The ODRC calculates the value of a utility's assets by reflecting the cost of replacing an existing asset with an "optimized" and "modern" equivalent asset (MEA) and adjusting it for depreciation.
What are the implications of not allowing ODRC as a basis for a utility's regulated asset base (RAB)?
Historical cost approach vs. ODRC
One alternative is to use the historical cost approach. This shift would result in a lower asset base which, when multiplied by the Weighted Average Cost of Capital (WACC), would lead to lower utility rates.
The Supreme Court voided ERC's use of the ODRC methodology, ruling that it fails to meet the “least cost manner” requirement for rate-setting as mandated by law and is “almost irrational.”
The Supreme Court emphasized that " regulators prescribing ODRC appear to fail to see the lack of economic logic in prices going up with the entry of a supposed efficient new supplier into a market without unserved demand. If the new supplier is truly efficient and viable, its marginal cost should not be any higher than the marginal cost of the incumbent supplier."
The SC also argued, "depreciated replacement cost, computed using an index-inflated MEA value divided by a subjectively determined economic life, is an invalid substitute for fair value and is an almost meaningless number in the economic and accounting sense."
Power to set rates
Since the resulting rate base derived from this MEA-adjusted number does not involve actual utility cost, consumers can argue that such a number is almost arbitrary.
The SC pointed out that while it leaves to the ERC's discretion as to appropriate methodology, it argued that "while the power to fix rates is a legislative function, whether exercised by the legislature itself or through an administrative agency, such as the ERC, a determination of whether the rates so fixed are reasonable and just is a purely judicial question and is subject to review by the courts."
The SC also said the Commission on Audit (COA) must audit all public utilities and that the ERC should respect its findings.
Greater scrutiny
This SC decision has far-reaching consequences. Utilities must revalue their assets based on the subsequent guidelines that the ERC must develop. It could mean rates will fall, and whether this will be retroactive remains uncertain.
What I found interesting is the adoption of the SC of a statutory standard of the US Supreme Court. In one of its decisions, the US SC stated that "just and reasonable" rates should be judged based on the results, not the methodology. The US SC argued that "it is not the theory but the impact of the rate order that counts."
This view will mean that even the calculation of the WACC will now be under greater scrutiny. Discussing the components of the WACC, like the CAPM, will be relevant. Do the results make sense?
A power industry expert with over 40 years in experience as chief executive officer in firms ranging from banking, power, and advisory services.
