able to borrow money on more attractive terms to finance construction. In other words, their cost of raising new capital will be lower. This reduction in the utilities' cost of capital during the construction period because of the inclusion of CWIP in rate base, also reduces rates to ratepayers over the life of the facility. Both on an aggregate dollars basis, and when the time value of money is considered, the inclusion of CWIP in rate base is cheaper for ratepayers than the exclusion of CWIP from rate base. Virtually the same conclusion has been reached in the enclosed study, Regulatory Treatment of Construction Work in Progress: A Comparative Analysis, which was performed by the Texas Public Utility Commission staff in 1982. This study reaches the general conclusion that:

"(1) Under all circumstances total ratepayer costs are lower over
the life of a power plant when CWIP is included in rate base;
(2) Based on the time value of money, the present value of
ratepayer costs is lower when CWIP is included in rate base,
if the ratepayer's after-tax opportunity cost of funds is
lower than the utility's before-tax cost of funds;

(3) The desirability of CWIP inclusion, from any particular
ratepayer's point of view, depends on that ratepayer's
opportunity cost of funds and the number of years the
ratepayer expects to live in Texas."

STATEMENT OF ROBERT M. SPANN

ON S.817, S. 1069 AND H.R. 555

"CONSTRUCTION WORK IN PROGRESS POLICY ACT OF 1983"
BEFORE THE

SUBCOMMITTEE ON ENERGY REGULATION

SENATE COMMITTEE ON ENERGY AND NATURAL RESOURCES

My name is Robert M. Spann. I am a Principal and member
of the Board of Directors of ICF Incorporated, a Washington,
D.C. consulting firm. One of my area of specialization is
electric utility rate design and financial forecasting. I have
provided expert testimony before a number of state public
utility commissions. I have served as a consultant to electric
utilities, state public utility commission staffs, consumer
groups, large users of electricity, as well as cogenerators and
small power producers. The areas of the expert testimony I
nave presented include: electric utility financial
forecasting, electric utility rate design, electric utility
demand forecasting, rates for purchases of capacity and energy
from cogenerators, construction work in progress in rate base,
and rate of return.

I have reviewed the April 12th statement of J. Bertram
Solomon before this Committee. Mr. Solomon concludes from a
series of tables and exhibits he prepared that "... when the
time value of money to the customers of utilities is taken into
consideration, including CWIP in rate base will also be more
costly to consumer than not including CWIP in the rate base."
I have reviewed Mr. Solomon's tables and calculations. Mr.
Solomon has seriously misinterpreted his own data. His data do
not indicate that CWIP will be more costly to consumers when
the time value of money is taken into consideration.

Specifically, all that Mr. Solomon's data shows is:

1. Including CWIP in rate base leads to higher rates
during the construction period and lower rates
during the period that the plant is in-service
relative to the alternative of not including CWIP
in rate base.

2. The present value of revenue requirements over the
life of the facility is the same regardless of
whether CWIP is included in rate base or is not
included in rate base.

Financial and Electric
Rate Impacts of Placing
Construction Work
In Progress

In Rate Base

Prepared for

Edison Electric Institute

Prepared by

ICF Incorporated

April 1984

Copyright 1984 by

EDISON ELECTRIC INSTITUTE

All rights reserved. No part of this book may be reproduced or transmitted in any form or
by any means, electronic or mechanical, including photocopying, recording, or any informa-
tion storage or retrieval system or method, now known or hereafter invented or adapted,
without express prior written permission of the publisher, Edison Electric Institute.

PRINTED IN THE UNITED STATES OF AMERICA

What Placing CWIP in Rate Base Means

• Placing CWIP in rate base means that the utility recovers its financing charges associated with construction currently from ratepayers through the return component of its rates, rather than adding them to the cost of construction for recovery when the facility is in-service.

• Not placing CWIP in rate base means that the utility earnings are credited with a non-cash return on facilities under construction. This non-cash credit (known as AFUDC) is added to the cost of the plant and recovered over the service life of the investment.

As such, the issue of placing CWIP in rate base has to do with the timing of the recovery of the financing charges associated with construction.

• The purpose of this presentation is to demonstrate the impacts of CWIP in rate base on ratepayers and utilities.

Potential Ratepayer Impacts of Placing CWIP in Rate Base

• Consumer pays lower rates over the service life of the facility, since the rate base is not permanently increased by the amount of financing charges associated with construction.

• Consumer pays a small increase each year as facility is being built rather than face a large increase in rates when the facility enters service. As such, placing CWIP in rate base leads to a more gradual time pattern of rates and helps avoid or mitigate "rate shock."

• Placing CWIP in rate base improves the financial position of utilities. This allows utililities to raise debt and equity capital at lower costs, thereby tending to lower electricity rates over the life of the facility.

Potential Impacts on Utility of Placing CWIP in Rate Base

• Raises internal cash flow, thus lowers external financing requirements.

• Improves financial health of utility, thereby lowers costs of raising debt and equity capital.

Allows facilities to be constructed when they are needed by avoiding the possibility that capital constraints might prevent construction of required facilities.

CWIP and the Cost of Debt and Equity Capital to Utilities

• Numerous studies have shown that the stronger the financial position of any corporation (regulated or unregulated), the lower the costs of raising debt and equity capital.

• The relevant comparison is not between placing CWIP in rate base and not placing CWIP in rate base, but between placing CWIP in rate base and

- not placing CWIP in rate base and paying higher costs for financing.

adoption of other regulatory policies which improve cash flow such as allowing utilities higher rates of return to maintain utility financial performance and same cost of debt and equity as if CWIP was placed in rate base.

Financial Indicators, CWIP and Cost of Debt and Equity to Utilities

Table 1 shows the average levels of key financial indicators by bond rating groups.

• The lower the bond rating, the higher the cost of raising debt and equity capital. For example, over the period 1972-1981, utilities with BAA bond ratings paid an average of 69 basis points higher interest rates than utilities with A bond ratings.

• Placing CWIP in rate base increases interest coverage and internal cash generation and lowers AFUDC as a percen tage of earnings during the construction period. As such, CWIP helps maintain higher bond ratings resulting in lower debt and equity costs.

• Alternative regulatory policies such as higher rates of return can achieve the same result. One question addressed in this study is which policy is cheaper for ratepayers in the long run.

SOURCE: "Electric Utility Industry Credit and Equity Analysis," The First Boston Corporation, July 1983.
Statistics are derived using a sample of 119 electric and combination companies.

Projecting Impacts of CWIP

• Two illustrative utility situations chosen for analysis.

Both utilities currently have 4,600 MW peak demands and are building a 600 MW unit, planned to enter service in

1988.

• The utilities differ in the need for new generating plants in the 1990s. Utility A will not build additional capacity in the 1990s. Utility B will build additional capacity of two 300 MW units to enter service in 1992 and 1996. The Technical Appendix details the assumptions used in this analysis.

Methodology for Determining Ratepayer Impacts

• Simply examining rates with and without CWIP in rate base may be misleading, since CWIP affects cost of capital.

• The appropriate comparison is between placing CWIP in rate base and

allowing the utility's bonds to be downgraded, resulting in higher costs of capital

- alternative regulatory policies (such as higher allowed returns) which maintain utility financial indicators and avoid downgrading of bonds.

• The following results assume policies are implemented beginning in 1985.