Earlier this month the Illinois Commerce Commission (ICC) handed down the final Order on Rehearing in Docket 11-0721 regarding Commonwealth Edison's (ComEd) new formula rate that is intended to reimburse the utility for its multi-billion dollar investment in grid modernization.
Based on how the statutory construct of the new formula rate has been interpreted thus far, ComEd's utility revenue would be reduced by more than $100 million per year starting in 2014. That has led ComEd to halt aspects of its project until the matter is heard by the courts. Meanwhile Ameren, another major utility serving Illinois, had a similar order in their formula rate case. Ameren has made it known that their plans for grid modernization face an uncertain future with significant delay in deployment a very real possibility.
In full disclosure, I'm a former regulator and currently consult to utilities in cases involving rate recovery. As such, I'm very familiar with traditional ratemaking and the construct of the new formula rate under Illinois' Energy Infrastructure Modernization Act (EIMA). I believe the ComEd and Ameren cases provide an excellent learning experience for the emerging smart grid industry, state regulators and electric distribution utilities.
Utility ratemaking is an arcane discipline, truly understood only by a small circle of professionals at utilities, regulatory commissions and consultancies. Those outside the process may not be aware that utilities can spend millions in capital additions on behalf of customers and wait extended periods of time to recover the costs in retail rates. To keep utilities whole, it is customary for utilities to be able to earn interest on these unfunded balances until new rates are updated. Traditionally the interest rate applied is a reflection of the utility's overall cost of funds that come from a mix of stock investment and debt known as the Weighted Average Cost of Capital or WACC.
Unfortunately, EIMA legislation calls for recovery of uncollected amounts plus interest but WACC is not specifically mentioned. Opponents of the new formula rate have seized on this perceived ambiguity and have thus far argued successfully that Ameren and ComEd should instead earn a rate equivalent to short-term debt. The lower interest rate, applied to hundreds of millions of dollars in annual spend, dramatically reduces the utilities' annual revenue and cash flow. This is not simply a case of sharpening the pencil and lowering what utility shareholders earn. It becomes a fundamental issue that adversely impacts capital budgeting in large smart grid projects. The relationship between rates and the attraction of capital has been made clear in recent public statements made by Anne Pramaggiore, ComEd CEO, and Richard Mark, CEO of Ameren.
Following the trajectory of EIMA, the bill never enjoyed the support of the governor, the attorney general, the chair of the ICC or AARP. The governor vetoed the first bill approved by the state legislature, which subsequently overrode the gubernatorial veto. That's democracy and disagreement over legislation is fair game. In my own time in office, numerous statutory policy mandates came to me to implement in the regulatory process. There certainly were instances where I did not agree with the policy direction so I very much understand how the ICC views their current position.
Regardless of philosophy, policy direction ultimately is ebb and a flow, a give and take. It does seem as though the regulatory process is a continuation of the legislative debate that took place last year. There is stiff opposition to the EIMA-performance-based rate, and a return to a status-quo focus to reduce utility cost recovery to the lowest possible number. Historically, utilities have understood rate pressure and have naturally played it safe, avoiding the sort of risk that is part of innovation. Proponents of EIMA want an entirely different dynamic that fosters excellent utility performance in return for greater stability in the recovery of investment. Stability and clarity are especially important given the more than $3 billion in capital that is needed. That will not be possible under the old confrontational and unpredictable rate setting process.
Today, as a result of the regulatory impasse, the smart grid renaissance in Illinois faces an uncertain future. Uncertainty is also affecting vendors' efforts to provide goods and services for these projects and create much needed jobs for the Illinois economy. It appears that in Illinois the broader picture has been lost. Grid automation is a modern global imperative to empower consumers, enhance reliability, facilitate the interconnection of renewable generation and protect our natural environment. A modern grid does require a modern regulatory process.
David O'Brien is a former Vermont Commissioner of Public Service and is now a strategic consultant to utilities at the BRIDGE Energy Group. He is presently consulting to ComEd on regulatory matters.