Within the utility industry, the finance of their capital programs is the dictator of the companies five to ten years direction, as they utilize many funding and investment instruments, whether a publicly funded utility or a privately funded utility, the borrowed capital to execute projects to serve the public needs remains the most important factor for project executed.
Over the last century, electricity and clean energy have been at the forefront of U.S. priorities in meeting the public's energy needs. In each state, many companies provide energy under regulations issued by local state and government commissions. In New Jersey, power companies operate through the PJM interconnections (Pennsylvania, Jersey, and Massachusetts) [1] and are regulated by the Federal Energy Regulatory Commission (FERC) [2].
Local Jersey companies are extending capital throughout PJM with plans to carry out reliability projects, in order to better supply customers with electricity. The capital expenditures of local companies are in turn incorporated into the application for an increase in the base rate per $/kW.h (kilowatt.hour) that is charged to customers with the best electricity [1]. In this article, we will understand in more detail the important role of the cost engineer in such an industry.
Utility Financing:-
Now let's take a step back and take a look at how utilities fund their projects and how project reporting is done to meet financial requirements. First, we need to understand the return on investment (ROI) factors for utilities when they invest in capital projects, such as a substation or power plant.
Any utility company has a basic rate of return formula, that determines how they should charge per kW.h, which is based on multiple factors such as revenue requirement, rate base, which is the amount of capital or assets the utility dedicates to providing its regulated services, allowed rate of return, which is the cost the utility incurs to finance its rate base, including both debt and equity, operating expenses, which are the costs of items such as supplies, labor (not used for plant construction), and items for resale that are consumed by the business in a short period of time (less than one year) and annual depreciation expense, which is the annual accounting charge for wear, tear, and obsolescence of plant, lastly, all taxes not counted as operating expenses and not directly charged to customers. [1]
R ≡ B • r + E + d + T. [3]
R: revenue requirement
B: rate base
r: allowed rate of return
E: operating expenses
d: annual depreciation expense
T: all taxes
What we can derive from here, when a utility company, for example, invests in a new asset, it contributes to the company's revenues in two ways: first, through the revenues generated by the electricity produced and sold, once the asset is commissioned, and second, through capital expenditures, which are then accounted for in the company's base rate increase. To understand more about what’s included in the Base rate, refer to Robert Hahne & Gregory’s Aliff book, Accounting for Public Utilities, Pub. 16, release 36, 2019, chapter 4.04. These two tycoons of the accounting world in the utility industry, better explains for you, how utility companies make revenue and how capital expenditures feed into the company application for base rate increase.
Now, it is safe to say that the equation below is true, even if it is very simplified:
ROI of an asset = income from the sale of electricity + Base rate increase due to capital expenditures + Base rate increase due to other factors.
[1]
“https://bear.warrington.ufl.edu/centers/purc/docs//papers/0528_jamison_rate_of_return.pdf ”
2018
Page 5, “HOW RATE OF RETURN REGULATION WORKS?”