Steel-for-fuel, data-for-fuel, and other good ideas for asset retirement
The following is a contributed article by Carl Linvill, Principal, and Megan O'Reilly, Associate, at the Regulatory Assistance Project.
An increasing number of coal-fired power plants are becoming uneconomic before their planned retirement, and a number of states are considering securitization as a tool to balance utility, community and ratepayer outcomes. However, implementing securitization in the public interest is a delicate exercise that requires careful consideration of local circumstances and policy objectives.
The "steel-for-fuel" approach recently employed by Xcel in Colorado is notable because it demonstrated three things a collaborative process can achieve: It considered local circumstances, balanced competing stakeholder interests, and arrived at a desirable, forward-looking solution that advanced the state's public policy aspirations.
This article focuses on three important elements addressed by steel-for-fuel:
- The need to retire obsolete coal assets and determine the allocation of stranded costs in so doing;
- Use of a securitization approach, which can reduce the cost to ratepayers of retiring the stranded asset while offering utility shareholders acceptable but not excessive recovery of sunk costs; and
- The need to then design a replacement portfolio aligned with state policy objectives — and to recognize that "steel in the ground" may not be the only ingredient in this portfolio.
Different solutions for different contexts
As other states consider securitization as a way to align the retirement of obsolete assets with their policy objectives, Colorado's approach provides an effective example others may choose to follow. Yet there is a danger that policymakers and legislators could look at the Colorado example and conclude that "steel-for-fuel" securitization is a universally beneficial strategy.
It is not that simple, however. In other states' contexts, policy alignment will require different solutions with different elements.
Offering the utility a new physical investment opportunity leverages the traditional cost-of-service, rate-of-return regulation model well. But it overlooks the question of where the utility business model ultimately should be headed — i.e., in a direction that can leverage the most cost-effective, integrated solutions to compensate for retiring assets.
Doubling down on the rate-basing of physical assets risks taking off the table many innovative least-cost alternatives — "data-for-fuel" solutions, such as energy efficiency, distributed generation, demand response, flexible demand and improved use of the existing infrastructure through the application of information technology.
Building a large-scale grid asset may be the best solution in some cases, and having the utility invest in and rate-base that asset may sometimes be the best solution. But it is certainly not always, or even usually, the best solution.
To ensure that a particular solution takes advantage of opportunities while ameliorating impacts, legislators and regulators should ask a number of difficult questions when thinking about using securitization for early asset retirement:
- Is the undepreciated balance of the retiring asset fully the responsibility of ratepayers, or should the cost of retiring that obsolete asset be shared by ratepayers and shareholders? An assessment should be made of the remaining cost, and a determination made regarding whether that cost should be fully borne by ratepayers. In many situations the answer will be yes, but that answer should not be presumed without examining the evidence.
- What cost of capital should be applied to the securitized asset? Utilities will propose a full weighted average cost of capital for the securitized asset, but some states have determined that the far lower cost of debt is more appropriate.
- Is a "steel-for-fuel" replacement strategy the most cost-effective resource strategy to meet the needs of the grid after the obsolete asset is removed from service? The answer will usually be no. "Data-for-fuel" — the use of data, information systems and system control technologies — is a highly cost-effective approach that makes the existing system more efficient and engages distributed energy resources to meet system needs. While some Steel-for-Fuel may be merited, a combination of physical assets and enabling technology is likely to meet needs most cost-effectively in most situations.
- Are some populations disproportionately affected by retiring the obsolete asset? Some communities are affected by asset retirement more directly than ratepayers or shareholders, or even the state as a whole. As a result, one element of a successful outcome may be a strategy that uses some savings from securitization to address immediate impacts.
Because arriving at a securitization strategy that serves the public interest requires balancing competing interests, and solutions may not fit neatly into the utility's current constructs, a collaborative process is critical to success.
One requirement is a well-aligned utility business model strategy. Procuring steel-for-fuel and data-for-fuel will involve some utility direct investment in physical assets.
Traditional rate-basing of these investments will offer the utility compensating rewards. An optimal replacement portfolio, however, could also include competitive solicitation for resources, investments by third parties and consumers, and an inviting information platform that engages these competitive, third-party and consumer players.
A collaborative process allows for consideration of these utility business model changes. Such a process can ask and answer a key question: How can utilities be compensated for creating the environment that allows the most cost effective and most beneficial solutions to emerge?
The answer echoes in all states pursuing utility business model reform — performance metrics need to be established, including metrics that reflect the openness of the utility platform, and utility compensation mechanisms need to reward the utility for well-run platforms.
Collaborative processes like the e21 initiative in Minnesota and the power sector transformation process in Rhode Island are good, inclusive forums that allow competing objectives, alternative solutions and appropriate performance metrics to be comprehensively considered and evaluated.
Securitization is a powerful strategy, and the Steel-for-Fuel approach was well-executed in Colorado. But that does not mean this approach is universally applicable. If applied injudiciously elsewhere, it could result in solutions that cost too much and inappropriately transfer risk to ratepayers.
Securitizing obsolete assets well requires simultaneous attention to several things: stranded asset cost-sharing, an open competitive process that puts all steel-based and data-driven solutions on the table and consideration of utility business models that reward the utility appropriately for offering a platform that lets the best solutions emerge.