An investor-owned electric utility subject to rate-of-return regulation currently generates 5 million Mwh per year from a single hydroelectric dam, with an operating cost of $5 per Mwh. The regulator allows the company to include the replacement cost of its plant and equipment in the rate base.
The dam has a replacement cost of $5 billion. The company also has transmission and distribution assets, of $1.5 billion, and has of $100 million annually in addition to the operating cost of the generating plant, so the total operating cost is $125 million and the rate base is $6.5 billion.
a. If the regulatory agency allows a 10 percent rate of return on the rate base, what is the regulated price of electricity, and the utility's annual earnings?
b. The utility projects its demand to grow by 20 percent to 6 million Mwh, and seeks permission from the regulatory agency to allow it to construct a 600 Mw coal-fired steam power plant that costs $3 billion.
The coal plant would have an operating cost of $30 per Mwh. Because the coal plant is difficult to turn on and off, the utility plans to generate 2.4 million Mwh from the coal plant and use the hydroelectric facility more to meet peak demand, so annual hydro generation falls to 3.6 million Mwh, as summarized in the following table.
Assuming that transmission and distribution costs remain the same as before, how much would utility seek to raise prices, and how much would annual earnings change if the price increase is granted?
|
Generating station
|
Capacity (Mw)
|
Annual generation (Mwh)
|
Replacement capital cost ($millions)
|
Operating cost ($/Mwh)
|
|
Period 1
|
|
|
|
|
|
Hydroelectric dam
|
1,000
|
5,000,000
|
$5,000
|
$5.00
|
|
Period 2
|
|
|
|
|
|
Hydroelectric dam
|
1,000
|
3,600,000
|
$5,000
|
$5.00
|
|
Coal-fired steam power plant
|
600
|
2,400,000
|
$3,000
|
$30.00
|