I've seen this done way too many times now -- multiplying PATH's $2.1 billion price tag by 14.3% and calling the result the amount of profit PATH will walk away with. This is not accurate.
The truth is much more expensive than that and no clear total profit number can be calculated right now. Their profit is endless.
So, how do they calculate that 14.3%? Stick with me here... it's not going to be hard and I promise not to go off on more complicated concepts.
There are two main components of PATH's Formula Rate. One is the Revenue Requirement. The other is the Ratebase. There are also two different categories of costs for PATH. Depending on the nature of the cost, each dollar spent ends up in either the Revenue Requirement or the Ratebase. These two different components are further explained below.
One set of costs, that I will call Operation & Maintenance (O&M) for simplification puposes, is reimbursed by ratepayers at dollar-for-dollar as it occurs. No interest or inflating of expenses here (at least that's the way it's supposed to work when PATH isn't creating "errors" in its formula rate filings that work in their favor). O&M, in its largest part, includes their advertising, public relations and marketing expenses and many other "general" day-to-day expenses of dragging this thing out day after day, month after month, year after year. O&M becomes a large part of what is known as the Revenue Requirement.
The other set of costs are composed in large part by what are known as Construction Work in Progress (CWIP) costs. This is the cost of land and land rights (easements), the actual physical components of the line, the engineering of the line and their regulatory expenses (there's more to it, but we'll stop there). These costs are capitalized (that is, they become an asset) and are placed in what is known as the Ratebase. In the Ratebase, these costs are subject to depreciation. Depreciation calculates the useful life of the asset. Everything wears out and needs to be replaced eventually, right? So these costs slowly disappear over time, just like the value of your new car once you drive it off the lot. However, the cost of land and land rights NEVER depreciates. Keep that in mind as we work through to the end. The amount in the ratebase does not zero out each year because the capitalized items have not fully depreciated. Instead, new CWIP is added to the ratebase every year, creating an even bigger number for PATH to earn a return on.
The ratebase earns PATH a yearly return. This is where the 14.3% comes in. PATH's Formula Rate was approved to consider the financing of PATH at 50% debt and 50% equity. So, in order to calculate the actual profit percentage PATH earns each year, you basically find the average of that 14.3% return on equity and whatever percentage at which the debt is currently being calculated. Right now, it's at something like 6%. So that makes about 10% profit for PATH every year on the amount in the ratebase. This is PATH's "return", or profit. Return is calculated by multiplying the total amount in the ratebase by that 10%. The amount in the ratebase keeps increasing every year, right up until the date the project is put in service and construction is complete.
The calculated return is added to PATH's other set of costs, the O&M, to come up with the total Revenue Requirement every year. The yearly Revenue Requirement is the amount the PJM ratepayers pay in any particular year.
In an ideal world, once construction is complete, the amount in the ratebase would begin to decrease because of depreciation. It would eventually disappear -- but, we have those land and land rights in there that will NEVER depreciate. This means that we're going to pay PATH a return on them forever.
So, that 14.3% is the profit PATH earns every year on 50% of the amount in the ratebase. Every year from here to eternity.
Any math geniuses who want to work that problem out and come up with the amount of profit PATH (really their parent companies, AEP & Allegheny Energy) stands to earn if they can ram this project through approvals?
This why they continue to hang onto this loser project in the face of all sane reality that it's NOT GOING TO HAPPEN. It's a gravy train they plan on riding well into the future to provide a steady stream of income.
The truth is much more expensive than that and no clear total profit number can be calculated right now. Their profit is endless.
So, how do they calculate that 14.3%? Stick with me here... it's not going to be hard and I promise not to go off on more complicated concepts.
There are two main components of PATH's Formula Rate. One is the Revenue Requirement. The other is the Ratebase. There are also two different categories of costs for PATH. Depending on the nature of the cost, each dollar spent ends up in either the Revenue Requirement or the Ratebase. These two different components are further explained below.
One set of costs, that I will call Operation & Maintenance (O&M) for simplification puposes, is reimbursed by ratepayers at dollar-for-dollar as it occurs. No interest or inflating of expenses here (at least that's the way it's supposed to work when PATH isn't creating "errors" in its formula rate filings that work in their favor). O&M, in its largest part, includes their advertising, public relations and marketing expenses and many other "general" day-to-day expenses of dragging this thing out day after day, month after month, year after year. O&M becomes a large part of what is known as the Revenue Requirement.
The other set of costs are composed in large part by what are known as Construction Work in Progress (CWIP) costs. This is the cost of land and land rights (easements), the actual physical components of the line, the engineering of the line and their regulatory expenses (there's more to it, but we'll stop there). These costs are capitalized (that is, they become an asset) and are placed in what is known as the Ratebase. In the Ratebase, these costs are subject to depreciation. Depreciation calculates the useful life of the asset. Everything wears out and needs to be replaced eventually, right? So these costs slowly disappear over time, just like the value of your new car once you drive it off the lot. However, the cost of land and land rights NEVER depreciates. Keep that in mind as we work through to the end. The amount in the ratebase does not zero out each year because the capitalized items have not fully depreciated. Instead, new CWIP is added to the ratebase every year, creating an even bigger number for PATH to earn a return on.
The ratebase earns PATH a yearly return. This is where the 14.3% comes in. PATH's Formula Rate was approved to consider the financing of PATH at 50% debt and 50% equity. So, in order to calculate the actual profit percentage PATH earns each year, you basically find the average of that 14.3% return on equity and whatever percentage at which the debt is currently being calculated. Right now, it's at something like 6%. So that makes about 10% profit for PATH every year on the amount in the ratebase. This is PATH's "return", or profit. Return is calculated by multiplying the total amount in the ratebase by that 10%. The amount in the ratebase keeps increasing every year, right up until the date the project is put in service and construction is complete.
The calculated return is added to PATH's other set of costs, the O&M, to come up with the total Revenue Requirement every year. The yearly Revenue Requirement is the amount the PJM ratepayers pay in any particular year.
In an ideal world, once construction is complete, the amount in the ratebase would begin to decrease because of depreciation. It would eventually disappear -- but, we have those land and land rights in there that will NEVER depreciate. This means that we're going to pay PATH a return on them forever.
So, that 14.3% is the profit PATH earns every year on 50% of the amount in the ratebase. Every year from here to eternity.
Any math geniuses who want to work that problem out and come up with the amount of profit PATH (really their parent companies, AEP & Allegheny Energy) stands to earn if they can ram this project through approvals?
This why they continue to hang onto this loser project in the face of all sane reality that it's NOT GOING TO HAPPEN. It's a gravy train they plan on riding well into the future to provide a steady stream of income.
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