Under the proposed modifications to the price regulations, refiners would no longer be allowed to allocate increased costs attributable to No. 2 oils or gasoline to residual fuel oil. However, in grouping residual fuel oil together with aviation fuel and such other products as kerosene, butane, benezene, naptha, and propane in the new category of "general refinery products" and allowing the allocation of increased costs to any product within that category, the FEA is making it likely that residual fuel oil will continue to carry increased costs properly attributable to other products. Take aviation fuel as an example. Over the past 2 years, it has approximately doubled in price-while residual fuel oil has more than tripled. Under the proposed modifications, refiners could continue to load increased costs attributable to aviation fuel on to residual fuel oil. In these times, the fact that there is a relatively inelastic demand for residual fuel oil, because voluntary conservation has already taken place, should not be the basis for unfairly loading increased costs onto this product while allowing other products with more elastic demands to carry less than their fair share of increased costs. About 30 percent of each barrel of oil is used to produce the products in the general refinery products category-and of this 30 percent, about one-quarter is used for residual fuel oil. Thus, there is considerable potential for loading increased costs from such other general refinery products as aviation fuel onto residual fuel oil, causing it a vastly disproportionate share of costs. Accordingly, I urge that the proposed changes in the price regulations be modified so as to assure that residual fuel oil, like the No. 2 oils, will not have to bear increased costs attributable to any other product. In conclusion, I urge that the electric consumers of New England not be asked to bear more than their fair share of the costs of any energy program and that the old oil entitlement program not be eliminated for importers of residual fuel oil. On behalf of the New England Power Pool and New England Electric System, I thank you for the opportunity to comment on your proposed amendments and will be pleased to answer any questions regarding my remarks. Senator STONE. Thank you, Mr. Nichols. Senator JOHNSTON. Yes. Thank you, Mr. Chairman. Why did you stop with nuclear and coal? Why did you not go out to the Continental Shelf? Mr. NICHOLS. I support that drilling on the Outer Continental Shelf. We are participating in oil drilling. Unfortunately, we have not been able to get the rights to drill off the New England coast. We are working hard at it, and I hope you will support it. At the present time, utility companies are actively participating in drilling both within the continental United States and offshore. Senator JOHNSTON. That makes our agreement almost complete. I think both you gentlemen have pointed out what a terrible impact the President's program would have on different segments of our economy, in your case different segments of the electric industry, and this morning we had testimony with respect to the airlines industry, and in the case of a host of other witnesses who have not and will not testify who also dramatically but equally find different segments of the economy being hurt. I don't know of any way of making that huge higher tax program acceptable without putting this economy into a real tailspin. I think both of you have made a very good case. Thank you. Senator STONE. Senator Glenn, do you have any questions? I would like to ask one short question. I have been in these hearings for a number of days, and I have been following the ripple effect going through our whole economy and how it gets passed on and the impact. It is rather frightening. You don't see see the end. It goes on and on and on. Do you have any indications of actual business failures of highusage customers who are particularly dependent on your product, and is there anything along that line with regard to ripple effect? Have you actually seen any businesses put out of business or where employment has been reduced as a result of the increasing prices just over the past year a situation which would be made even worse if we go in the direction contemplated? Mr. FUQUA. I don't know that I could document specifically, Senator, any cases of bankruptcies attributable to the high cost of electric service at this point. Certainly, it would be a factor because of the tremendous increases. You understand, of course, that these fuel costs almost uniformly throughout the country are passed along to the customer through a fuel adjustment clause arrangement. Otherwise, the utility companies themselves would go broke very shortly, because we could not possibly absorb the increased costs of fuel. That is as good as answer as I can give at the moment. Senator GLENN. You say you are studying coal as an alternative source. Cost wise, by the time you get coal to Florida, how does it compare in cost to oil? Mr. FUQUA. We studied coal for a long time-coal from Kentucky fields down to Tidewater and Hampton Roads and Port Evergladesand we found it was never economically sound. We have never found tion costs. However, we have been studying it, and we have gone down to Colombia where there are some reserves, and that might someday work out. We feel that the nuclear powerplants are the salvation of the industry, and we have moved ahead as fast as we could on that. We have two in operation. Of course, you realize that if we did not depend on those nuclears for part of our energy generation, we would have to burn more oil, and the price would be even higher. I think it is rather dramatic and, as a rule of thumb, we are talking in terms of $13, $14, or maybe $15 a barrel. An equivalent barrel of natural gas is $3. An equivalent barrel of uranium is $1. So, it depends on the mix that you are able to use. That is an important thing. We have some who depend 100 percent on it. Mr. NICHOLS. We have converted some of our facilities in the past year, and we have burned some coal. We have had to do it with environmental variances that were at most 7 months long. Buying coal with that kind of a restriction is a very difficult proposition. But, even so, by scouring the world markets as well as the U.S. markets, we have burned a considerable amount of coal that is the equivalent of about $8 to $9 for oil. Some of it was as cheap as the equivalent of $6 oil. This coal was partly domestic and partly foreign. Senator GLENN. May I ask one more question, Mr. Chairman? I know this gets into a very touchy and sensitive political area, but both of you come from areas which border offshore areas where oil is supposed to be available if we could just get out there and drill it, but there is a lot of citizen interest in not doing that. Do you think people are coming around more to letting that be done? Do you think as a general comment that people are coming around to realizing the enormity of the situation we are in and being willing to accept the drilling? Mr. NICHOLS. Definitely, yes. This does not mean there are not still some spokesmen who are in strong opposition, but the overall answer is definitely, yes. Mr. FUQUA. I would echo Mr. Nichols on that point also. Senator GLENN. I don't like eastern Ohio looking like a combat zone from strip mining either. I think what scenic detriment we do to the ocean by putting a couple of drilling rigs out there does not compare to the alternative of not having jobs available. Thank you, Mr. Chairman. I have no further questions. Senator STONE. Which of the groups served by your customers would be hardest hit with the passthrough of fuel adjustment if the Ford proposal of extra taxation on the use of imported oil went into effect, Mr. Fuqua? Mr. FUQUA. I suppose I would have to answer that the fixed-income retiree would be the hardest hit and the most disadvantaged. Senator STONE. They would be burdened the most? Mr. FUQUA. Yes, sir. Senator STONE. Are there further comments? If not, thank you very much for testifying. It is not our purpose to make things harder but to make things easier and better. Again, Before I turn the Chair back to the Senator from Louisiana, I would like to state in preparing for this hearing, we extended an invitation to Dr. Irwin Steltzer and Dr. Herman Roseman, president and vice president of National Economic Research Associates, to appear regarding the effect of the various components of the President's proposals on the electric utility industry. They are, in my opinion, among the most sophisticated and reliable authorities in the Nation regarding the economics of the utilities. Unfortunately, both of them had previous commitments, but National Economic Research Associates did send us a statement by Dr. Roseman analyzing in great detail the proposal to include construction work in progress in utilities' rate bases, and the increase of the investment tax credit for utilities. With unanimous consent from the committee, I would like to place Dr. Roseman's statement in the record of this hearing. [The prepared statement of Mr. Roseman follows:] NATIONAL ECONOMIC RESEARCH ASSOCIATES, INC., January 31, 1975. To: Energy Research Group 1 Re: President Ford's Proposal on CWIP This memorandum comments on the proposals in the President's State of the Union address of January 15, with respect to construction work in progress and investment tax credit. 1. The fact sheet which accompanied the address states that the inclusion of CWIP in rate base would add 11 percent to electric utility rates. My inquiries at FEA indicated that the source of this figure was a recent speech by John Nassikas. In what follows I will describe my independent estimate. The Office of Accounting and Finance of the FPC, in "A Study of the Electric Utility Industry" in September 1974, indicated that electric utilities had about $19.6 billion in construction work in progress at the end of 1973. Their figures also indicated that the amount of CWIP had been increasing by about $3 billion per year. Suppose it were $22 billion at the end of 1974. Suppose that the average utility is allowed a 9 percent after-tax rate of return on rate base. Putting this amount in rate base would then mean additional after-tax revenues of $1.98 billion. Assuming a 48 percent marginal income tax rate, this would imply a $3.8 billion increase in before-tax revenues. According to a chart in the same publication, electric utility revenues in 1973 were about $32.6 billion. Total electric revenues in 1974 were up about 20 percent, which indicates that revenues in 1974 were about $39 billion. Combining these two computations indicates that allowing construction work in progress in the rate base would increase revenues by something like 9.7 percent. This is close enough to the 11 percent used in the fact sheet to President Ford's address to indicate that his figures are not far off the mark. 2. There are a number of ways in which including CWIP in rate base will impact on the finances of utilities. One way is by directly increasing cash flow. As I have already indicated, including CWIP in rate base would imply an increase in after-tax earnings from operations of approximately $2 billion. This is a large amount relative to the financing requirements of the electric utility industry. 1 Fred Searls read an early draft of this memorandum, corrected some of the conceptual errors in it, and added some important refinements. Any errors which remain are, of course, my responsibility. 2 Curiously, the Office of Economics of the FPC, in "An Analysis of the Electric Utility Industry's Financial Requirements" (p. 24), published in September 1974, estimated that including CWIP in rate base would increase revenues by about 7 percent. 3 In most utilities the interest on the debt portion of funds used during construction is already taken as a current deduction in computing income taxes charged to operations. A few companies, however, get this tax effect out in computing the allowance for funds used during construction and hence do not use it as to reduce taxes charged to operations. For the latter companies, inclusion of CWIP in rate base would also mean deducting the interest portion of AFDC in computing income taxes charged to operations. Although this effect may be substantial for individual companies it probably would not have a material effect on For example, a recent compilation by EBASCO indicates that total external financing of electric utilities in 1974 was $12.2 billion, of which $1.95 billion was raised by the sale of common stock. Although the volume of common stock sales was considerably depressed by harsh market conditions, it is nevertheless clear that including CWIP in rate base can have a very substantial effect on the amount of equity securities which the utilities have to sell. This, in turn, can make it all the easier to sell the other securities which the utilities have to sell. This, in turn, can make it all the easier to sell the other securities. 3. Inclusion of CWIP in rate base will improve coverage ratios substantially. It will have different effects on coverage, however, depending on how the coverage is calculated. Let me here consider the two main methods. One method of calculating coverage, which I will call the SEC method, does permit the inclusion of AFDC in income. The other method, which is usually prescribed in bond indentures, eliminates most of the AFDC from income. Since including CWIP in rate base will mean the substitution of cash earnings for AFDC, the effect on coverage will differ depending on which type of calculation is being done. As I have indicated, in calculating coverage by the SEC method, AFDC is already included in income, so that substituting cash earnings for AFDC does not improve coverage. However, coverage is on a pretax basis. This means that when CWIP is included in rate base and results in additional cash earnings, it also results in additional income taxes, so that the pretax coverage will increase even according to the SEC method. Assume that my earlier estimate of $3.8 billion in additional revenues is correct. Of this about $1.8 billion would be an increase in income taxes. We can assess the significance of such an increase in income taxes and in pretax earnings by asking how much additional debt can be sold if pretax earnings are increased by $1.8 billion? Assuming that we start with and strive to maintain a coverage ratio of 2.0 times, an increase of $1.8 billion in pretax income will support an increase of $0.9 billion in interest payments. Even with an average cost of debt of as much as 10 percent, this would imply that under the SEC method the industry could sell an additional $9.0 billion worth of bonds in the next year. If we look at the impact on coverage according to the indentures, it would be about twice as great. That is, pretax income as defined in the indenture would be up about $3.8 billion. This would enable the industry to sell bonds with interest of $1.9 billion per year. That would amount to another $19 billion in bonds, or more than twice the total amount of bonds sold in 1974. Some of the increase in pretax income may be needed, however, to offset erosion of coverage for existing bonds from other factors. Another way of looking at the matter is by attempting to calculate the industry's coverage more directly. In 1972, total interest payments of utilities were about $3 billion. This may have risen to as much as about $5 billion in 1974. An increase of $1.8 billion in pretax income (defined by the SEC method) would raise the coverage ratio by about 0.35; that is, the coverage might rise from (say) 2.0 to 2.35. An increase of $3.8 billion in pretax income (defined according to the indenture) would raise the coverage ratio by about 0.75 or (say) from 2.0 to 2.75. It is clear that by any of these measures, the inclusion of construction work in progress in the rate base will have a very major impact on the electric utility industry's coverage ratios and its ability to sell additional bonds. 4. By the same token, the coverage ratios on preferred stocks will also increase accordingly, as will the industry's ability to sell new preferred stock. 5. It should be noted that coverage ratios are calculated on the basis of actual earnings, rather than on the basis of prospective earnings. If we were to assume that the industry's pretax earnings were to rise by $3.8 billion per year, the full impact on coverage would not occur until a full year had elapsed. But even after the first month, the impact would be to increase pretax earnings by $0.3 billion, which by our previous arithmetic would immediately permit utilities to sell an additional $1.5 billion in bonds. But this is as much bonds as the industry has been selling in two months. Thus, it would appear that even within a month the impact of such an increase in pretax earnings could enable the industry to sell an additional two month's worth of bonds. The substitution is, of course, only approximate. AFDC rates have been traditionally lower than allowed rates of return (despite a long period when current costs of new capital have been higher) but allowed rates of return have not often been realized in recent years |