Review of the Economic System Planning Criteria

June 15th, 2012 / RPG

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Background

ERCOT Public

“The criteria must include a comparison of the estimated cost of the transmission project and the estimated cost savings that may result from the transmission project.”

Project #39537Rulemaking to Implement HB 971, Relating to Economic Criteria for a Certificate of Convenience and Necessity for an Electric Transmission Project

To determine the societal benefit of a proposed project, the revenue requirement of the capital cost of the project is compared to the expected savings in system production costs resulting from the project over the expected life of the project.

3.11.2, Planning Criteria

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Net Societal Benefit

Societal Impact Test – the increase in the societal surplus (equal to the reduction in production costs) due to a project must exceed the annual carrying cost of a proposed project.

ERCOT Public

P

S

D

Q

CS

PS

Societal Surplus S’

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1/6: The magic number

In 2006, ERCOT stakeholders analyzed the components typically included in regulated rate-based transmission assets for various ERCOT TDSP’s. We learned that:

– Different TDSP’s incur different expenses (taxes, financing costs, etc.) based on location, capital structure, or organization type.

– An average, or most likely range of expenses would be most practical for use in estimating the annual rate-based revenue requirements for a capital transmission project.

ERCOT Public

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Pro-forma Transmission Revenue Requirement Calculation

ERCOT collected estimates and/or actual figures for select transmission providers:

ERCOT Public

Debt (% of total capital)

Debt Rate

Equity Rate

FIT Rate

IDC

Franchise Tax

Gross Receipts Tax

Inflation Rate

Property Tax Rate

To create a pro-forma spreadsheet to calculate a first year revenue requirement for a regulated transmission project.

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Pro-forma 1st year revenue requirement

ERCOT Public

Project Financials (Revenue Requirements)

(Thousands)

-1 0 1 2 3

Return on Rate Base 2005 2006 2007 2008 2009

Equity   0 1,297 1,264 1,232

Debt   0 1,203 1,173 1,143

Total   0 2,500 2,437 2,375

Depreciation   0 791 791 791

Fixed O&M   0 0 0 0

Var O&M   0 624 637 649

Property Taxes   0 791 791 791

FIT plus   0 8 -105 -18

Gross Receipt Tax   0 8 8 8

Total Revenue Requirement   0 4,713 4,550 4,587

For a hypothetical $30,000 transmission investment, given average assumptions, approximately $4,700 would be added to the rate base in year 1.

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Demonstrating Economy

ERCOT Public

Hypothetical Project Cost: $30,000

Pro-forma estimate of 1st year revenue requirement: $4,713

To demonstrate economic merit, the marginal cost of the upgrade, on an annual basis, should be roughly commensurate with its marginal benefit.

If a project returns at least its 1st year revenue requirement in production cost savings in year one of its inclusion in rates, ~ MC=MB

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Input Assumptions – do they change?

• Tax rates – generally flat• Capital structure – possibly dynamic• Cost of capital - dynamic• Taxable Status – varies by organizational structure

ERCOT Public

ERCOT selected entities from public / investor owned transmission providers to determine if the 1/6 was still a relevant threshold for economy.

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Data sources:

• Public / conveniently available data of the inputs below varied by organization

• Different organizations have different reporting requirements

ERCOT Public

Debt (% of total capital)

Debt Rate

Equity Rate

FIT Rate

IDC

Franchise Tax

Gross Receipts Tax

Inflation Rate

Property Tax Rate

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Alternate Approach

Utilize transmission service revenue requirement data from Schedule A (most recent)

Rev Requirement – O&M

Rate Base

ERCOT Public

Revenue Requirement %=

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Preliminary Results

• Comparing the results of both approaches to determine the economic threshold yielded similar or identical results.

• The review, thus far, has determined that the 1/6th criteria is still reasonable and relevant.

• ERCOT shall establish a procedure to periodically verify and/or update the economic threshold.

ERCOT Public