Rethinking Contracts For Purchasing Power: The Economic Advantages Of Dispatchability

The purpose of this article is to evaluate and compare the incremental cost of purchased power from non-utility generators versus utility built generation considering a variety of contracts for energy purchases. Four types of contracts are evaluated: I) Flat Rate Produce and Pay, 2) On-Peak/Off-Peak, 3) Basic Dispatchable, and 4) Actual Cycle Energy Dispatch. The type of contract can affect the competitiveness of electric rates through increased energy production costs as well as increased risks, in terms of financial liability, affecting the cost of debt to the purchasing utility. An analysis conducted for a representative utility calculates the effects of NUG power purchases on a utility's energy production costs and the cost of new debt issuances. Dispatchable energy contracts are shown to provide significant economic and operating advantages over Flat Rate and OnPeak/Off-Peak energy contracts. In addition, an example shows that NUG purchases based on the actual thermal cycle and fuel costs for dispatch cost less than utility-built generation financed at the utility's weighted average cost of capital. NUG's are also shown to act as external instruments that increase a utility's leverage and result in a higher cost of debt for the utility. However, this increase is less than the finance costs for an identical facility built by the utility. NUG contracts for a utility which already has significant risk exposure are shown to parallel a capital lease. Under these conditions, additional payment obligations to NUGs increase the cost of new debt issuances making an equity issuance for utility built capacity a more attractive option.