ML20112J250

Critique of Hudson Inst/Lilco Defense of Shoreham Economics. Related Info Encl

ML20112J250
Person / Time
Site:	Shoreham File:Long Island Lighting Company icon.png
Issue date:	08/31/1983
From:	ENERGY SYSTEMS RESEARCH GROUP, INC., GEORGETOWN CONSULTING GROUP, INC.
To:
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ML20112J037	List: ML20112J250 ML20112J298
References
FOIA-84-250 83-14-R, NUDOCS 8501180217
Download: ML20112J250 (50)

Text

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Ni 83-14/R

.L ., -.

CRITIQUE OF THE HUDSON INSTITITUTE/LILCO .

DEFENSE OF SHOREHAM ECONOMICS Prepared for the County of Suffolk by V

Energy Systems Research Group, Inc.

Georgetown Consulting Group, Inc.

August, 1983 e

8501180217 840508 PDR FOIA BELAIR84-250 PDR l

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Table of Contents

1. INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . 1 1.1 Eackground. . . . . . . . . . . . . . . . . . . . . 1 -

1.2 Overview

The Hudson Institute Findings Are Inaccurate. . . . . . . . . . . . . . . . . . . 1 1.3 The County's Findings . . . . . . . . . . . . . . . 3

2. FLAWS IN LILCO/ HUDSON INSTITUTE Rate Impact Computations . . . .. . . . . . . . . . . . 6 2.1 Mathematical Manipulation Overstates Results by 320% . . . . . . . . . . . . . . . . . . 6 2.2 Six Areas of Dispute. . . . . . . . . . . . . . . . 8 2.3 Shoreham Operating Costs. . . . . . . . . . . . . . 10 2.4 Capital Costs Changed to Ratepayers . . . . . . . . 14 2.5 Make-Up Energy Costs. . . . . . . .. . . . . . . . 16 2.6 New Plant Investments . . . . . . . . . . . . . . . 19 2.7 Property Tax. . . . . . . . . . . . . . . . . . . . 20 2.8 Miscellaneous Costs . . . . . . . . . . . .- . . . . . 22 i

3. LILCO's FIN ANCIAL HEALTH . . . . . . . . . . . . . . . . 24 3.1 Impact of Abandonment on LILCO Stockholders . . . . 24 3.2 Effect of Shoreham Abandonment on Other New York Utilities- . . . . . .g. . . . . . . 29 3.3 Cost Sharing is Legal . . . . . . . . . . . . . . . 33 3.4 Summary of LILCO's Financial Health . . . . . . . . 35 b

B

. i LIST OF TABLES TABLE 1: ' RATE IMPACTS OF ABANDONMENT UNDER ALTERNATIVE SCENARIOS . . . . . . . . . . . . . . . 5 TABLE'2:-

SUMMARY

DIFFERENCES BETWEEN HI AND COUNTY , . . . . 9 TABLE 3: RATE TREATMENT FOR ABANDONMENT OF PLANT . . . . . . 34 LIST OF FIGURES FIGURE 1: COMPARISON OF O&M ESTIMATES . . . . . . . . . . . 12 FIGURE 2: COMPARISON OF ADDITIONAL CAPITAL EXPENDITURES ESTIMATES .. . . . . . . . . . . . . 13 FIGURE 3: CAPACITY FACTOR COMPARISONS . . . . . . . . . . . 18 FIGURE-4: RATE WASH SCENARIO - SHOREHAM ABANDONED . . . . . 26 FIGURE 5: LOW RETURN SCENARIO - SHOREHAM ABANDONED. . . . . 27 FIGURE 6: HIGH RETURN SCENARIO - SHOREHAM ABANDONED . . . . 28 FIGURE 7 . . . . . . . . . . . . . . . . . . . . . . . . . .

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FIGURE 8 . . . . . . . . . . . . . . . . . . . . . . . . . . 31 I

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. , I. INTRODUCTION 1 ,

'l.l. Background Energy Systems Research Group ("ESRG")* and Georgetown Cons'alting Group ("Georgetown")** have previously prepared analy-ses,concerning the impacts on rates and LILCO's financial integrity if the shoreham plant is abandoned. These analyses ,

were presented to Governor Cuomo's Shoreham Commission on July.15, 1983.

On August 8, 1983, the Hudson Institute ("HI") presented an analysis commissioned by -LILCO concerning the economic impacts of abandoning Shoreham.*** The purpose of this report is to provide comments on the HI analysis in the areas of rate impacts and impacts on LILCO's financial integrity if Shoreham is abandoned.****

1.2. Overview

The Hudson Institute Findings Are Inaccurate The HI' report discusses a wide range of impact issues (e.g., <

repercussion on employment, responses in capital markets, adjust-ments in world-wide oil prices,'and the moral costs to the state and nation). However, underpinning these necessarily

• Long Island Without the Shoreham Power Plant: Electricity Cost and System Planning Consecuences, Energy Systems Research Group, Inc., Boston, MA,. July, 1983. The report is in five volumes, a Summary of Findings and four. tech-nical reports.

• • Financial and Regulatory Consecuences, Georgetown Consulting Group, July,1983.

• • • The Potential Impact of Failure to Open Shoreham (Draft

. Final Report), Hudson Institute, August, 1983. We shall allude to "LILCO/HI" in the text,since HI relied heavily on LILCO' assumptions and computations contained-in Preliminary Critique, Suf folk County Studv' of Shoreham Abandonment, LILCO Office of Engineering, June, 1983.

'****- By' separate. report, Union Associates will comment upon-the HI findings in areas such as property taxes and employment impacts.

t .- -

. improccicnietic cp;culatieno cro two fundamantal premicss

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Firct, that the rete impncts of.not op@rattng Shorchnm would ba massive and necessarily greater than 11 Shoreham cperates; and, second, that LILco would be in dire financial condition (i.e.,

defaults and possibly bankruptcy would ensue) if Shoreham is abandoned.

HI, by design or conceptual confusion, reports its results in a way which overstates rate impacts by a factor of 3.2 (e.g.,

when they say 10 percent impacts on rate they really mean 3 percent). A systematically misleading (or careless) mathematical manipulation in the LILCO/HI analysis, once exposed and corrected, accounts for fully two-thirds of the difference with the County rate impact estimates. The residual differencesbetween the HI and ESRG studies are identified in Section 2 and analysis is pro-

, vided to show why HI (using LILCO's in-house estimates and arguments). presents results skewed t'o favor the economic case for Shoreham operating.

HI repeatedly raises the spectre of bankruptcy and other asserted dire consequences to LILCO if Shoreham is abandoned.

This will be put in perspective in Section 3: LILCO is likely to be an extremely healthy entity for the next twenty years with or without Shoreham (e.g., under Rate Wash conditions).

Remove the misleading mathematics, the speculative excesses, the one-sided judgments, and the basic conclusion re-emerges:

Shoreham not opening need only have minor effects on the ratepayers and the Company.

e

1.3 The County's Findinga s.

In the ESRG study, the cost to ratepay'ers was computed for Shoreham operating and compared to the costs of Shoreham not operating under a range of plausible future conditions

(" scenarios").

The results were reported for a 20-year planning period in discounted 1983 "present value" (or "present worth")

dollars to take into account the time value of money.* For completeness, the summary Table 1 from the ESRG July 1983 report is reproduced below.

In the benchmark Rate Wash scenario ratepayers are no worse off without Shoreham than with Shoreham -- the average percent impacts are zero. The Rate Wash is achieved through a minimal cost-sharing procedure where 91 percent of the Shoreham costs are recovered through rates. Put another way, in the Rate Wash case, all bonds and preferred stocks are fully paid, equity is main-p tained, but return on equity (that 'is, common stock) is 80 per-cent of what it otherwise would have been.

Referring to Table 1, in no instance are the rate impacts greater than a few percent, and in many scenar'ios the ratepayers would be better off without Shoreham. Even in the case where the full capital costs of Shoreham (the investment, plus full return, plus taxes) are borne by ratepayers, the impact of not opening Shoreham is only 2.2 percent.

LILCO's original cost impact estimates were expressed in inflated dollars over 40 years, a dubious technique accounting for over 90% of their reported cost impacts.

Fortunately, HI reports its findings using the County's approach.

.- In ths Georgotwon study, LILCO's financial condition was eva-luated under a range of Shoreham capital recovery scenarios. In both the 100 percent and Rate Wash Case ('91 percent recovery),

LILCO's financial performance was projected to be very strong.

Even,at low recovery (65 percent), LILCO's financial condition would improve relative to recent performance. These findings are ,

summarized in Section 3. Further, as also is reviewed in Section 3, there is ample regulatory and legal precedent to partial reco-very for facilities that are not "used as useful." Such treat-ment is not only procedurally sound, it would in the present case be equitable.

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TABLE 1 RATE IMPACTS OF ABANDONMENT UNDER ALTERNATIVE SCENARIOS Cost L cact of Abandonment Ct :ulative Change Average

. in Required Revenues Percent (1983 present value Change in Scenario

• rescription dellars in millions) Rates Rats Wash Rates unaffected by abandenment* 0 0.0% .

Load Forecast High 1.6%/ year peak growth (frcm base case of 0.8%) 230 1.1 Irw 0.0%/ year peak growth -310 -1.6 Fuel Price Escalation High oil at 3% real, after 1987 (frcm 2%)

Coal at 2% (frczn 1%) 120 0.6 Lcw Oil at 1% real, after 1987. Coal at 0% real -100 -0.5 En:rgy Frcm Pcwer Pcol High Double energy assun:-d available (Sec. 3) -50 -0.2 104 No energy available frcn pool 60 0.3 Nuclear O&M Ccsts - High Dcuble real increase in ,

y . projected costs (Sec. 4) -210 -1.1

- Lcw No real increase in costs 210 1.1 Putura Shoreham Investment High Dcuble real increase in projected in-vestments (Se:. 4) -290 '

-1.4 Lcw No real increase in invest:ents 290 l.4 Shoreham Capital Recovery Full 100% of Shoreham in rate base (vs. 91%) 430 2.2 Ina 65% of Shoreham in rate base -1340 -6.7 Time Pericxl of Analysis

- Ierig 30 years,1984-2013 (frczn 20 years) -60 -0.3

- Short 10 years, 1984-1993 -160 -1.2 Ccriservation Pursue conservation to replace Invest: rent Shoreham generation -580 -2.9 Option Shoreham Effects cf having started the Shoreham Never Built ** project in the first place -3405 -17.0

• The base data used in the Rate Wash case is described at length in the text cf the earlier report. In the sensitivity tests reported here, individual data-itens of the base set were modified one at a ti:Te.

c*This is equivalent to a case in which ratepayers are fully protected frcn the costs of the Shoreham investment.

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2. FLAWS IN LILCO/ HUDSON INSTITUTE RATE IMPACT COMPUTATIONS l HI's technique is to " adjust" the County's results. Actually, j HI simply takes over LILCO's adjustments '(as presented in their Preliminary' Critique), discarding along.the way some of the more absurd costs LILCO charges to a shoreham abandonment (especially, the non-economic conversion of certain oil-fired plants to coal, improper property' tax effects, and the costs of the abortive Bokum Resources uranium investment).

HI's derivative method, however, subjects it to the danger of incorporating the errors embodied in its source. The most blatant example of this, a systematic computational confusion which causes HI to overstate rate impacts by over three times, is discussed in sub-section 2.1. The remainder of the discussion below concerns HI's adoption of LILCO's in-house estimates and why these estimates are over optimistic on Shoreham costs (as they have been for the past r dozen years), and consistently exaggerate the rate impacts of a future without Shoreham compared to a future with Shoreham.

2.1 Mathematical Manipulation Overstates Results by 320%

All of the LILCO/HI reported rate impact figures are exaggerated by a factor of 3.2. The problem is easy to understand. The rate impacts are defined by the following equation *:

Rate Impact = (RR without Shoreham - RR with Shoreham) x 1004 (RR with Shoreham) where "RR" is the required revenues over a 20-year time period discounted to 1983 present worth dollars.

• This treatment was introduced'by the County's consultants. The LILCO/HI technique is to make various adjustments to the County's required revenue stream with and without Shoreham.

i, .

Tha LILCO/HI arror la thnt they borrow the "RR with Shorcham" from ESRG, but they use the wronu number. For example

'the " calculated rate penalty" from p. 7 of the HI report uses the "ESRG estimate" of S6.3 billion in the denominator. But this is not the ESRG estimate. It was taken from Table 11, p. 64 of ESRG's Lcnc Island Without the Shoreham Power Plant, Summary of Findines. But as the footnote clearly indicates, this figure

" excludes revenues required whether or not Shoreham operates".*

In other words, for presentational purposes, those elements of revenues required in either case are not included in the S6.3

. billion. .The correct figure for " required revenues with Shoreham" is $20.0 billion.**

If HI had used the correct figure in computing its rate impacts, the results would be a factor of 3.2 less (S20.0/56.3).

Where HI reports a range of " adjusted" impacts from the Rate Wash y value of zero to 10 to 38 percent it really should report 3 to 12 percent. Correcting this one mistake eliminates over two-thirds of the difference between the County and HI estimate of percent rate impact. It is unfortunate that LILCO/HI have exaggerated their findings. Whether by error or design it can only raise doubts as to the objectivity and the accuracy of their analysis.

"Nor is this a measure of rate increases associated with Shoreham as HI may believe (p.6). One measure of Shoreham-related increase is shown in Table 1 under the "Shoreham Never Built Scenario" (S3.4 billion not S6.3 billion).

• • See Lono Island Without the Shoreham Power Plant: Electricity Cost and System Plannino Consecuences, Technical Recort D n Summary of Computer Outouts (p. 7).

(.

., . 2.2 Six Arena of Dinpute N -

L Two-thirds of the difference between the County's rate impact estimates and HI's were accounted for by using the proper mathematical expression for rate impacts as discussed in the previous subsection. The remaining differences are summarized in Table 2 and discussed in the following subsections. .

It will be concluded that HI has added nothing new or compelling.

The Rate Wash scenario remains the best mid-range estimate of rate impacts.

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. TABLE 2

s, .

SUMMARY

DIFFERENCES BETWEEN HI AND COUNTY f

Average Percent Chance in Rates Comments Rate Wash Scenario 0%

HI "Adiustments"*

l.-Adopt LILCO estimates 2% Optimistic in- -

of Shoreham operating house judgment sub--

Costs stitutes for statistical analy-sis (Sec. 2.3)

'2. Ratepayers pay more for- 5% Full return, plus Shoreham investment when extra ratepayer it does not operate than penalty for rapid when it does amortization and delays assumed following LILCO despite serious flaws in logic and realism (Sec. 2.4)

3. Adopt LILCO's Make-Up 1% Optimistic in-Energy Estimates house judgement on

, Shoreham perfor-7 mance substitutes for. statistical analysis. ESRG assumptions.

, mischaracterized

,(Sec. 2.5).

4. Accept LILCO's in-service 1% LILCO's~ demand dates for new capacity forecast is too requirements high (Sec. 2.6).

5. Change property tax 0.5% Undocumented assumptions manipulations of undocumented sour--

ces (Sec. 2.7).

6. Add " miscellaneous" 1% Grab bag of small costs effects. Ignores miscellaneous im-

-pacts favoring abandonment which are at least com-parable (Sec.

. 2.8).

" HI gives a range of percentage adjustments. The midpoint values are.given here suitably corrected per the discussion in Sec. 2.1.

2.3 Shornhem Oporntino C'oTtn

• 1i If Shoreham opsna, significant costs,-above and bayond paying'for the Shoreham investment, will be incurred. These include Shoreham operation and maintenance (O&M) expenses, addi-tional* capital expenditures during the lifetime of the plant,

-nuclear fuel costs, plant decommissioning and disposal of highly radioactive spent fuel.

Of these cost categories, the last two -- decommissioning and spent ~ fuel disposal -- are relatively small expenditures (about $100 million 1983 PW).

Although the LILCO/MI estimates

.are optimistically low, the dif ference with County mid-range projections is small, amounting to a rate impact of only about one-quarter of one percent. Further, there is no disagreement between the County and LILCO/HI on nuclear fuel expenses.

The areas of substantial differences on Shoreham operating costs between the County and LILCO/HI (about $400 million 1983 PW) concern projections of O&M and additional capital expen-ditures. Here, the difference in approach is~ striking. LILCO's estimates (apparently adopted by HI) are simply judgmentally pro-duced. If systematic mathematical methods and data analysis were used in generating the estimates, they have not been documented to or alluded to in any published documents to date.

There are strong indications that the LILCO/HI projections of'Shoreham.0&M and capital expenses (called " continuing capital

' costs" in'the HI report) rely on a strong dose of wishful i

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{- .,

, ., thinking. The County's mathods, on the other hand, employed sta-tistical analysis to account for the historic pattern of these costs in. terms of a number of factors characterizing each plant

(" explanatory variables")*. The statistically derived rela,tionships can then be applied to.the particular charac-teristics of Shoreham'to provide a basis for cost projections. ,

Figures 1 and 2 illustrate the situaton by comparing esti-mates of projected Shoreham O&M and capital expenditures, respec-tively. The historical experience is also shown and projected with a simple time trend extrapolating that experience into the future. The ESRG Shoreham projection, based on the more complex multivariate regression statistical technique, is plotted along with LILCO's estimate. Costs are rising at a much faster rate than used by the County. There is simply no evidence for LILCO's no growth assumptions and HI/LILCO present no basis for them. It is wishful' and heroic thinking in the face of powerful evidence to the contrary.

, The thrust of the HI response seems to be that while the statistical approach is a valid method, Shoreham is special and will not be governed by the empirically developed relationships because preventative steps are being taken at time of construction. However, there are substantive reasons to believe that the statistical analysis employed by the County may actually underestimate future costs:

• See Long Island Without the Shoreham Power Plant, Summarv ei Findings and Technical Report B,, op. cit.

a .

FIGURE 1 l'i O COMPARISON OF O&M ESTIMATES 100 TIME TREND

, ESRG

,-- STATISTICAL

/ A'ALYSIS

/ APPLIED TO 90 , SHOREHA*4 .

/

o'

/

80 i

/

/

N 70  ! -/ - -

~ ' ~ ~ ~ [j g e; 33

[ '

FOR SHOREHAM O&M

[

COSTS f, '

IN 1983 /[

DOL- [

LARS iPER 50 -

[

• KILO-WATT l' INDUSTRY ~

i HISTORICAL 40 '

l ,

30 .

I i'

20 IC 1970 1975 1980 1985 luvu 1993 evuu YEARS

FIGURE 2 120

. COMPARISON OF ADDITIONAL _

CAPITAL EXPENDITURES ESTIMATES 110 TIME TREND 100 ESRG

,- - - STATI S TI C AE 90 1 ANALygrs

/ APPLIED

/ TO

/ SHOREHA's 80-

/

/

,/

ADDI- /

TIONAL /

CAPITAL EXPEN- ,/

DITURES '

$N 1933 /

l@OLLARS /

PER KN /

/

SC j

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/

1 4C

/

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/

30 l* INDUSTRY HISTORICAL

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_ _ _ _ , _ LILCO ASSUMPTIONS FOR S HOREH A.".

20 10 .

1970 1973 Ayou 1985 1990 1995 2000 YEAR

[ , .

(1) plants of more rcctnt vintage cro more compicx cnd,

_ as in the case of Shoreham, backfitted with equipment not originally intended leading to congested, non-optimal installation configurations, k2) this is reflected in the finding from the statistical analysis that, all other things equal, the later a ,

plant comes in-service the hicher are its costs related presumably to their extra complexity and more expensive equipment, (3) as emerging problems throughout the nuclear industry with respect to pipe cracks, vessel embrittlement, and a variety of aging problems are incorporated in the data over time, the projections of lifetime Shoreham costs are likely to increase.

The nuclear optimism which led LILCO to underestimate v Shoreham construction costs by a factor of 10 is again at play in leading LILCO (and HI) to adopt a wishful vision of future Shoreham costs. The scientific evidence indicates otherwise.

2.4 Caoital Costs Charced to Rateoayers If all of the capital-related costs of Shoreham --

amortization of investment, full return on debt and equity, Federal and State taxes -- are passed through to LILCO's custo-mers, rates will go up by S0.4 billion or 2.2 percent (see Table 1). LILCO/HI include this in their basic scenario comparison.

This alone would simply be a different definition of scenarios:

the Rate Wash scenario (with 91 percent of Shoreham in rate base *) and the LILCO/HI scenario (with 100 percent in rate base).

• Actually, with LILCO's latest (August, 1983) increase in ultimate Shoreham cost from $3.2 to S3.4 billion, the Rate Wash scenario would allow-92 percent recovery of Shoreham costs and return. If ultimate costs rise to, say, $4 billion at the Rate Wash would correspond to 94% recovery.

[: 's In'the letter Full Recovery case LILCO would get the semo from retepnyers for Shoreham whether or not it generates power.

But in addition, LILCO/HI would have the ratepayers pay more for the plant if it were not operating (not "used and useful") than if it were. How is this possible? First, LILCO/HI assume a rapid depreciation schedule favorable to the Company while pena-lizing the ratepayers.* Second, LILCO reasons that the plant should cost more if it does not open than if it does due to regu-latory delays.

Though HI finds this reasoning compelling, for independent

. observers, many serious questions will be raised. Is it plausible that LILCO will be allowed to gain extra profits at ratepayer expense for building a plant which never operates? Is it conceivable that a ratemaking formula will be adopted which makes LILCO's economic position better without Shoreham than 7

with? Will there not be extended d'ebate on Shoreham's destiny in all scenarios? Is it not just as likely that the total investment could be less under abandonment than under completion?**

The Full Recovery scenario is a 2 percent impact scenario, not the 5 percent of LILCO/HI (see Table 2). Their scenario is not politically, regulatorily or logically credible.

• What would be accelerated is the write-off of Shoreham for tax purposes, a benefit of abandonment not included in the County 's estimates .

• • For example, even as this is being written, a back-up diesel generator crankshaft has sheared during preliminary tests adumbrating, no doubt, additional delay and cost. A decision to abandon could avoid expenditures which otherwise would be necessary to bring the plant into operation.

L

, , 2.5 Mrko-Up Energy Coltn LILCO/HI's adjustments to ESRG figures result in an overali l percent rate impact effect. Though this difference is relative-ly small, it merits discussion because the LILCO/HI assumptions are not acceptable. Half of the difference is due to differences in estimates of future plant availability (" capacity factors") ,

and the other half apparently to mischaracterizations of County assumptions.

LILCO's capacity factors (a measure of plant availability) are based on judgment.* ESRG's capacity factor estimates, by contrast, are based on analyzing the historic pattern of plant performance as a function of a number of significant explanatory variables ** (boiling or pressurized water reactor, saltwater cooled or non-waltwater cooled and so on). The statistical method has the advantage of grounding the estimates in documen-table methods and data accessible to independent observers. This method attempts to capture causative relationships that can pro-vide quantitative guidance to analysts. To accept LILCO's pro-jection of capacity factors is to rely ultimately on faith in the estimator. There is at this point in time, enough information on nuclear plant performance to get beyond opinions as a basis for planning.

• HI's assumptions are not clear from their text but the bottom line on make-up energy costs is identical to LILCO's.

• • See Long Island Without Shoreham, Summary of Findinos and Technical Reoort B2 op. cit.

9

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In this case, LILCO'c opinion on future Shoreham capacity factors is likely to be too optimistic. pigure 3 summarizes LILCO's and ESRG's assumptions on capacity factor for the first ten years-of Shoreham operations and shows that the statistically based projection is lower than both as is the historic experience for Shoreham-like plants.

LILCO/HI defend their rosier view by analyzing the historical data and removing instances of downtime from the record because they feel such events could not occur at Shoreham.

This is a dubious procedure on a number of accounts. First, LILCO/HI use an inappropriate set of historic data for comparison >

to Shoreham. They use the set of BWR's while Shoreham is a salt--

water cooled BWR, an important distinction in defining a com-parable set of nuclear plants since the cooling method is crucial in understanding plant performance.

r . Second, selectively removing data on downtime from the data base is problematic. No two cases of unplanned outage will be 1,dentical. The pathways leading to such events are infinite.

Statistical analysis _gives estimates across many plant-years of experience of their probability and duration. LILCO/HI, by tampering with the data base, are discarding this information.

Third, and most significant, the evidence is mounting that plant availability will deteriorate as nuclear plants age. Rather than adjusting the County's estimates upward, HI would have been closer to the mark had it decreased the County capacity fac-tors, which do not reflect such deterioration, as too optimistic.

FIGURE 3 CAPACITY FACTOR COMPARI-GONS 65 62.0 e

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, , Finally, tho HI report 10 cimply innccurato concerning

, certain County assumptions influencing make-up costs. HI thinks 1

the ESRG analysis included a projection of one-third make-up power coming on average from the New York Power Pool (p. III-23) while in fact the NYPP make up power assumed is only a few per-cent until 1991 based on dispatch economics as reported in the ,

Summarv of Findines. In fact, eliminating all NYPP power for Shoreham replacement would effect rate impacts by only 0.3 per-cent (see Table 1). But this is unlikely. The purchase of addi-tional power becomes more attractive because less efficient units are "at the margin" with Shoreham not available. The relative costs between imports and displaced units governs the least-cost dispatch strategy.

Finally, HI thinks the County's analysis relied on average generation prices in computing make-up cost (p. V-8). This is incorrect,'as marginal prices ware properly used throughout (ESRG

~

i Summary of Findings, p. 37).

2, 6 New Plant Investment HI accepts LILCO's assumption that an additional facility will be needed in 1994 (and another in 1999) in the form of 400 MW coal plants. Based primarily on differences in forecasts, the ESRG projections require the facilities in 1998 and 2000.*

The reasons for the differences have been discussed at

• It should be stressed that the 400 MW coal steam plants are.

employed as " worst case" fall back options in the County analysis. Better would be a.hard. hitting conservation program coupled with the adoption of modular renewable energy and clean coal technologies as technical and economic uncertainties are resolved over the next ten years.

..9-t

1cngth in previouc documents. Tha LILCO load forecast 1.6 percent / year is too high. The ESRG forecast 0.8 percent / year is reasonable and is based on a model which~has performed well for six years in the LILCO service-area. It is fully documented in Technical Report A of the County presentation. If anything, it may underestimate the demand dampening effects of the " rate shock" which will hit Long' Island in all scenarios.

On the supply side, HI calls into question the firm capacity interties assumed by ESRG. But this assumption is that used by the New York Power. Pool in its most recent report.* HI has offered no new evidence to call into question the reasonableness of the County's analysis.**

2.7 Propert'r Tax One of the ratepayer costs of opening the plant is the Shoreham property taxes which would, be included in LILCO's y

required revenues. In the case of the plant not operating these payments would be avoided. As HI points out (p. V-9), LILCO erroneously charges the shoreham abandonment scenario with property tax.***

• Recort of the Member Systems of the New York Power Pool, 1983, Vol. 2, p. 34.

• • For comparison, it is interesting to note that the recently released Enerov Master Plan (Draft Reoort), N.Y. State Energy Office, August, 1983, finds that a new plant would not be needed, in the absence of Shoreham, until 1997 (vol. 1, p.

111).

• • • Indirect tax effects (those not included in rates) need to be treated separately. LILCO confounds rate-related impacts with possible indirect impacts.

, Tha total Shorehnm tax over the twenty year planning paried g is.$0.6 billion (1983 PW).* This figure is based directly on LILCO estimates ** . On the other hand, the additional units required in 1998 and 2000 will cost ratepayers about $0.1 billion.

Therefore, the net property. tax benefit to abandonment assumed by the County is S0.5 billion.

But HI " adjusts" the County figures by subtracting.$0.1 billion. The basis for the correction was manipulations on cer-tain unpub.11shed property tax estimates apparently developed by LILCO. Though their report is unclear on what was done,*** it

• appears that HI first removed two factors from LILCO's property tax treatment: indirect property tax effects which should not be included in rate impact calculations and property taxes from LILCO's assumption of uneconomical coal conversions in the Shoreham-Out scenarios which HI properly rejects. If HI 7 correctly a'djusts LILCO figures for these effects, there should be no difference between LILCO/HI and the County. That a small disagreement remains is either due to an error, an unstated assumption, or related to different projections of new coal-plant start-up dates between LILCO and the County.

• Lono Island Without the Shoreham Power Plant, Summary o_f, Findinas, op. cit., _p. 64.

• • Direct Testimony of A. Madsen, PSC Case No. 28252, Ex. 1,

p. 13.

• • • see p. V-10.

I 2.8 Miscollancous Coltn Finally, following LILCO, HI lists a series of miscella-n'eous effects by which the County analysi's needs, in their opi-nion, to be adjusted. The HI techniques (pp. V-6 and V-7) is to list LILCO's nine miscellaneous cost categories and then check-off those which they find reasonable and which not. The bottom line is to accept about one-half of LILCO's estimates for a grand total impact on rates of about 0.9 percent (SO.2 billion over 20 years).

i HI offers no documentation on the impacts of each effect or the basis for accepting LILCO's estimates. The analysis appears to essentially accept LILCO's own undocumented estimates.*

There are, in fact, a number of conceivable small effects, some favoring Shoreham operations and some not. LILCO/HI have come up with a grab bag of the former category only, y There are serious conceptual difficulties with many of the miscellaneous factors they adopt.** At the same time, there are s

• Sans LILCO's absurd inclusion of the Bokum Resources uranium investment charges as a charge to abandonment. The disposition of these costs are not dependent on the fate of Shoreham.

• • For example, impacts on intra-Long Island exchanges have a zero net effect on Long Islanders and should not be included. Firm capacity payments should not be included in ESRG's analysis since no additional firm capacity is required or assumed.

General property taxes may or may not rise to compensate for lost Shordham revenue. But if they are assumed to rise then indirect property tax impacts should be correspondingly reduced (HI apparently double counts here.) The Shoreham personnel that LILCO would need to absorb- according to LILCO/HI could use-fully be put to work on a conservation program turning this

" miscellaneous cost" from a penalty of abandonment into an impor-tant benefit.

r anumb2rofmiscollancoubarcaswherotheCountycnslysisiscon-sorvativo. For example, no credit was takEn for a rapid tax write-off of the Shoreham investment under abandonment (a 50.2 billion additional credit to abandonment). No credit was taken

'for the fact that the substituted coal facilities in the abandon-ment scenario would still be available when Shoreham would have to be retired and replaced by new units. Finally, no credit was taken in the Rate Wash case for heightened conservation effort despite the likelihood that conservation would move higher up on the planning agenda without Shoreham. As shown in Table 1, this

. potential credit to abandonment alone could swamp all of the miscellaneous costs LILCO/HI can think up.

S P

s e

L . .

3. LILCO'S FINANCIAL HEALTH What are the financial consequences if Lilco recovers less than LOO % of its Shoreham investment? HI claims any scenario for less than 100% recovery would (1) " s e v e r ely impa ct" LILCO stockholders, (2) would cause a ripple of adverse impacts for all other New York State Utilities, and (3) is not legal. We will refute each of these claims.

3.1 IMPACT OF ABANDONMENT ON LILCO STOCKHOLDEPS

• HI offers as support for its statement of severe impacts for stockholders two scenarios -- 50% Shoreham cost recovery or 0% recovery. This is a tautological approach -- the findings are r

contained definitionally in the premis es -- because in the scenarios HI chooses to consider common equity has been eliminated from the outset. The choice of these scenarios then allows HI to dwell on the consequences of bankruptcy as if this were the inevitable conclusion of any plan that allowed for the sharing of costs between investors and ratepayers.

This is clearly not the case. Under the County's Rate Wash Case at 91% Shoreham-cost recovery, there are no severe ' financial impacts, and in fact, LILCO's financial position improves The findings in tnis section are discussec in Georgetow..

Consulting Group, Inc., Op. cit.

i O

c dramatically f rom its current position. Figure 4 shows LILCO's key financial indicators under Rate Wash are comparable to A and AA rated utili ti es .

The interest coverages shown in Figure 4 are measures of the extent to which LILCO's pre-tax income exceeds LILCO's interest -

costs. Interest coverage is considered so important by investors that a certain minimum requi rement is generally specified in a company's mortgage indenture. Under the Rate Wash Scenario, LILCO's indenture coverage far exceeds its minimum requirement of i 2.0 times.

The Internal Cash Generation indicator is a ratio of the amount of cash a utility generates internally versus its cash re qui rements for construction. In the Rate Wash Scenario, LILCO can finance its future construction prima rily f rom internally y .

generated cash which lessens its dependence on outside financial markets.

The Rate Wash Scenario represents only a modest departure from full shoreham cost recovery. Instead of the devastating financial impact projected by HI, we find LILCO with financial results comparable to A and AA rated utilities.

, s P -

FIGURE 4 ,

RATE WASH SCEN ARIO -

SHOREHAM ABANDONED FIN A N CI A L INDIC ATOR S LONG ISLAND LIGHTING COMPANY (NDENTURE COYERAGE SEC COVERAGE INTERN AL INCLUDING AFC CASH GENER ATION 4.5 -

4.0 -

gge -

) 3,$ , 'a a' natte Letto 100 " .

3.0 - "

3.0 M h\N ...

L8kCC Let C o 2.5 - mates 50 ^ ' ~

Tanott

/ /

/ 2.5 - '#

0 _

2.0 0.--

toss toes seen se ei en toss teso se es en sees toes attual pagJtttro attWAL Pn0Jtttt0 Actuat eaCJECitD l '

l

I -

In addition to the Rate Wash Scenario, Georgetown also analyzed LILCO's financial position for a Low Return Scenario which a'ssumed 65% Shoreham cost recovery. The revenues required from hatepayers under this scenario are sufficient to maintain the mortgage and SEC coverages (including AFC) to a minimum of 2.4 times.

In addition, internal cash generation does not fall below 40% and the dividend yield as a percent of book equity was

, maintained. Even under this scenario, LILCO's key financial indicators are maintained or improved versus LILCO's current position as shown in Figure 5.

7 FIGURE 5 -

LOW RETURN SCEN ARIO -

SHOREHAM ABANDONED FIN A NCI AL INDIC ATORS LONG ISLAND LIGHTING COMPANY ,

INDENTURE COVERAGE SEC COYERAGE INTERN AL INCLUDING AFC CASH GENER ATION 4.5 -

4.0 -

150 -

3.5 - u 1 Litco 100 -

T

3.0 - 2.0 '

,,, LetC o LaL C o @

'N E 8'Tre t o vaatti N'

p 2.5 - tanott N 2.5 - *a-2.0 - - _

2.0 -

0s test toes teso ao et se toes ***e se et er toes toes ACtWat paeditttD AC1Wat Pa0JECitD actWaL PaCJECTit These two scenarios just dis cus s ed , Rate Wash and Low ,

return, illustrate that LILCO's financial health can be maintai.ned or improved and ratepayers can benefit from lower or breakeven rates under shoreham abandonment scenarios.

It is also useful to review the 100% return scenario which -

HI promotes. In this scenario investors do not bear the risks associated with an operating nuclear plant although they enjoy the benefits of a 100% Shoreham cost recovery. Under this scenario we see LILCd emerge with financial indi.cators that place it among the strongest and healthiest utilities in the country.

LILCO's interest coverages as shown in Figure 6 would exceed those achieved by A and AA rated or better utilities.

FIGURE 6 HIGH RETURN SCENARIO -

SHOREHAM ABANDONED FIN ANCI AL INDIC ATORS LONG ISLAND LIGHTING COMPANY s

INDENTURE COVERAGE SEC COVERAGE INTERN AL INCLUDING AFC CASN GENER ATION 4.5 -

4.0 - 150 -

3.5 - 3.5 L LCo 100-l 3.0 - 3.0 L8LCO

(// V ...

into Tanat? /

2.5 -

"'TE D E O W W' *a*

2.5 - //'

3.0 A 2.0

' ^ ^

0 - ,

- ^^ _

l test toes tooo se et en toes teso se at as toss tese Pa0JECTED ACTUAL en0JtCTtp ACTWat Pa0JECTED ACTUAL

.p .

3.2 -EFFSCT OF SHOREHAM ABANDONMENT ON OTHER NEW YORK UTILITIES HI's second point, that adverse financial effects will rippl'e throughout all the New York State utilities, is not l supportable. Let's examine the evidence as presented in Chapter -

VI of the HI report.

EI offers two incidents which occurred in the 1970's -- the 1

missed Con Edison dividend in April, 1974, and the accident at i l

Three Mile Island in March, 1979 -- which they,beli eve may have significantly aff ected other electric utilities' capital costs.

In order to draw any conclusions f rom these two examples, we must be able to separate their effects f rom other significant economic events which occur during the same time.

For example, HI provides an analysis on pages VI-2 thru VI-4 that it believes shows that LILCO's, as well as ~ other New Ycrk State utilities' bond yields were impacted by the missed Con Edison dividend. In order to isolate the impact, of Con Edison's missed dividend on New York State utility bond yields it is necessary to remove from HI's analysis the changes in yield from other factors. One major influence which must be removed is the change in the risk free interest rate.

In Figure 7 we have used a long term U . S . Government bond as a proxy for the risk free interest rate. As our graph makes clear, it is the change in interest rates in general, not con Edison's dividend policy, that was the predominant influence on LILCO's bond yields .

l W ,,'.

I FIGURE 7 .

14

, l* '. ' . Con Edison

4 s .-

. . ,o 12 -

t*.

10 -

: .** . LILCO s-

- t s

1 e

• .* . . :: .:.c ........::...

.....,.is.....=

... U.S. ^.

Government -

o

• 6 -

a '

r d

> 4 _

2 -

O I I I i 1/73 7/73 1/74 7/74 12/74 MONTH .

Con Edison (7.9%, 2001)

LILCO (7.5%, 2001)

U.S. Government (6.75%, 1993) e

The tendency of utility bond yields to move with U.S.

Government bond yields is not surprising. Figure 8 as published in "The' Wall Street Journal" (August 19, 1983, page 26) presents this relationship for 1983.

FIGURE 8 j ?.. ,,kl. 5M_ _._ . ibI-I'Nf.bj

.- m

?M eu F'JS'J C tmtmES A

==vs a., yr3 Aan & 44 m 1*

\ W.$

r +# p~ ~

,m

,aham LONG-ilEM TRiASL'RY5

?*!<

os vari e i.e G

mu

. m. man ' pg :n '

in 7 T. .L .. T. . a n . - -

HI, in its real to find a " ripple" effect, fails to adjust its analysis for this fundamental relationship and it therefore produces an unsupported and mi.sleading result.

The effect of changes in the risk free interest rate is not the only economic event HI fails to separate from its analysis.

HI provides a graph in its figure VII that illustrates extreme incre$ses in the price of oil which coincide with the dates (1974

& 1979) of the two incidents we are attempting to analyze. These '

price shocks resulted in a 176% increase in the average price of crude petroleum in 1974 and a 40% increase in 1979.

HI concedes the important affect of oil prices on their analysis :

" . . .The ef f ects of rising oil prices are not separated from those of the con Edison incident" (p. VI-5).

"Because the national indexes of utility bonds included non-electrical utilities that were not subject to the ef fects of the oil price rise, this comparison could not determine whether r-elect r'i c utili ties ~ENew York were affected more by the Con Edison incident than electric utilitier outside the state." (p. VI-6).

In the Three Mile Island example, HI admits: "there is no evidence of a spillover effect on bond yi el ds that is particularly concentrated in utilities in the area" (p. VI-8).

Therefore, by HI's own logic, the analysis of these two incidents should be dismissed as inconclusive. However, HI goes on to quantify the effects of a one percent increase in interest rates for all New York State Utilities as if it had proved a "spillover" effect existed. This hypoth e ti cal cost is then allocated by HI to ratepayers. This cavalier approach leaves the misleading impression that rates will % ecessarily rise for all utilities in New York 'Stato if Shoreham wTere not to operate.

This is a particularily illogical speculation when the robust financial health of LILCO under Rate Wash conditions is considered.

3.3 COST SHARING IS LEGAL The third point , that anything less than 100% Shoreham cost recovery is illegal repeats Lilco's earlier rhetoric without adding substantive legal or regulatory arguments".- The regulatory treatment for abandonments has been presented in the Georgetown report. The following table shows that the actual nationwide regulatory treatments of abandonments has, in the majority of cases, provided for a sharing of costs between investors and 7

rat,epaye r s . .This cost sharing was often accomplished by allowing a utility to amortize its investment over time but not to recover carrying costs on the unamortized investment.

The Decisions of the New York Public Service Commission have in the past permitted full recovery of abondoned investments.

While the past decisions are important to understanding the

regulatory environment in the state of New York, it does not mean i that in the future the Public Service Commission will I

[ automatically repeat those decisions. Clearly, the magnitude of l -a $3.4 billion Shoreham abandonment will require u ni qu e J

e a

,,,, , - - . . , - , - - . - . - e,, - -- -.-.-c- - + - - ~ , - - - . - - -

.,, -- y

es

, TABLE 3 _

RATE TREATMENT FOR ABANDONMENT OF PLANT THE NATIONAL EXPERIENCE Years to Rate Base Stdte Utility Write Off Treatment Alabama Alabama Power 5 No

~

Dist. Col. Potomac Elec. 10 Yes FERC Jersey Central 20 No New Eng. Power 5 No Northern States Power 10 No Maryland ' Potomac Elec. 10 No Mass. Boston Edison -

Partial Maine Central ME Power 5 No Michigan Consumers Power 10 No Detroit Edison 10 No New Jersey Atlantic Elec. 30 No Public Service 20 No Public Service - 15 No I Rockland Elec. 20 No Jersey Central No New York NYSEG 5 Yes Rockland 3-10 Yes Con Edison 2 , Yes Ohio Cleve. Elec. 10 No Texas Gulf States 5 ,

No Houston LEP 5 No Virginia Potomac Elec. 10 No Va. Electric 10 No Wisconsin Madison G&L 1 No Wis. Elec. 3 Yes Wis. P&L 3 Yes I

u deliberations including considerations of a wide range of cost sharing options which have been employed nationwide. .

HI.is wrong when it claims that only a 100% profit recovery for investors is consistent with sound legal and regulatory practices. A ratemaking formula in which the tremendous costs of ,

the Shoreham project are shared by investors, at least to a small extent as in the Rate Wash scenario, is not only procedurally sound, it is equitable .

3.4

SUMMARY

OF LILCO'S FINANCIAL HEALTH To summarize, we find that contrary to HI's claim that anything less than 100% Shoreham cost recovery will result in severe financial consequences, LILCO,actually maintains or p roves its present financial position under a range of Shoreham im' recovery options from 65% recovery,to 91% recovery.

- HI's claim of a state-wide ripple effect on utilities capital costs is unsupportable. HI relied on data from periods of rising interest rates and severe oil price increases without attempting to remove these effects from itsr analyses." HI would have a reader believe Con Edison's dividend policy has a greater nationwide financial impact on utilities than rising interest rates or a 176% increase in oil prices. HI's informal analysis must be rejected as, at best, inconclusive. -

O

t . .

,s. ..

..a _

HI's assertion that cost sharing for abandonments is prohibited by law simply ignores national regulatory experience.

In the m'ajority of abandonment cases the regulatory treatment has been to provide.for cost sharing between investors and ratepayers. Rates may rise ~ substantially over the next several years because of the.Shoreham proj e ct whether or not the plant operates. A decision to require investors to share a portion

• of these Shoreham cost , penalties if the plant never delivers any service is not only legal, it is consistent witt principles of justice and equity.

• Recall that in the County's Rate Wash scenario thatl portion is Enall. Ratepayers provide 100% return on bonds and on preferred stock and 80% of return on com:non stock.

36 -

i

• g Q

W RESPONSE OF THE LONG ISLAND LIGHTING COMPANY TO

~

THE DAVERMAN REPORT J August, 1983 prepared by THE OFFICE OF ENGINEERING LONG ISLAND LIGHTING COMPANY The Long Island Lighting Company has conducted a preliminary review of the " Feasibility Study of Power Services Delivery Options, Municipalization of Electric and Gas Facilities, Suffolk County, New York." prepared by Daverman &

Ascociates, P.C., and has found that, if Suffolk County recommends a municipal electric system for its constituents, the true cost of electric service for the County would be substantially higher than it would be if residents remained within the LILCO system.

Our overall assessment is that, .while the Daverman Report is a worthwhile

+

preliminary examination of the resources needed for Suffolk County to take over a portion of the LILCO system, there are serious flaws in many of the report's cssumptions.

On the positive side, the Daverman report at least acknowledges the possibi,lity of using Reproduction Costs New Less Depreciation (RCNLD) as the proper measure of property value rather than Original Cost Less Depreciation (OCLD). In fact, the law in New York is that LILCO would be entitled to the higher RCNLD cost.

The Daverman Report realistically evaluates the potential amount of low cost' "off Long Island" power that could be obtained by a Suffolk County Municipal Electric System. In fact, whatever low cost, upstate power would be available to Long Island consumers will come into Long Island whether or not there is a municipal electric system in Suffolk County.

Finally, the Daverman Report recognizes that Suffolk County residents will i pay their portion of the costs of the Shoreham Nuclear Power Station regardless of its operation or abandonment.

< There are however, several substantial errors and' weaknesses in the Daverman Rsport which should be addressed.

The Report assumes that the County could simply condemn 48 per cent of l LILCO's generation facilities. In fact, LILCO is entitled to retain its most officient generating plant to serve a prior public use in providing Olsctricity for customers in Nassau County and the Rockaways. These customers ara entitled to be protected from any adverse consequences of a Suffolk County

taksover.

l Suffolk County would be restricted to condemning the generating units most l axpansive to acquire and operate. These would include two of the four Northport j Units, tho Holbrook Gas Turbines, all of Shoreham and LILCO's entire interest in-Nine Mi Point #2.

h

s,__s.

'9..

Pcg3 2 The Report dramatically underestimates the award from Suffolk County to LILCO. Examples of areas where these estimates are faulty include:

- the use of book depreciation rather than actual observed depreciation.

- the use of original cost for real estate rather than an up-to-date appraisal.

- the failure to include assets acquired at no cost. .

- the failure to include construction work in progress.

- the failure to include a damage award to LILCO for higher operating expenses resulting from the disengagement of the electric and gas systems.

- the use of original cost for operating generating plants rather than RCNLD.

- the failure to include the proper cost of the generating units which would '

hava to be acquired as discussed above.

The following table illustrates these discrepancies with column one listing the Daverman estimate, column two, the LILCO estimate and column three the LILCO estimate using Daverman's inappropriate assumptions:

SUFFOLK COUNTY BOND REQUIRE!!ENTS

($ X Million)

RCNLD DAVEPJiAN LILCO LILCO ESTI?iATE WITH A. AWARD TO LILCO ESTI?iATE ESTI!! ATE DAVER'iAN PARA'1ETERS i -

Distribution Plant 433 1056 1056 Transmission Plant 327 800 800 Solit Elec/ Gas Ineff. 0 119 119 Ehtraordinary Writeoffs 0 385 t 385 Generation: Fossil 230 577 800 Nuclear 1542 5298 2560 Improv. to 1936 0 50 35 General Plant 46 15 15 Other , 432 510 510 Subtotal T61T 8810 MT B. OTHER COUNTY COSTS 490 1440 1120 TOTAL 3500 10250 7400 So that while the Daverman estimate of an award to LILCO is set at $3.5 billion, our rough preliminary estimate is somewhat over $10 billion and even using Daverman's assumptions, the award to LILCO would be $7.4 billion.

-Perhaps these discrepancies highlight one of the more serious consequences of a condemnation proceeding such as is being reviewed through the Daverman l

Raport. The fact of the matter is that if the legislature approves the condemnation, and if the voters in the County ratify the legislature's approval, the act is done. Yet, it is likely to be several years before the price of the property is settled upon. At that point, there is no turning bcck. The County is required to pay the settlement price determined by the c urts even if it is substantially more than was bargained for by either l

l

r s, .

i Pcga 3 Davarman or the County.

The likely result of such action vould be an economic hardship for Suffolk County residents.

Further, there are flaws in Daverman's revenue requirement assumptions for Suffolk County. These differences would likely result in a substantially different picture regarding the cost of electricity for Suffolk County .

racidents. As set forth in the following table, rough preliminary estimates indicate that if the County sets up its own system, the cost per kwh would be ,

24.7 cents. If Suffolk stays with LILCO, the cost per kwh would be 15.7 cents.

Again, using the inappropriate Daverman Report figures, the cost per kwh would bs 20.1 cents.

1986 COST OF ELECTRICITY SUFFOLK STAYS SUFFOLK WITH LILCO ESTI? TATE WITH MUNICIPAL LILCO DAVER'1AN PARAMETERS Fuel 138 218 218 Operations & !!aintenance 202 156 165 Property Tax 146 112 110 Gross Revenue Tax 0 47 0 Additions & Replacements 60 0 50 Capital Recovery 1110 455 - 800 Credits (100) 0 (75)

TOTAL 1556 988 1268 C/kwh 24.7 15.7 20.1

+ 57% BASE + 28%

It should be pointed out that our review of the Daverman Report is proliminary. It would take substantially more time to establish the precise mcgnitude of the higher electric rates which would result from a municipal taksover of the LILCO system.

It is obvious however, that some of the inherent advantages of a municipal electric system would be in the system's ability to issue tax exempt bonds, th0reby reducing the overall debt. LILCO is currently exploring the possibilities of restructuring its debt through tax exempt bonds. If such a rastructuring is accomplished, it would partially obviate the County's financial cdvantage.

9

F-

.y l TO: Members of the Shoreham Commission FROM: Alfred E. Kahn h

SUBJECT:

The attached memo of August lith DATE: August 29,1983 As some of you may be aware, some of the members of the Commission had a preliminary meeting with members of the staff in order to plan the economic presentations for August 31st--to figure out what runs of the RAM model to do, how to accomodate the various suggestions of members of the Commission for running various assumptions, and how to go about assessing the financial consequences of a LILCO bankruptcy.

In preparation for the meeting,I prepared the attached rough draft of j ruminations. Since they went beyond merely outlining possible runs and expressed some personal opinions on some of those issues, it seemed to me I ought to make copies available to all of you.

AEK/ lek l

/

~

s 6

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F.q.

=?

l W

. l l

TO: Shoreham Study Commission j

' FROM: Alfred E. Kahn

SUBJECT:

The economic effect of Shoreham ,

DATE: August 11,1983 Our appraisal of the effect of Shoreham on the economy of Long 9

Island, whether it operates or does not operate, can be made to . turn critically--at least so far as the direct effects are concerned--on the assumptions we make about the. extent to which the capital costs of that plant can be imposed upon the company itself--its stockholders ~ and, if enough of the s

burden is imposed on it, its creditors as well. Whether the rate increase is 57%

--as LILCO has estimated, on the assumption that the plant goes into service and the ratepayers shoulder 100% of its capital costs, or under ESRG's scenario, in which the plant does not go into operation and ratepayers shoulder 93% of

~

those costs--or 76%, under t'he Hudson Institute's estimates, under the assumption that the plant does not open and ratepayers are burdened with 100%

of the capital costs--it is of course those huge prospective increases that set in motion the adverse effects of the plant on the Long1sland economy.

The critical component of those rate increases 'is the carrying charges of the $3 billion-plus investment in Shoreham. So, obviously, the estimated size of the requisite rate increases--whether the plant opens or not--can be made to vary critically simply. by making different assumptions about the extent to which the LILCO stockholders and creditors can be made to swallow those capital costs. At the extreme, for example, it does not require

-. . ._ .___L.. -_.

r

- s .

any complicated modelling or runs of the RAM model to demonstrate that if one assumes that none of the capital costs need be shouldered by the ratepayers--an assumption that clearly has more plausibility (but how much plausibility I propose to discuss in this memorandum) if one assumes that the plant does not open than if it is permitted to go into operation--rates need not be posited to go up at all, and the direct adserse effect on the economy of Long Island can be reduced to something like zero. -

These considerations make it very clear that our entire analysis of the economic effects of Shoreham--both the direct effects on ratepayers and the indirect effects (of sharply increased electric rates) on the economy of the Island--must involve critically, and therefore promptly--an explicit and thorough consideration of two closely interrelated issues, on which we have almost totally failed so far to concentrate: first: what is the range within which

> LILCO may lawfully be made to absorb the capital costs of Shoreham; and, second, the indirect consequences of trying to force LILCO to swallow varying proportions of those capital costs--for LILC , for electric ratepayers on the I

Island, for all the public utilities of the state and the costs of capital to them and therefore to their customers, .for the credit worthiness of the state

! generally, and perhaps also for utilities and their costs of capital and therefore their customers across the country. .

The legal possibilities of making LILCO swallow varving proportions of the capital costs of Shoreham.

- It seems to me our discussions of this question thus far have been irresponsible, in the sense that we have freely hypothesized varying proportions of the capital costs of Shoreham, up to 100%, being imposed on the Company without at any time explicitly considering the extent to which, under varying assumed circumstances, that kind of result is likely to be legally permissible. I n/e.Tla"

s .

suggest that we cannot delay explicit consideration of this question any. longer, if we are to come to any reasonable recommendations or fact-finding within the next several weeks.

I take the liberty of making the following suggestions, even though I'm not a lawyer, on the basis of my own regulatory experience, simply in order to pose the questions and move our discussions forward.

1. We know--at least I think we know--that the modal practice in the several states and federal jurisdictions, in the event that nuclear plants are left unfinished,is to permit the companies to amortize the accumulated capital costs over some period of time--I take it something like ten years is typical--but are allowed no return, during the amortization period, on the remaining unamortized balance.

This,1 very roughly calculate, is a sizeable economic penalty.

Assume, for example, a $3 billion investment, amortized over a ten-year period--charging ratepayers, therefore, $300 million a year. Assume, next, a

- composite rate of return that tt}e company would ordinarily be allowed, but is disallowed in this instance, of 12E Since the average outstanding balance of unrecovered capital, over the ten year period, will be $1.5 billion, this means that the company will be foregoing--i.e., will be forced itself to absorb--$180 million a year over that same period, on average. If my method of calculation is correct, this means that the company is recovering only 300/480 of the total capital costs--that is to say,621% (I'm sure that the proper calculations are much more complicated: for example, mine do not take into account at all the federalincome tax consequences of this treatment.)

(This suggests to me, to anticipate my discussion below, that we ought to run the RAM model to see what a 621% recovery of capital costs does to the pertinent LILCO financial ratios, to the likelihood of its bdnkruptcy, to its IFO/I'/a

f ,,

ability ta finance under the two obvious alternative assumptions about its continued participation in Nine Mile 2, its cost of capital and that of other New York utilities, the State of New York, and so on.)

2. What we do not know, and ought to ask someone like Alan Roth to tell us, is the kind of circumstances under which this resolution has been legally acceptable, and whether those circumstances apply to the LILCO situation.

a. I have little doubt, at one extreme, that such a resolution might be legally acceptable if the regulatory commission were able to make a bona fide finding that comple: tion of the plant and its entry into service would not be in the interest of ratepayers, assuming the normal regulatory treatment of its capital ecsts--i.e., tha't, assuming similar treatment of the recovery of capital costs under the two competing scenarios, rates over the life of the plant (properly discounted to present value) would be higher if the plant were permitted to be completed and go into operation than if it were not. I believe we would not be able to make such a finding in this case, in part because ESRG does not do so. ESRG's answer -to the foregoing implied question is that--under the assumptionI have stipulated--rates would not be much higher if the plant is closed down than if it goes into operation.

In short,I have the impression that a commission cannot legitimately decide not to let a plant be completed and go into operation on the basis of a calculation that ratepayers would be better off under such a scenario.only because, and only to the extent that, th'e company itself could be made to absorb some of the capital costs in that event. Such a decision would, I think, constitute confiscation. .g g, ,

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b. Alternatively, I think a decision to make the company ', ,,

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absorb some portion of the capital costs could be sustained to the extent that

. , .. i17.fh{'g was based on a bona fide determination by th'e regulatory commission that that n/eir/a

portion of the capital outlays was imprudent. It is my strong impression, however, that imprudence may legitimately be determined only as of the time the expenditures were actually made, not on the basis of hindsight.

c. Applying this interpretation to the Shoreham situation,

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I suggest that no regulatory commission could find that it was imprudent for

.LILCO to 'have undertaken to build a nuclear plant, or--since the site was approved by the NRC (or the AEC)--to have placed it at Shoreham. Nor do I-believe that the New York Commission could now find that at some point along the way it was imprudent for LILCO not to have stopped construction. This is perhaps another way of saying that a disallowance of some of the capital costs could not be based upon the fact, for example, that in the last year or two the world price of oil has slumped, and that the consensus projections of future oil prices iri 1983 are markedly less gloomy than they were in 1981.

> If this reasoning is sound, the only legally permissible disallowances would be of inflations of construction costs that, a regulatory commission would have to find, a more diligent builder would have avoided. (AndI assume it would have to take into account the extent to which the costs of nuclear plants under construction all over the country have inflated relative to what has happened to the costs of Shoreham.)

I find it close to impossible to believe that such a finding could end up disallowing anything like as much as one half, say, of the Shoreham capital costs, even though in some real sense the market value of Shoreham today, determined on the basis of one's best estimate of the present value of the net fuel savings (net of O&M costs, of future additional capital costs, including the costs of decommissioning) uniter d*' '

34 AM.

If these ruminations are sound, we are not only wasting our time looking into the consequences of a 100% disallowance of the costs of Shoreham, i

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but deceiving khe people of Long Island into a belief that there is or may be available to them a resolution of the Shoreham problem that would be totally painless to them--except, to be sure, to those of them'who own LILCO stocks and bonds--even considering only the direct effects of various treatments of Shoreham on electric rates. Indeed', depending upon what our legal advisors tell us about the . circumstances in which regulatory commissions have successfully allowed amortization only (without return on the unamortized balance), we may be deceiving ratepayers 'on Long Island into thinking that they may be able to avoid up to 371% of the capital costs of Shoreham (assuming my arithmetic

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above is correct). -

3. It is perhaps laboring the obvious, but let me put this last proposition in a different way. Here we have a company that obtained the requisite legal approvals of its site and of its proceeding' to construct a plant.

Assume that it similarly o'atains the requisite regulatory approval of its ,

o'perating the plant--or would obtain such approvals but for the refusal of- ,

Suffolk County to participate in an emergency plan. And assume also that

.neither we nor the Public Service Commission would be able to find, on economic grounds alone, that the plant should not be opened--assuming similar rate treatment of the capital costs whether Shoreham operates or does not (and assuming that that is the proper assumption!). In those circumstances, I find l_

! .myself highly skeptical that LILCO could be lawfully deprived even of the 371%

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of its capital costs, even if the plant were not completed and did not go into operation for the reasonI have just outlined.

Financial market consequences I do not think it necessary at this point for me to spell out the kinds of inquiries we need to make 'under this heading. I call to your attention only the

. fact that we do already have the positions of the two contending sides on the n/e/1'/a

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b indirect effects of major diallowances of capital recoveries on capital markets A

generally and on the cost of capital of the New York utilities and New York State obligations--in the presentations by the Hudson Institute, on the one side, and ESRG, on the other. To what extent these need supplementing,I must leave to our staff to advise us; and I call to your attention also the question of the extent to which we need some expert assistance--by people like Stu Myers and/or Jensen to help us appraise these conflicting arguments.

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