Managing CapEx Risk against the Odds:A Consumer Perspective

NARUC Winter MeetingsFebruary 10, 2014

Paula M. CarmodyPeople’s Counsel

Maryland Office of People’s Counsel

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Independent state agency

People’s Counsel appointed by Maryland Attorney General

Represent interests of residential utility customers in Maryland◦ Electricity◦ Gas◦ Telecommunications◦ Private water ◦ Transportation

State and federal agencies and courts

Maryland Office of People’s Counsel

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Maryland is a restructured state◦ Generating facilities are owned by competitive

companies◦ Ratepayers are not responsible for construction

and operating costs◦ Environmental compliance will be borne by

competitive companies

◦ BUT: We have other cap ex requirements Transmission projects Distribution infrastructure Smart meters

A little background

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Increased capital investments

→ Rate Pressure

→ Increase rates→ Adopt trackers and surcharges

and/or→ Manage O&M costs→ Adopt risk management

tools

Capital Investment and Reasonable Rates

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CPCN proceedings Approval of projects based on need and

estimated costs Cost recovery

Traditional: Cost recovery when plant is “in” and operating (‘Used and useful”) Cap Ex are recovered from ratepayers through rates

Other cost recovery adjustments

Generation and Transmission Investments

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Generation and Transmission Plant◦ Need has already been established by CPCN

◦ Costs will be recovered from ratepayers absent a prudency challenge

Prudency challenges can be difficult◦ Cost escalations or over-runs are not sufficient by

themselves to avoid cost recovery

◦ Typically will need to show gross mismanagement, fraud or concealment

Cost recovery

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Cost overruns and price escalation ◦ Design◦ Management of the Project◦ Labor◦ Financing◦ Problems with developers, contractors, suppliers◦ External factors

Siting and permitting Environmental or other compliance Weather Supply cost escalation

Risk Factorswith Large Projects

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Cost over-runs are a problem and a risk for ratepayers – They will pay in the end

BUT Utilities have the primary responsibility for

managing and completing these projects Ratepayers and regulators have a right to

expect this will be done in an efficient manner and at reasonable cost

The risk should not just be shifted to ratepayers

Who Should Bear the Risk?

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BUT It is worthwhile to consider other

approaches that may deliver capital intensive projects at less risk of increased costs

One proposal: Hedging as a tool to protect against price escalation and cost overruns

Can Risk Management Tools Benefit Ratepayers?

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Hedging of project costs: Food for thought or a proven tool to address these risks?◦ Success stories?

Does hedging protect the utility and the ratepayer equally?

What project costs are to be managed through hedging tools?

Materials price escalation External factors

Cost overruns due to poor project management

Questions to Ask About Financial Hedging

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Does hedging shift responsibility from the utility to the ratepayers?◦ Does it create any disincentives for the utility to

act efficiently? How do you establish that a hedging tool is

the most efficient and cost-effective way to address cap ex risk of a particular project?

Does use of a hedging tool require regulatory pre-approval?

Recovery of hedging costs◦ Will some argue that a return should also be paid?

Questions to Ask About Financial Hedging

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Paula M. Carmody, People’s Counsel Maryland Office of People’s Counsel

6 St. Paul Street, Suite 2102 Baltimore, MD 21202

410-767-8150 paulac@opc.state.md.us

www.opc.state.md.us

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