by Roy Ellis, Christopher Smith, Ted Pelecky and Michael Ballaban, Ernst & Young
After Hurricane Sandy blasted ashore in 2012, utility companies worked around the clock to get the lights back on, spending enormous sums along the way.
But the efforts didn’t end there. More than a year after the storm’s gales subsided, utility companies continue to face a different obstacle: cost recovery.
It’s an increasingly familiar scenario for utilities, which have responded to a string of severe storms in recent years. Higher costs and greater storm frequency have led to additional regulatory scrutiny of restoration expenses, with a greater burden of proof on utilities that are seeking cost recovery.
In addition, given the high profile and political nature of these events, regulators are undertaking an increased level of due diligence, especially if a utility’s performance is deemed less than perfect.
Without a compelling, transparent case for recovery, utility shareholders face significant financial headwinds. Many utilities experienced significant difficulty fully recovering restoration costs after powerful storms such as Hurricane Ike in 2008 and Tropical Storm Irene in 2011. Sandy has proved no different.
State utility commissions disallow costs for many reasons. In certain cases, submitting utilities don’t meet a minimum standard of proof that costs were prudently incurred. In other instances, charges were deferred but remain at risk for disallowance if the utility does not meet certain reliability performance metrics. Some utilities are forced to write off charges because they lack regulatory mechanisms to defer expenses.
When a storm hits, a utility’s primary focus is on restoring power; however, after all customers are back in service, the same sense of urgency and focus applied to the restoration process also should extend to cost recovery efforts. Storm response should be viewed as complete only after all prudently incurred costs are recovered.
Given today’s challenging regulatory environment, utilities should develop a storm response plan to optimize the likelihood of cost recovery. The time to consider planning for storm recovery begins well before any storm.
Consider the following key steps when developing a storm response plan:
- Document regulatory requirements for recovery of storm costs in each operating jurisdiction, and validate that existing company standards are consistent with regulatory guidelines. This research will help guide a utility as it develops policy guidelines and requirements documents that will be incorporated into the storm response plan. The research should include: an understanding of the level of commission scrutiny on costs; specific categories of investigation; and the level of documentation needed in submissions to meet the burden of proof. A review of past storm cost recovery filings from interveners also might provide insight into themes.
- Standardize processes associated with cost review and embed them into storm restoration efforts. Regulatory and accounting functions should work collaboratively to establish policies that readily identify and catalog all storm-related costs while appropriately excluding nonrecoverable items, expenses or both that might affect corporate reputation. This process will provide maximum opportunity to facilitate timely cost recovery. To mitigate certain avoidable risks, functional groups within the utility must work collaboratively. Our clients cite the need to balance the benefits of system and process standardization with local operational and customer knowledge. A clearly defined approach that spells out roles and responsibilities along with consistent, proactive communication with those involved might enhance the transparency of storm documentation submitted to the commission. As a first step, develop contractor invoice templates that address cost recovery regulatory requirements. The templates should include key information such as work location, a description of activities undertaken, a list of labor and equipment along with associated hours and rates, and other appropriate documentation that confirms third-party contractor work is performed as described. Standardization of policies with vendors will help clarify expectations and facilitate timely submission of invoices. This is critical because vendor invoicing delays impede a utility’s ability to file efficiently and effectively for recovery of storm costs.
- Communicate with storm restoration resources before any restoration activities begin regarding expectations for storm cost documentation. Reinforcing the importance of storm cost documentation during storm planning and pre-mobilization stages will help facilitate the timely processing of invoices submitted for payment. For example, a memo that identifies cost, allocation and documentation guidelines should be developed jointly by the finance and regulatory groups and distributed to all storm restoration resources. This will reinforce rules for veteran staff and educate contractor and mutual aid resources unfamiliar with company policies about the importance of following guidelines. In addition, this will promote a consistent, documented application of cost review procedures.
- Establish data retention procedures that help facilitate review and provide evidence to regulators of cost prudency. Allowing unsupported expenses to become part of a regulatory submission introduces reputational risk and the possibility of extended commission discovery into the utility’s storm practices. Retaining complete records of all storm costs is essential for undertaking an internal review, compiling data for filings, and responding to regulatory requests for information. Data should be available electronically and organized to enable review of any or all categories of information (e.g., vendor, town, work stream). Our discussions with certain utilities found that a measurable percentage of invoices are filed for recovery without supporting documentation. This should be unacceptable.
- Invest in tools to facilitate expense data aggregation, review and analytics. Investing in technology that permits analysis of large volumes of electronic data in one platform will facilitate internal review and provide a path to fully document cost submissions. Many utilities undertake cost review by employing spreadsheets and scanned PDF images stored in accounts payable systems and some still use hard copy documentation. Software platforms, however, are available to manage the review and analysis of electronically stored payables data in one location. These technologies enable expense transactions to be categorized more efficiently. Other features include guided analytics, which facilitate key work searches and consistent data exports across work streams, and real-time scanning of receipts and invoices.
- Clarity on ownership of the storm cost recovery process. Much discussion is afforded to which functional organization within the utility owns the end-to-end storm recovery process. This is despite that any one group cannot claim ultimate accountability. Distribution operations is the tip of the spear in restoration efforts. This arm of the utility knows what work was done where. Other parts of the utility, however, can play crucial roles. The finance group, for instance, must validate the costs that were incurred in labor, unit costs, etc. And the regulatory function must provide guidance and oversight because this group is responsible for the material that is filed with regulators for cost recovery. Utilities where storm recovery processes and functions exist in silos will be challenged to maximize cost recovery. Inability to recover prudently incurred costs results in a loss for customers, shareholders and all other stakeholders.
- Lengthen the storm restoration period to include rehabilitation where smart technologies are deployed. It’s important to differentiate rehabilitation from restoration. Just because power has been restored doesn’t necessarily mean the system has been rehabilitated to its pre-storm state. This is of particular importance now as utilities deploy smart technologies alongside the core electric grid infrastructure. For all the right reasons, the purpose of storm restoration is to restore power to customers. It might be weeks or months before damaged smart technology is replaced, however. Storm restoration periods should be extended to allow for the full rehabilitation of the system. Utilities also should carefully segregate storm-related costs from routine repair and replacement costs to capture the impact of weather-related events. Such a step is critical when a utility files for storm cost recovery, especially if such a recovery mechanism exists outside of a general rate case.
- Conduct a thorough review of costs to ensure conformance to regulatory requirements and company policies before filing for recovery. Maintaining credibility through the identification of potential adjustments before undergoing commission scrutiny is essential for mitigating financial and reputational risks. Implementing detailed and consistent review testing procedures of cost data and documenting results before submission to the commission will provide greater assurance that all expenses are storm and jurisdictional appropriate and will serve as evidence during any regulatory prudency review undertaken.
Storms are arriving with greater force and frequency, placing a huge financial burden on utilities.
When disasters strike, utility workers are deployed to restore power. These employees take pride in their work, and they do the industry proud. Storm cost capture and documentation is rightfully a secondary focus. Yet enhanced regulatory scrutiny dictates that utilities improve these processes.
By embedding cost recovery considerations throughout the storm response process, the utility is able to create a more efficient, cost-effective process.
This approach might facilitate rapid, transparent cost recovery filings that will greatly improve financial results. Failure to do so exposes utilities to financial losses each time a storm hits.
Roy Ellis is executive director in the Power & Utilities Advisory Practice of Ernst & Young.
Christopher Smith is a senior manager in the Power & Utilities Advisory Practice of Ernst & Young.
Ted Pelecky is a senior manager in the Power & Utilities Advisory Practice of Ernst & Young.
Michael Ballaban is a manager in the Power & Utilities Advisory Practice of Ernst & Young.
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