Adjusted forecast acquisition cost

What Is Adjusted Forecast Acquisition Cost?

Adjusted Forecast Acquisition Cost refers to a mechanism primarily used within the utility regulation and finance sector, specifically by regulated public utilities, to account for and recover fluctuating expenses related to acquiring essential resources. It represents an estimated cost for future resource acquisition, such as fuel or purchased power, which is then periodically "adjusted" to reflect the actual costs incurred. This mechanism falls under broader categories like automatic adjustment clauses or cost recovery mechanisms, designed to allow utilities to track and recoup significant, volatile costs outside of a general rate case. The aim of the Adjusted Forecast Acquisition Cost is to ensure that utilities can maintain financial stability while providing reliable service, by balancing the need to recover legitimate costs with the objective of providing stable and predictable rates for consumers.

History and Origin

The concept behind the Adjusted Forecast Acquisition Cost, and similar cost recovery mechanisms, emerged largely in response to the significant volatility of certain utility expenses, particularly fuel costs, starting in the 1970s. Prior to these mechanisms, utilities would establish their rates based on historical costs in a traditional rate case. However, sudden and substantial increases in the price of fuels like oil and natural gas could quickly render those rates insufficient to cover operating expenses, leading to financial strain for the utility. To address this, regulatory bodies began implementing "automatic adjustment clauses" (AACs) or "trackers." These clauses allowed utilities to periodically adjust their rates to reflect changes in specific, volatile costs without undergoing a full rate case, which is a lengthy and expensive process. The "Fuel Cost Recovery Mechanism," for instance, has been in effect in Georgia since 1979, following state legislation, enabling electric utilities to recover monies spent for fuel purchases.⁵ This evolution aimed to ensure timely recovery of costs largely beyond the utility's control, such as market fluctuations in wholesale fuel and power.⁴

Key Takeaways

• Adjusted Forecast Acquisition Cost is a regulatory tool for utilities to manage volatile expenses.
• It allows utilities to estimate future resource costs and then true up those estimates with actual expenditures.
• This mechanism helps utilities recover significant and unpredictable costs, such as for fuel and purchased power, more promptly than through traditional rate cases.
• It contributes to the financial health of regulated utilities by reducing exposure to cash flow volatility.
• The system includes provisions for reconciliation, ensuring that over- or under-recoveries are accounted for in future rates.

Formula and Calculation

The Adjusted Forecast Acquisition Cost itself isn't a single, universal formula, but rather a component within a broader regulatory adjustment clause. It typically involves forecasting the acquisition cost for a future period and then, after the period concludes, reconciling that forecast against the actual incurred costs. The difference, whether an over-recovery or under-recovery, is then either refunded to or collected from customers in subsequent billing cycles.

A simplified representation of how an adjustment might be applied is:

Where:

• (\text{Actual Acquisition Cost}) refers to the real expenses incurred by the utility for resources like fuel costs and purchased power over a specific period.
• (\text{Forecast Acquisition Cost}) is the estimated expense for these resources that was included in the utility's rates for the same period.
• (\text{Prior Period Adjustment Balance}) accounts for any cumulative over- or under-recovery from previous adjustment periods, ensuring a full true-up.
• (\text{Forecasted Sales Units}) is the projected volume of electricity or gas sales over which the adjustment will be spread.

This adjustment per unit is then applied to customer bills, ensuring that the utility ultimately recovers its prudently incurred costs, or returns any over-collected amounts.³

Interpreting the Adjusted Forecast Acquisition Cost

Interpreting the Adjusted Forecast Acquisition Cost involves understanding its role in balancing utility financial stability with consumer rate predictability. When this cost mechanism results in a surcharge on customer bills, it indicates that the actual expenses for fuel and purchased power exceeded what was initially forecasted and incorporated into base rates. Conversely, a credit on customer bills suggests that actual costs were lower than anticipated, leading to a refund to ratepayers.

Regulators, such as public utility commissions, closely scrutinize the components of the Adjusted Forecast Acquisition Cost to ensure that only prudently incurred costs are passed through to consumers. This oversight helps maintain the integrity of the cost of service regulation framework, where utilities are allowed to recover their costs of providing service plus a reasonable return. The presence and magnitude of the adjustments offer insights into market volatility for energy resources and the effectiveness of the utility's forecasting abilities.

Hypothetical Example

Consider "Horizon Power," a regulated electric utility. For the upcoming quarter, Horizon Power forecasts its total purchased power costs to be $50 million, based on expected demand and market prices. This $50 million is included in its Adjusted Forecast Acquisition Cost calculation for the quarter, and rates are set accordingly, assuming sales of 100 million kilowatt-hours (kWh).

At the end of the quarter, due to an unexpected spike in natural gas prices, Horizon Power's actual purchased power costs totaled $55 million. The utility also determined it had a prior period under-recovery balance of $1 million from the last quarter.

Using the simplified adjustment formula:

In the following quarter, Horizon Power would apply a surcharge of $0.06 per kWh to customer bills to recover the $6 million difference (the $5 million current period under-recovery plus the $1 million prior period balance). If a customer used 500 kWh, their bill would include an additional $3.00 ($0.06 x 500 kWh) for the Adjusted Forecast Acquisition Cost.

Practical Applications

The Adjusted Forecast Acquisition Cost is fundamentally applied in the utility regulation and finance sector to manage the financial risks associated with volatile operating expenses. Its primary applications include:

• Rate Setting and Adjustment: This mechanism allows utilities to reflect changes in fuel and purchased power costs in customer rates more frequently than a full rate case would permit. This ensures that the utility's revenue requirements are met, covering the actual costs of providing service.
• Regulatory Accounting: From an accounting perspective, the differences between forecasted and actual acquisition costs are often recorded as regulatory assets or liabilities on the utility's balance sheet. These are amounts that are expected to be recovered from or refunded to customers in future rates.² The Securities and Exchange Commission (SEC) provides guidance on how regulated utilities should account for these items, allowing them to defer certain costs that would otherwise be expensed in the current period, thus smoothing out financial impacts.
• Risk Management for Utilities: By creating a path for timely cost recovery, the Adjusted Forecast Acquisition Cost significantly mitigates the financial exposure of utilities to unpredictable market fluctuations in energy prices. This reduces the risk of earnings volatility and helps maintain the utility's creditworthiness, which can influence its ability to secure financing for infrastructure investments.
• Consumer Protection: While allowing cost recovery, regulatory oversight ensures that utilities do not profit from these adjustments. Regulators typically require detailed filings and often conduct hearings to review the prudence of costs included in the adjustment, protecting consumers from unwarranted charges.¹

Limitations and Criticisms

While essential for utility financial stability, the Adjusted Forecast Acquisition Cost and similar adjustment clauses face certain limitations and criticisms:

• Reduced Incentive for Cost Control: A primary critique is that these mechanisms might reduce a utility's incentive to manage or hedge against volatile costs. If a utility knows that all prudently incurred fuel costs and purchased power expenses will eventually be recovered through customer rates, it might exert less effort in securing the lowest possible prices or investing in more stable, alternative energy sources.
• Lack of Transparency: For the average consumer, the mechanics of these adjustments can be complex and difficult to understand, leading to a perception of opaque billing practices. The separate line items on utility bills for these adjustments can cause confusion and frustration, particularly when they lead to increases outside of a general rate review.
• Regulatory Lag and Timing: Although designed to reduce regulatory lag, there can still be a delay between when costs are incurred and when they are fully recovered or refunded. This lag can sometimes create temporary financial burdens for utilities or slow the return of over-collected funds to customers, particularly during periods of rapid and sustained price changes.
• Prudence Reviews: While regulators conduct prudence reviews, determining what constitutes a "prudently incurred" cost can be subjective and contentious. Disallowances of costs by regulators, though intended to protect consumers, can negatively impact utility financials.

Despite these criticisms, regulatory bodies often implement measures such as regular audits and strict reporting requirements to ensure accountability and balance the utility's need for cost recovery with consumer interests.

Adjusted Forecast Acquisition Cost vs. Fuel Adjustment Clause

The Adjusted Forecast Acquisition Cost (AFAC) is often a component or specific methodology utilized within a broader Fuel Adjustment Clause (FAC). The FAC is a common regulatory mechanism that allows electric or gas utilities to adjust customer rates to reflect fluctuations in the cost of fuel used for generation or the cost of purchased power. It's a general term for a rate rider designed to pass through these variable costs.

The AFAC, on the other hand, describes a particular approach within such a clause where a utility initially forecasts its acquisition costs for a period. This forecasted amount is then compared against the actual costs at the end of the period, and the difference is reconciled through an adjustment to customer bills. Therefore, while a FAC is the overall mechanism for recovering volatile fuel and purchased power costs, the Adjusted Forecast Acquisition Cost refers to the specific process of forecasting, incurring, and then reconciling those costs against actuals, often with past under- or over-recoveries incorporated into the current adjustment. Both terms operate within the realm of utility regulation to manage cost volatility and ensure appropriate financial outcomes for regulated entities and their customers.

FAQs

What types of utilities use Adjusted Forecast Acquisition Cost?

This mechanism is primarily used by regulated electric, gas, and sometimes water utilities that face volatile and significant costs for acquiring their primary resources, such as natural gas for power generation or wholesale electricity.

Is the Adjusted Forecast Acquisition Cost a profit center for utilities?

No. Regulatory bodies generally design these mechanisms to be revenue-neutral, meaning utilities are only allowed to recover the actual, prudently incurred costs, not to earn a profit on them. Any over-collections must be returned to customers, and under-collections are recovered. This is typically verified through regular audits and filings.

How does this affect my utility bill?

The Adjusted Forecast Acquisition Cost can appear as a separate line item on your utility bill, often as part of a larger "fuel adjustment" or "purchased power adjustment" charge. It will either be a surcharge (if actual costs were higher than forecasted) or a credit (if actual costs were lower). The amount will vary based on your usage and the per-unit adjustment rate.

What is a "regulatory asset" in this context?

A regulatory asset is an accounting entry that allows a utility to defer certain costs on its balance sheet that would normally be expensed immediately on the income statement. In the context of Adjusted Forecast Acquisition Cost, if a utility under-recovers its actual fuel or purchased power costs in a given period, that under-recovery can be recorded as a regulatory asset, indicating that the utility expects to recover those costs from customers in future billing cycles through the adjustment mechanism. These assets are then typically subject to amortization as they are recovered.