Difficulties surround transmission system financing

Patricia Irwin, Contributing Editor

As loads increase, upgrading (and extending) transmission lines is more important than ever. Unfortunately, financing those projects is becoming more difficult as utilities adjust their business strategies to compete in the changeable power arena.

Yes, the U.S. transmission system is aging and heavily loaded, but there are a number of impediments to upgrading and extending lines. Uncertainty and changing requirements make transmission financing a challenge.

Regulatory issues

Well, beyond the problem of securing rights of way, there are significant regulatory and financial issues that make financing projects difficult. “The main issue is the high level of uncertainty in the transmission market,” stated Howard S. Gorman, vice president of R.J. Rudden Associates Inc., an economic and managemet consulting firm specializing in energy and utility matters.

“Not only can’t people quantify the financial risk, but there are significant unresolved questions as to whether FERC’s vision of the market will come to fruition. That vision could be realized entirely, regionally, or not at all, and each outcome has dramatically different implications for companies that own, operate and ultimately finance transmission systems,” said Gorman.

There is also the question of whether transmission companies will have control over their capital budgets. In FERC’s proposed standard market design, a transmission company may be required to build lines that it cannot (or does not want to) raise money for, or risk having another party build the line.

While a new transmission line may reduce the overall cost that end-users pay for electricity, incumbent transmission companies may have to incur capital costs for lines that do not benefit them or their investors. On the plus side, a transmission owner can raise money as a regulated utility, but as long as it does not have control over its capital budget, it may be forced to do things that are not financially sound. This is not a good way to attract investors.

Money matters

Indirectly affecting financing is the big-money question of valuation. So far, the industry does not have a good method for valuing transmission assets, mostly because it is not exactly clear what will happen next in the areas of taxes and tax laws, and return on equity (ROE).

For example, tax laws can significantly impact the perception of value. Imagine a transmission asset with a book value of $900 million and a tax base of $500 million. If the owner sells the assets for book value ($900 million), there is a $400 million taxable gain.

The tax on $400 million is not a small chunk of change. So, figuring out who will pay it has a significant effect on how transmission assets are regarded–hence, valued. So, who pays?

The seller could pay, but this impairs after-tax cash flow. Under possible federal legislation, the tax on certain sales of transmission assets could be deferred, but then the government would miss out on a big paycheck. The buyer could pay, but then the purchase price goes up. And, in most cases, this premium cannot be included in the rate base without special dispensation. If the premium is included in the rate base, then rates go up; if not, then the transaction will probably not be economic for the buyer.

Further, investors looking for the old ‘widows and orphans’ fund will not be happy to hear that it is not clear what return on equity (ROE) the FERC will allow for regulated transmission assets. There have been a number of proposals floated, and FERC recently approved an ROE of just under 13 percent for the Midwest ISO (MISO) members (under the MISO template), but that is just one region.

“It is unlikely that FERC will approve a global rate, because situations vary between regions and companies. But generally, the ROE that people expect for transmission assets is 11 percent at a minimum, and 15 percent or more, as an aggressive number. Remember, it is not the rate itself, but the appropriateness of the rate that attracts investors. And, just as important, investors will reward companies that have coherent strategies and actually achieve consistent returns for investors–whatever the allowed ROE,” Gorman added.

Gorman is a vice president for R. J. Rudden Associates Inc; he can be reached at Hgorman@RJRudden.com.

Irwin is a professional engineer who began her career as a substation engineer with an East Coast utility. She is an experienced technical writer and has written articles for a variety of publications. She can be reached at EditorEW@aol.com.

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