Recovery of Financing Costs During Construction
What are the differences between traditional cost recovery and recovery of financing costs during construction?
Traditionally, utilities are allowed to recover the cost of investments, such as power plants, after the plants begin to operate and serve customers. During the construction period, utilities incur construction ("brick and mortar" and labor) costs—and related financing costs. Because of the tremendous cost of investments like power plants, utilities also incur additional costs to cover the financing costs incurred during the construction period. Traditionally, recovery of these financing costs is deferred during the construction period, added to the ultimate cost of the plant and recovered from customers over the useful life of the plant (40-60 years in the case of a nuclear generating plant). As an alternative, rates can be set to allow for recovery of financing costs during the construction period and therefore avoid "interest on interest" expenses.
Recovery of financing costs during the construction period is possible by including the ongoing financing costs related to the new units in the rate base charged to customers. When financing costs are included in the rate base, the company avoids paying "interest on interest" and reduces the total return required over the life of the asset. The construction costs made up during the recovery period can result in lower financing costs for all utility projects. Better credit ratings can lower the interest costs that the company (and, ultimately, the customer) pays to finance the cost of new power plants and all other utility investments.
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