The Columbia/Pacific Institute

 

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MEMORANDUM

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October 17, 1997

FOR	File
FROM	Angus Duncan
SUBJECT	Transition Cost Principles/Pragmatics

Attached is a brief treatment of the principal "how-to" issues associated with transition cost recovery. The approaches it describes are generally consistent with interests expressed by public interest and tribal parties, but it seeks to reconcile these with customer concerns for cost management and for equity in assessing transition costs.

Transition Cost Issues

Rationale for Dealing with Transition Costs: A BPA transition cost mechanism is a controversial but inescapable issue for regional policymakers to address. This is so financially because BPA’s high fixed costs (debt) leave it little flexibility to deal with three areas of uncertainty: (1) market prices; (2) the agency’s limited ability to affect its overall cost structure by reducing discretionary costs; and, (3) the potential for higher fish restoration costs. Politically the issue must be dealt with because the equity shareholders -- Treasury and the Congress -- have no appetite for a BPA bailout.

Default Option - Shift Costs to Transmission: Failure to develop a consensus mechanism leaves BPA with a default mechanism: shifting costs from its Power Marketing business line to its transmission customers. This alternative will have uneven application, charging some transmission-only customers who have no historical Pacific Northwest obligations, while allowing historic customers who have delivery alternatives to avoid it. Cost-shifting also runs contrary to FERC and national policy on separation of functions, and may come under pressure from national energy suppliers. It will certainly be litigated by DSI’s and others.

Transition Cost Recovery Principles/Issues/Criteria: There are many issues of calculation, allocation, collection, etc. to designing a mechanism. The most important of these are:

1. Cost Control

Customers fear that giving BPA a transition cost authority will relieve the current market pressure to control costs. Fish advocates and tribes fear "cost control" is code for fish cost caps and funding levels indifferent to biological needs. Any transition cost mechanism must reconcile both these legitimate concerns.

Possible solutions: Develop proxies for market pressure to control costs (e.g., independent performance audits), needed in any event when BPA costs<market. Make transition cost activation contingent, not automatic (e.g., first establish and meet cost-control and operating efficiency goals; enhance revenues). Require the BPA Administrator to satisfy a third party that the agency can’t meet its costs without recourse to transition cost authority. Cap customer transition cost liability for individual customers, with Treasury deferrals carrying any excess.

A more far-reaching solution would be to reorient the agency to a less competitive, more passive, market-taker kind of supplier. BPA products could be packaged and auctioned, with the secondary (wholesale) market then repackaging and reselling them at retail. A substantial reduction in BPA’s marketing and contract management departments would be possible. However, the agency would be foregoing (potentially) significant revenues by not marketing its own value-added products that exploit the flexibility of the hydropower system, and of emerging trading floor-based markets.

(See also the trigger mechanism described below, which addresses short-term, non-recurring shortfalls in a manner that retains market discipline on BPA.)

2. Trigger Mechanism

There are several approaches to a triggering device being discussed.

Some parties have proposed that the trigger be based on BPA's level of financial reserves (cash on hand). If these reserves dropped to a specified low level - e.g. $X00 million, - a charge would trigger on all BPA customers that would rebuild reserves to an appropriate level.

A second, but politically more complex alternative mechanism, supported by some utilities, would focus on BPA repayment of US Treasury debt. The proposed stranded cost methodology would be triggered by initial shortfalls in BPA's payment of its Treasury obligations. The shortfalls could cause the amount that is not paid on schedule to be refinanced at market-based interest rates and to be scheduled for repayment through the revenues collected from the stranded investment recovery mechanism. OMB and the Treasury would have to concur in this approach.

We recommend a third approach that combines elements of both of these, but differs by distinguishing between short-term, non-recurring BPA revenue shortfalls, and projected chronic, long-term deficits of a magnitude that might be caused by major modifications of the hydro system for fish recovery.

Under this third approach, we would use BPA's probability of Treasury repayment as the stranded cost trigger. BPA and the region would set a threshold ( X %) level of probability of repayment . Stranded cost recovery would be either prospective or retrospective depending on whether projected revenues are sufficient to meet or exceed this threshold after all other system costs have been covered.

So long as the repayment probability exceeds the stipulated threshold, no prospective stranded cost recovery would be authorized. In this case, if BPA actual revenues, after cost review and management, failed to cover system costs, a retrospective stranded cost recovery charge would be applied, triggered by reserves falling below $_____ million.

However, if BPA projects a repayment probability below the threshold, and especially if shortfalls are projected to be substantial and recurring, BPA would be authorized to levy a prospective stranded cost recovery charge. Such a charge would be limited only to recovery sufficient to meet, but not to exceed, the stipulated threshold. In this way, a prospective stranded cost recovery could not be used by BPA to relieve all pressure to control costs.

There would need to be independent verification of BPA’s assumptions and calculation of the probability projection, so parties were satisfied that the agency could not manipulate the process to a predetermined outcome.

3. Calculation

How much might need to be collected? It depends on the uncertainties noted above. There is Power Council staff analysis that assumes: (1) BPA’s ‘96 rate case costs; (2) competitive supply costs rise over 20 years from 1.6ó to 2.2ó; and, (3) fish costs that at the outside might include breaching five dams. An average transition cost recovery charge of about 2 mills for 2002-2015 appears to cover BPA’s deficit under this scenario. Lower fish costs or market prices rising faster would drive this level down (the reverse case would drive it up).

Five year rolling fish and wildlife budgets (ten year budgets for capital projects) would contribute to agency and customer predictability of these costs.

4. Limitation on Customer Liability

To deal with customers’ need for predictability in their cost projections, we also propose that a customer’s exposure to stranded cost recovery not exceed approximately (__Y__ ) mills/kWh for current transactions. Stranded costs that would otherwise be unrecovered under this constraint would be dealt with in two ways.

First, BPA would have the authority to front-load recovery to the extent that it projects multi-year shortfalls that may spike above the cap on customer exposure. That is, a projected spike in costs in Year Two may be anticipated and flattened by beginning the stranded cost recovery charge in Year One.

Second, any remaining costs unrecoverable in advance would be treated the same as short-term, non-recurring costs. That is, they would result in failure to meet the Treasury repayment schedule, would be rescheduled and repaid with interest in as short a time period as possible.

Such a limit on customer liability is in lieu of an arbitrary fish cost cap unrelated to the biological requirements for fish recovery.

5. Allocation

The simplest approach is also the most broadly-based: assume a regional responsibility to restore the river, and charge everyone who touches the regional transmission system (not just BPA’s). This approach would assure other river users would pay some share of fish costs, as well as out-of-region west coast customers who have historically benefited from the system.

Alternately, the charge could be targeted to historic Bonneville power marketing beneficiaries, and assessed in proportion to BPA power use calculated over a test period. There are questions of allocating charges based on capacity, or energy, or some combination.

The best regional solution is probably to combine these approaches: a modest wires charge to pick up out-of-region users, and a charge to all end users who have been historical beneficiaries of the federal power system.

6. Collection

The simplest method is to calculate the charge on an end-use-customer basis and collect it from wholesale suppliers at transmission point of delivery. Load shifts (e.g., customers changing suppliers) would be reflected by adjusting charges collected from the wholesale supplier.

If the charge is calculated and collected prospectively, there would need to be a true-up mechanism. If it is collected after the fact, some party (Treasury?) would be required to back up cash flow. A partial advance recovery authority might mitigate the adverse qualities of both approaches.

7. Bypass

To the extent BPA must rely on a transmission surcharge to collect stranded costs, FERC should adopt regulations providing for recovery of any stranded costs imposed upon (or uncollectible by) BPA as a consequence of another utility granting transmission service that allows departing BPA customers to bypass BPA’s transmission system.