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UTILITY FINANCIAL TRANSITION
IMPACTS: FROM FOSSIL TO CLEAN
BY RON LEHR ● DECEMBER 2018

The rapid cost decline of renewable
TABLE OF CONTENTS
energy means the cost of running coal
generation now exceeds the all-in cost
INSIGHTS FROM COLORADO
1of replacing it with wind and solar in
STEP ONE: ANALYZING COSTS OF EXISTING
many parts of the United States. This
GENERATION
3
cost crossover is causing rapid
STEP TWO: DEALING WITH UTILITY AND
reconsideration of the prudency of
CUSTOMER FINANCIAL IMPACTS OF
allowing existing coal generation to
EARLY COAL RETIREMENT
5continue operating, particularly for
STEP THREE: RECOGNIZING SAVINGS
regulated investor-owned utilities that
FROM EARLY RETIREMENTS AND MAKING
recover plant costs through
A DEAL10
regulation. Untangling potentiallystranded assets and transitioning thisRECOMMENDATIONS FOR DECISION
unproductive capital into new clean
MAKERS
12energy resources requires balancing
consumer, environmental, investor, and local interests through complicatedregulatory proceedings.
This series of briefs can help regulators and utility stakeholders navigate thesecomplex proceedings and achieve a fair balance of interests to accelerate the clean
energy transition. This four-part series addresses the implications of financialtransition, the “steel for fuel” investment strategy, debt for equity swaps torefinance uneconomic assets, and depreciation options and policies.

INSIGHTS FROM COLORADO
In late 2013, the Colorado Public Utilities Commission (PUC) approved a portfolio of new
generation resources to meet future needs for Public Service Company of Colorado (PSCo). In
that approved portfolio, 450 megawatts (MW) of wind and 170 MW of solar photovoltaics werechosen from a larger group of bids responding to the utility’s Request for Proposals. The utility’s

1analysis showed that adding wind and solar would reduce costs of service for customers, 1 raisingfour questions:•

If new renewables could reduce customers’ costs, what existing generation increased
costs by comparison?

•

Could generation that increased costs be identified using financial information andfinancial analysis?

•

Could high-cost generation be retired early in favor of adding more clean resources atlower costs?

•

Which options were available for refinancing utility capital investments out of old fossil
and into new clean energy?

Since 2013, many answers have emerged for these questions. By analyzing publicly available
financial information filed with the Federal Energy Regulatory Commission (FERC), policymakers
and utility stakeholders can identify areas where running existing generation (particularly older,less efficient coal-fired plants) costs more than replacing it with wind or solar. In addition, a
suite of financial instruments can facilitate and reduce costs of financial transition away fromfossil toward cleaner resources.
Colorado’s experience with financial transition from coal to cleaner energy is a case study for
analyzing costs of existing generation and introducing financial tools available to manage theaccelerating clean energy transition for electric utilities that own fossil generation. It introduces
concepts that are more thoroughly covered in a series of technical briefs on three topics:•••

Adjusting depreciation accounting to balance consumer, utility, and environmental
interests
Refinancing utility equity with debt securities
Analyzing an investment strategy that swaps capital-intensive renewable assets for coalfired generation, which Colorado utility Xcel Energy calls “steel for fuel.” 2This package of policies can help electricity stakeholders understand which financial tools canaccelerate the financial transition away from fuel-fired assets toward cheaper solar and wind
generation, and other clean energy assets.
To this end, the briefs identify how these financial transition instruments can be used togenerate diverse benefits – saving customers money, reducing investor risk and increasing
1

A brief 2014 You Tube video by Ron Binz details how that analysis determined lower “present worth of revenue
requirements” or lower customer costs when renewables were added to PSCo’s generation fleet.
https://www.youtube.com/watch?v=Ffgyhk2PuGE The video likely captures the leading position for You Tube
videos that feature utility spread sheets. Current status of Colorado’s transition to clean energy are detailed in a
recent blog post: https://www.rmi.org/saving-colorado-customers-money-with-clean-energy/
2“Steel for Fuel” Issue Brief posted at: https://energyinnovation.org/wp-content/uploads/2018/11/Steel-for-FuelBrief_December-2018.pdf

2

returns, reducing harmful emissions from fossil-fueled generation, and addressing just transition
concerns by mitigating impacts on communities and workers affected by early plant closures.

STEP ONE: ANALYZING COSTS OF EXISTING GENERATION
Obtaining information about relative marginal costs of energy (MCOE) 3 for existing utility-owned
generation and potential replacements can be challenging, in large part due to information
asymmetry. Utilities hold most of the information required to analyze comparative costs forenergy from various resources while regulators, advocates, and consumers have less access todata required for analysis.
Utility-led production cost modeling, based on engineering methods and company economic
data, represents the most common approach to determining MCOE for power plants.
Production cost modeling comes with opportunities for utilities to select model inputs tocondition analysis to produce desired results. Model inputs are subject to claims ofconfidentiality and models themselves are usually proprietary, subject to non-disclosure
requirements, and expensive to license and use. As a result of these barriers, production costmodeling conflicts are common among utilities, their regulators, and various stakeholders.
Not included in “variable operating and maintenance costs” or “O&M” analyses are plant capitalcosts, what it costs to buy and own generating plants. These investment costs include money
spent on capital assets, and interest and financial returns to pay for financing plant ownership,commonly referred to as return “of and on” invested capital.
Investment costs should be considered for economically rational decision-making, and theymatter a great deal to utility investors. The specter of no longer earning returns on invested
capital further deepens utility antipathy toward dispassionately examining cost-effective
alternatives to existing generation. 4.
FINANCIAL ANALYSIS TO DERIVE PLANT-LEVEL MCOE
By contrast, financial analysis of publicly traded companies can be based on publicly available
data 5 filed by utilities for use by investors, regulators, and tax collectors. Investors in particular
expect these sources of utility data to be filed accurately, without self-serving compromises oromissions. Inaccurate financial filings can result in criminal indictments and investors would
3

The marginal cost of energy (MCOE) for any given power plant is the cost of generating an additional unit ofoutput, usually measured in kilowatt-hours or megawatt-hours. The MCOE drives utility and market decisionmaking about which power plant to run at a given time. An economically optimal dispatch would minimize MCOE,
meaning the last unit called upon to generate power has a lower MCOE than all other available units that were notcalled. If a new power plant becomes available with a lower MCOE than existing generation, it may impact the fleetwide MCOE, lowering aggregate cost of energy and setting a new equilibrium.

4

See “utility financial incentives” below.

5

The Federal Energy Regulatory Commission, The United States Department of Energy’s Energy Information
Administration, and the Securities and Exchange Commission provide public financial data for utilities. Accessing
this data for the purposes of providing plant level MCOE is a non-trivial exercise due to data inconsistencies andcomplexities, but it can be done: https://catalyst.coop/data-we-wrangle/
3

punish a utility that filed false financial information. Wall Street analysts construct their own
utility corporate financial models and use them to support their advice about utility investment
decisions. For these reasons, financial analysis can be a reliable resource to determine utility
plant level MCOE.
Colorado stakeholders worked with financial analysts and data experts 6 to examine publicfinancial data for each of PSCo’s power plants, determining that plant-level MCOE for most of
PSCo’s coal fleet were more expensive to own and run than new wind power. 7 Wind power was
assumed to be available at $25 per megawatt-hour (MWh), a figure which includes the federal
production tax credit for wind. 8 More recent PSCo bids and evaluation of wind and solar costs
have ratified that new wind and solar costs are lower than coal plant MCOE. 9,10Comparing the operating costs of fossil fueled power plants in Xcel Colorado’s service territory with the
projected all-in cost of wind energy in a long-term power purchase agreement in 2018.
6

Uday Varandaragan, then with Climate Policy Initiative, led the financial analysis team that created a full corporate
financial model and used it to determine plant level MCOE. He has since joined Rocky Mountain Institute to further
develop a range of financial modeling capabilities and alternatives. Public data base access and functionality was
assisted by Catalyst Cooperative, see fn. 5

7https://www.greentechmedia.com/articles/read/wind-could-replace-6000-gigawatt-hours-of-coal-in-colorado.

8

The production tax credit is phasing down from its original level.

9See, https://www.documentcloud.org/documents/4340162-Xcel-Solicitation-Report.html A later report slightly
increased reported median bid prices.
10

PSCo leads other utilities with regard to their efforts to integrate large proportions of wind and rightfully prides
itself on its leadership. It reports no reason to believe that integration efforts won’t continue to be successful as it
moves toward 55% renewable energy, mostly wind. It is pursuing joining a broader and deeper wholesale market
which would make more integration easier and cheaper. PSCo’s CEO touts its “steel for fuel” program of replacing
fossil with renewables as beneficial for shareholders.
4

STEP TWO: DEALING WITH UTILITY AND CUSTOMER FINANCIAL IMPACTS
OF EARLY COAL RETIREMENTS
Comparing MCOE to the levelized cost of new renewable generation is necessary but not
sufficient to justify replacing these assets – reliability depends on enough generation and ability
to deliver power to customers being available at all times. Electric system modeling determining
whether reliability can be maintained as some generation resources are retired and replacedwith others can help assure the transition keeps the lights on. Portfolios constructed of a varietyof resources (energy efficiency, demand management, wind, solar, storage, customer-sited anddistributed resources, energy and system flexibility gained from implementing broader and more
efficient wholesale markets, as well as conventional generation maintained to support transition)
can provide modeling alternatives that reduce overall system operations, transition, andintegration costs. 11
UTILITY FINANCIAL INCENTIVES
Recordings of utility executives on quarterly earnings calls with investor analysts andpresentations to utility financial conferences reveal company promises to maintain or improve“earnings per share” by making capital investments. Utility managers follow these promises withassurances they can obtain regulatory approvals.
These interactions with financial representatives reveal the basic financial incentive for investor
owned utilities: Earn financial returns allowed by regulators on equity invested to provide utility
services to customers. Since equity investors take ownership risks for buying and owningcompany shares, they expect to be rewarded with earnings per share passed on through stock
dividends and growth in their stock price commensurate with their risk exposure. 12
Earnings are not provided for operating expenses such as fuel purchases, employeecompensation, or system monitoring. Neither do utility shareholders receive earnings on the
portion of their investments financed by debt or bonds that represent loans utilities take fromtheir bond investors. Instead, expenses and debt costs are returned to utilities “dollar for dollar”
without additional earnings.
When early coal plant retirements are under discussion, utility financial incentives are on full
display. First, the Uniform System of Accounts, mandated for use by all U.S. utilities, requires

11

PSCo leads other utilities with regard to their efforts to integrate large proportions of wind and rightfully prides
itself on its leadership. It reports no reason to believe that integration efforts won’t continue to be successful as it
moves toward 55% renewable energy, mostly wind. It is pursuing joining a broader and deeper wholesale market
which would make more integration easier and cheaper. PSCo’s CEO touts its “steel for fuel” program of replacing
fossil with renewables as beneficial for shareholders.
See also, Dyson, M., Engle, A, and Farbes, J., “The Economics of Clean Energy Portfolios”, Rocky Mountain Insitute,2018 https://rmi.org/insight/the-economics-of-clean-energy-portfolios/D
12

A more detailed discussion of how utilities create value and make money is provided in Kihm, S., Aggarwal, S.,
Lehr, R., and Burgess, E., “You Get What You Pay For: Moving Toward Value in Utility Compensation” June, 2015 at
http://investors.xcelenergy.com/
5collection and reporting of plant asset values, found mainly in “Plant in Service” categories in theaccounting system. 13 Together with accounts that track investment costs for generation plants,
plant accounts are usually the largest amounts found in utility accounts.
For utilities that own generation, earning returns authorized by regulators on equity invested ingeneration plants is the very essence of the utility business. Discussions about retiring theseplants early are, therefore, acutely sensitive for utility mangers who tend to assume that equity
earnings will continue until plants reach full retirement age. Allowing utilities an opportunity to
reinvest capital in new, productive renewable generation is one strategy for resolving thistension. 14
UNDEPRECIATED PLANT BALANCES
If regulators decide to retire coal plants early, utilities will want to recover remaining,
undepreciated plant balances on their books, including earning on equity investments reported
in these account balances. This is understandable, given utility managers’ constant interactions
with investment analysts concerning earnings, but regulatory practice suggests these balances
are recoverable only if attached to “used and useful” assets.
Plants are unlikely to be fully depreciated even if they are held in service until they reach the endof their estimated lifetimes, because utilities respond to incentives to continue to invest in plant
to earn additional returns. Some plants are required to clean up pollution, requiring investment,
and plant life estimates are subject to constant reevaluation and change.
If retired “early,” plant in service accounts will likely have substantial remaining undepreciatedamounts that must be addressed. Changes in depreciation amounts and schedules are likely tobe proposed when early retirement is under discussion. A separate issue paper in this series
fully considers approaches and implications for adjusting depreciation in the context of financialtransition. 15
REFINANCING UNDEPRECIATED PLANT BALANCES
Whether depreciation is accelerated or not, once a plant is retired, the remaining investment
total becomes a “regulatory asset,” held on the books of account for a regulated utility andrecognized by their regulators as appropriate for inclusion in consumers’ rates. Regulatory
assets do not represent real assets like a generation plants in service, but rather are a regulatory
construct to allow recovery in rates on the occasion of an early retirement of plants.

13

https://www.ferc.gov/enforcement/acct-matts/usofa.asp

14“Steel for Fuel” posted at https://energyinnovation.org/wp-content/uploads/2018/11/Steel-for-FuelBrief_December-2018.pdf
15Depreciation and Early Plant Retirements posted at: https://energyinnovation.org/wpcontent/uploads/2018/11/Depreciation-and-Early-Plant-Retirements-Brief_December-2018.pdf

6Regulatory assets can represent utility expectations that profits would flow from equity invested
in operating plants for plants’ expected lifetimes. Utility executives are unlikely to willingly giveup expected profits unless some accommodation with their profit expectations is recognized in
the form of earnings on new regulatory assets. Questions that arise in resolving balancing ofinterests and expectations that accompanies decisions to retire plants early are whether, and if so,
how much recovery of equity earnings is reasonable. The answers will reflect accommodations
made to address particular interests and circumstances.
Two approaches have emerged to use alternative financing mechanisms to reduce costs ofholding regulatory assets – debt for equity swaps and securitization. Debt for equity swaps
would eliminate or reduce equity on which utilities earn profits. Securitization returns utility
investment as bond proceeds paid to a utility replace both debt and equity, with attendantearnings, requiring reinvestment if a utility wishes to earn profits on new equity invested in thebusiness. Both effectively trade lower-cost debt for higher-cost shareholder equity in theregulatory asset, and both reduce utility profits.
Additional financial mechanisms are being discussed, such as applications of green bonds andgreen tariffs to add capital flexibility to utility fossil to clean transitions. 16
Debt for equity
Financial leverage can potentially reduce consumers’ costs by replacing the equity portion of aregulatory asset with corporate debt. Replacing equity with debt, known as “debt leverage,”recognizes differences between owning and operating generation plants with their attendantrisks, 17 and maintaining a regulatory asset where the only risk is that regulators might change
their minds about allowing recovery.
Refinancing regulatory assets with new bonds can take some of the heat out of arguments
among interests about deciding the balance of financial impacts. Simply replacing some, or all, ofthe equity portion of regulatory assets with lower cost utility corporate debt could be a means oflowering costs of carrying these assets. By itself, a higher debt margin might be a concern, but onbalance when considered with other factors, it might not be too important. Swapping debt for
equity could be a way to sweeten the overall deal for consumers, so where their interests need
to be accommodated, corporate debt refinance might be an option to consider. 18

16

See generally, Uday Varadarajan, et al., Harnessing Financial Tools to Transform the Electric Sector, Sierra Club,
November 2018. Available at: https://www.sierraclub.org/sites/www.sierraclub.org/files/sierra-club-harnessingfinancial-tools-electric-sector.pdf.
17

These risks include the risk of malfunction, fuel risk, price risk, technology risk, and other risks that are fleshed out
in the Debt for Equity issue brief at https://energyinnovation.org/wp-content/uploads/2018/11/Debt-for-EquityIssue-Brief_December-2018.pdf
18

Corporate debt refinance and attendant risks are addressed in greater depth in the Debt for Equity brief:
https://energyinnovation.org/wp-content/uploads/2018/11/Debt-for-Equity-Issue-Brief_December-2018.pdf
7Securitization
Authorizing and implementing securitized or ratepayer backed bonds is another approach toachieving financial leverage to reduce consumer costs for holding regulatory assets on a utility’sbooks. These bonds, which may require new legislation in some states, refund utility debt andequity represented in accounts holding regulatory assets using the promise of repayment
defined in state legislation and a commission financing order. This offers more security to bondinvestors—hence “securitization.” Decades of experience with securitized utility bonds show
they can achieve overall lower cost of capital and provide substantial consumer savings whencompared to both corporate debt and equity. 19

Summary of U.S. states where securitization is permitted.

19

Bond rating agencies require the process of issuing these bonds to meet their exacting requirements to allow
bonds to achieve AAA ratings and deliver the lowest possible interest rates. These requirements are well known,
but complex when encountered initially, so achieving the right conditions in both legislation and in subsequent
regulatory proceedings is also complicated. Many examples can help participants in these discussions understandthe details. If stakeholders in this process can be brought to realize that refinancing with rate payer backed bonds
creates substantial streams of savings that can be shared by all—including utility shareholders—then complexity canbe understood as worth the efforts. See, e.g. Joe Fischera, Securitization: Is it the Right Tool for Me Today?,presentation to National Association of Regulatory Utility Commissioners, November 13, 2018.
https://pubs.naruc.org/pub/F51B000A-EFC1-4568-1C63-764920117214.
8

Along with substantial consumer fuel cost savings from retiring fossil generation early andreplacing it with fuel-free clean energy resources, interest rate savings are the largest source ofpotential consumer savings in financial transitions that move toward clean energy. The
proposition that clean is less expensive than dirty is compelling on economic grounds alone
wherever new clean energy can replace more expensive, old dirty energy. Adding regulatory
asset securitization makes it a potential winning argument even where climate goals are notvalued.

Comparing the relative costs of capital for securitized debt, corporate debt, equity, and regulatorauthorized returns on equity.

STEP THREE: RECOGNIZING SAVINGS FROM EARLY RETIREMENTS AND
MAKING A DEAL
Terms that can be considered in deal-making among stakeholders engaged in retirements andrefinance include:•

Demonstrated fuel and other operations and maintenance savings through financial
analysis of comparative, plant level marginal costs of energy•

Management of related depreciation changes to reflect both least cost and equitable
cost responsibility•

Refinancing utility regulatory assets to achieve investment cost savings•

Reinvesting refinance proceeds to benefit shareholders, impacted communities, andconsumers

Each of these terms can allow stakeholders to achieve an attractive balance between variedinterests of consumers, clean energy supporters, displaced workers, utilities, and equity andbond holders.
BALANCING INTERESTS
When early retirement is under discussion, various parties and stakeholder interests must bebalanced, together with shareholders’ earnings expectations. For example, where early retired
coal plants can be replaced with lower cost wind and solar energy, consumers will also benefit
from less pollution and more portfolio diversity.
9Power supplies become arguably more reliable and less risky over the long term given that fuelcost and availability risks, usually passed onto consumers through fuel cost collection bill riders,will be avoided.
In setting depreciation accounting for early retired plants, stakeholders confront a series oftradeoffs. Utilities will have financial incentives to accelerate depreciation on their
undepreciated plant balances since they would prefer to get return of and on their unpaid
investments, both in full and sooner rather than later.
However, faster depreciation results in pressure for rate increases that consumers do not favor.
A balance must be struck between these competing interests.

Regulators can balance an array of diverse interests to achieve positive outcomes through early coalretirement by replacing it with cheaper, cleaner resources through low-cost financing.

Some will argue that current consumers rather than future consumers should pay forundepreciated plant balances for early retired plants, since current consumers are closer in time
to using these plant’s outputs—they used it, so they should pay for it. It is also true, however,that future consumers will benefit from early plant retirements that avoid higher marginal costsof energy and instead use energy from lower marginal cost clean energy resources.
On this logic, future consumers might bear some responsibility for refinancing costs that got oldplants out of the way so newer and less costly facilities could replace them. Again, room exists
for compromise and recognition of a balance of interests among these competing claims andequities.
It is possible that some fuel cost and refinance savings could be shared to address external costs
and community transition opportunities. In proposed Colorado securitization legislation, 15
10

percent of securitized bond totals was directed to mitigating transition costs and risks forcommunities and workers impacted by early plant retirements. 20
A series of proposals is under development to associate some of these savings with newinvestments in clean energy options to help to speed the transition from fossil to clean energy.
As potential savings in this financial transition are better understood and documented, morecreative thinking about how to handle these investment opportunities is expected to expand theoptions that can be considered. 21
Recognizing that early retirement can provide streams of savings makes balancing interests inearly retirement much easier, as interested parties recognize that they will be better off if abalanced outcome that respects all claims can be reached.
UTILITY INVESTMENT IN NEW CLEAN ENERGY
Allowing utilities to own a portion of new clean energy investments also leaves shareholders
better off, since new investments are more productive per dollar invested than old ones.
Whatever compromise produces an overall deal that includes early plant retirements, it is clearthat an easier pathway to a good deal will not involve utility equity owners giving up theirearnings claims without getting something in return. Allowing utilities to own some resulting
investment in new clean energy can compensate utility shareholders for foregoing earnings onearly retired plants or regulatory assets, or some, or all, of both. Unusual coalitions supporting
utility ownership outcomes can provide important support for regulatory approvals of suchinvestments.

RECOMMENDATIONS FOR DECISION MAKERS
FOR UTILITY EXECUTIVES:
•

•

•

20

Consider creating an explicit and public financial transition management strategy
including financial analysis of MCOE resource alternatives, depreciation accounting that
supports transition from fossil to clean resources, early fossil plant retirements, andreinvestment in clean resources
Develop communications for financial analysts, state commissions and stakeholders, andshareholders and debt investors emphasizing how well-managed financial transition can
increase overall benefits to accelerate capital movement from fossil to clean energy
investments
Develop competitive bidding for least-cost clean replacement energy that encourages
abundant bids and drives low-cost clean energy bids

HB07-1339 at: https://leg.colorado.gov/bills/hb17-1339.

21

Uday Varadarajan, et al., Harnessing Financial Tools to Transform the Electric Sector, Sierra Club, November 2018.
Available at: https://www.sierraclub.org/sites/www.sierraclub.org/files/sierra-club-harnessing-financial-toolselectric-sector.pdf.
11

•
•

•

Develop standards for utility ownership of a portion of replacement power when
fashioning deals that result in beneficial transition
Recognize benefits from fuel and other operations and maintenance savings from earlyplant retirements and from refinancing undepreciated plant balances, then share savings
with consumers and impacted communities and workers to facilitate balanced dealmaking
Analyze early retirement benefits that include positive investor financial results to justify
balanced deal making to manage regulatory risks

FOR STATE REGULATORY COMMISSIONERS AND STAFF:
•

•

•

•

•

Encourage regulated utilities to develop plans to manage financial transition using
financial analysis showing least cost for consumers, fuel and O&M savings, refinancing
savings, and investor benefits
Allow utilities that strike deals for early plant retirements providing consumer fuel andoperations and refinancing savings to own a portion of replacement resources, if they are
shown to be competitively selected in fair and open bidding processes
Provide tools regulators need (like authorizing securitized and ratepayer-backed bonds)
in concert with active communications with commissioners and staff, then pursue
enabling legislation if needed
Encourage state policies to proactively address financial transition, thereby avoiding costs
arising from utility credit ratings downgrades, negative equity advice, and bankruptcies
that can result from inattention and delay in addressing transition issues
Support constructive dialogue with commissions and staff, and among utilities and theirstakeholders who can pursue transition management that makes everybody better off

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