has shown the risks to ratepayers are real, as nuclear and clean coal plants financed through CWIP and prepayment have run many billions of dollars over budget. As an example, under a state law that allowed for upfront payments, additional units under construction at the V.C. Summer Nuclear Station in South Carolina currently cost SCE&G’s customers an average of $23.16 each month, or 16.1 percent of their total bill. The overruns for the plant are expected to be $4 billion.

Prepayment of Power Plans and Other Investments: Policy

Compensation only for prudent investments in assets that are “used and useful” for the utilities’ current customers.

In this policy: FederalState

Policymakers should not allow or approve advanced or upfront payment for major capital construction projects, including nuclear and coal plants.