The need for proper risk allocation in build-vs. -buy decisions: A response

Journal Article · Sat Jun 01 04:00:00 EDT 1991 · Electricity Journal; (United States)

DOI:https://doi.org/10.1016/1040-6190(91)90143-H· OSTI ID:5571820

Perl, L J; Luftig, M D

The authors are writing in reply to Naill and Sharp's article, Risky Business The Case for Independents, which makes reference to our article published in November, 1990. Naill and Sharp argue that purchasing from IPPs actually reduces risks facing utilities, hence they dispute our contention that purchasing from IPPs will increase the utility's cost of capital. They argue, moreover, that the adjustment the authors propose would simply make IPPs uneconomic depriving consumers of the advantages associated with competition in the production of electricity. The authors disagree. While the many advantages claimed by the authors for IPPs are real, they do not offset the quasi-debt which long-term purchased power contracts add to a utility's bank. Failure to adjust for this effect adds to IPPs' many real advantages an unjustified one, making them seem more economic than they may be. Moreover, since by shifting risks to the utility the IPP reduces its cost of capital, adjusting the utility's balance sheet to reflect these risks will not make cost effective IPPs uncompetitive. Our point is that utilities should take account of all costs and benefits in analyzing bids or negotiated purchases from third parties and adjust the prices accordingly. The primary evidence that IPPs shift risk to utilities is found in their cost of capital. As shown in our article, IPPs have lower after tax costs of capital than utilities. If, as they suggest, utilities and ratepayers incur the same or less risk when utilities buy power from IPPs as when they own the capacity, one would have to conclude that either utilities are significantly under-leveraged or IPPs are grossly over-leveraged. The large number of utility downgradings and the willingness of institutions to lend money to highly leveraged IPPs suggest that neither is the case. We address their arguments in the order in which they appeared.

• OSTI ID: 5571820
• Journal Information: Electricity Journal; (United States), Journal Name: Electricity Journal; (United States) Vol. 4:5; ISSN ELEJE; ISSN 1040-6190
• Country of Publication: United States
• Language: English

Related Subjects

29 ENERGY PLANNING, POLICY, AND ECONOMY
296000* -- Energy Planning & Policy-- Electric Power
CAPITALIZED COST
COST
ECONOMICS
ELECTRIC UTILITIES
FINANCING
OPERATING COST
PLANNING
POWER DEMAND
POWER GENERATION
PUBLIC UTILITIES