A math expert named Dr. Andy Bardwell sometimes helps Boulder's "utility watch dog" Leslie Glustrom to plumb the cost analyses in Xcel Energy's filings. In that effort he came to detect that future fuel costs seem to be discounted. In tackling Xcel's new Electric Resource Plan (ERP) for Colorado, Glustrom (my colleague at Clean Energy Action) confirmed through a discovery question to the utility that future expenses on fuels like coal and natural gas are indeed being discounted, and aggressively so -- at 7.6 percent.
Reading the tomes filed by big utilities is enough like falling down the rabbit hole, but finding a math wrinkle in yards of spreadsheets is a eureka moment on par with Alice finding a tiny bottle on a three-legged table marked "Drink Me." Indeed, a discount rate is like a magic potion that is used in financial models for shrinking and growing values to establish net present value (NPV), as if a telescope could be squashed to make all those tiny objects far away become "present."
In Bardwell's professional testimony on this to the Public Utilities Commission, he put it this way: "The net present value of several mutually exclusive possible investments having different distributions of capital outlay and revenue generation through time; the one with the greatest NPV is generally the one chosen." (Note: if you wish to see Bardwell's testimony, go here and look at the last item "Bardwell Testimony" and download.)
As with any drug or power tool, the key is how it's used. The discount rate significantly favors the present over the future, and right off this should set off parental alarm bells. But suffice it to say that where time represents opportunity to add actual value, favoring the present can be legitimate. After all, most rational actors would prefer to get $100 today rather than $100 in a year if in that year a person could make a return on that money.
So it's normal to use the discount rate on capital expenses like upgrades to a coal plant or large installations of solar power. But it's not okay to use it on expenses that involve no capital or loans and are in fact paid for at time of purchase by other people's money. Defenders of the discount rate note that it's used equally across all categories (income, expenses, capital and interest payments), however, applying it to other peoples' money without also allowing those people to benefit from the business proposition is not equal treatment. It's just plain taking other peoples' money for granted as one's own and then discounting it.
"There is no justification for applying Xcel's Weighted Average Cost of Capital as the discount rate to future un-financed operational expenses, such as fuel costs, in the selection of the most cost- effective generation resources. As they are passed through directly to customers as they are incurred, capital does not need to be raised in advance to finance these costs..." ~ Andy Bardwell
Consider a commonplace experience: you get a loan to pay for your car (such as the financing Xcel puts into big projects), but you never get a loan to pay for its fuel or a lock-down on fuel prices. Those fuel expenses will be your unpredictable burden each month with that car. That translates, in this case, to the utility bill's fuel expenses when they are passed straight through to you each month in a little line item called the ECA, or the electric commodity adjustment, on Xcel's bills.
Consider: with a discount rate of 7.6 percent, each decade into the future cuts the value of a fuel buck by over half, meaning that a dollar of fuel 10 years from now shows up at 45 cents in the present valuations. Forty years hence, such future fuel will "cost" only four cents on the buck, according to Bardwell's testimony. Pretty understandable to us who liked high school math and recall that compound rates of change result in exponential rates of change, so any discount rate that is not de minimis can compound in wacky ways really fast. One pill makes you smaller and one pill makes you larger.
Now here's another big kicker: One highly threatening result of this practice is that discounting fuel costs so steeply also discounts the real savings to be felt from fuel-free energy coming from renewables like wind and solar, not to mention super cost-effective efficiency. Xcel's analytic tables with fuels discounted at 7.6 percent show that adding significant renewables isn't attractive for rate payers. Conversely, other analyses presented with Bardwell's testimony show that lowering the discount rate to the rate of inflation (or even slightly higher) show that fuel-free energy is the real winner for rate payers. Not to mention our climate.
So correct that discount rate and bring on the energy saving from renewables and efficiency! Bardwell vigorously advocated for the PUC to have Xcel use the inflation rate of 2.8 percent on future fuel expenses. He also asked the PUC to direct Xcel to supply new valuations with a variety of lower rates applied to fuels.
My Dad was a professional investor and loved to extol compounded interest as the "eighth greatest wonders of the world" for its jaw-dropping capacity to grow money. Now imagine that powerful tool being used incorrectly, such as to hide future fuel expenses or the savings to come from clean energy. Boulder's own Dr. Al Bartlett grew famous by teaching: "The greatest shortcoming of the human race is the inability to understand the exponential function," offered to confront our species' exponential population growth. Imagine that misunderstanding applied in quiet rooms where math is supposedly revered and applied for the benefit of future rate payers -- only to provide them with horrendous fuel and climate costs down the road for no good reason.