With the annual property appraisal process underway, we certainly understand the concern we’re hearing in the counties and school districts where we have plants and mines about what we view as the value of those sites.
As a longtime corporate citizen in these communities, we want them to be great places to live, work and grow. And as the largest taxpayer in these communities, we recognize the sizable portion of total property taxes our payments cover and the potential impact when those payments change. We are committed to pay our fair share as prescribed by Texas law.
So what are the factors that determine the fair taxable value of a power plant?
To begin with, knowing how our business works is very important. Luminant’s power plants operate in what’s known as the Electric Reliability Council of Texas (ERCOT) competitive market. There’s often confusion about what this means since the competitive power market in Texas is such a change from years ago when all generators were regulated. Even now, utilities owned by cities and co-ops remain regulated. So are the poles and wires companies, such as Oncor.
At Luminant, we’re no longer a tightly regulated utility with the government setting rates for customers, deciding when and where plants can be built and then shouldering ratepayers with the capital cost. We no longer have a guaranteed rate of return.
Instead, we must now contend with fluctuating market forces and the price of natural gas. Since the marginal demand for power is generally met by natural gas plants, the wholesale electricity prices in the ERCOT market have historically moved with the price of natural gas.
And as we see in the news almost daily there is a LOT of natural gas out there. Horizontal drilling and hydraulic fracturing technology opened oceans of natural gas in Texas and other states. The increased production of natural gas has created jobs and boosted the state economy, and dramatically lowered wholesale power prices.
For example, in 2008, average annual wholesale power prices were more than $63 per megawatt in the ERCOT market where we compete. Since then, the trend line for prices descended in tandem with gas until 2014, when they took a sharp drop. In January 2015, wholesale power prices averaged $23 per megawatt. Power prices tumbled because natural gas fell in price. And natural gas prices are forecast to remain low for years to come.
The benefit for consumers in the competitive market is pretty obvious. They enjoy lower power prices driven by cheaper natural gas. Our plants are impacted also, but in a different way. Lower power prices mean less revenue at those plants. Less revenue means a plant holds a lower property value in the year ahead.
Let’s keep this in historical context, too. From 2003 to 2008, property taxes rose significantly, reflecting rising wholesale electric power prices that were largely driven by high natural gas prices. Just as property taxes rose with power prices before 2008, we believe property taxes should decrease as power prices have, and we don’t believe certain counties’ assessments take this fact into account in their appraisals.
Of course, there are other factors that impact plant revenue, too. We must also consider higher fuel and operating costs and increased regulatory burdens. For example, from 2010 through 2014, our environmental capital expenditures totaled approximately $700 million. Additional capital costs are expected to total about $500 million from 2015 through 2020 to comply with final and pending EPA regulations.
Given these facts, how is the taxable value of a plant set? The best, most accurate and most sensible way to determine the fair taxable value of a power plant each Jan. 1, the date prescribed by state law, is by using what’s called a market-based income model. Market-based income models are widely relied on in Texas by owners and potential buyers of large industrial properties that are income-producing assets. They’re also used by investors who buy the publicly traded stock or debt of power plant owners.
To find fair value, market-based income models look at the actual economics from operating plants in the price and cost environment on that day:
- How much revenue comes in from wholesale power sales at market prices?
- What are the costs to run the plants?
- What does it cost to procure or produce fuel at the plants, and what capital investments must be made to meet continuing environmental and economic improvements?
So, the fair value of a power plant is dynamic with market forces and, importantly, fluid year to year.
When a county appraisal district disagrees with our rendering of plant value, Luminant files a protest as set out by Texas law. We follow the same administrative process as any homeowner or business would by appealing to the Appraisal Review Board. Even as the protest moves forward, our goal remains to work with a county appraisal district to determine the fair taxable valuation for our power plants and mines through negotiated agreements if possible and pay our taxes in January, as usual.
If an agreement isn’t possible and a court must decide the value, Luminant will still pay taxes in January 2016 on the non-contested value of its plants.
Luminant fully supports the wholesale power market in Texas. It provides our growing state with competitive prices and dependable electricity through a diverse mix of fuels. Markets are about finding balance and equilibrium. For the wholesale power market, it’s the right price. For the property market, it’s the fair value. This year, the balancing forces of the market are guiding plant taxable values to much lower levels.
Regardless of these circumstances, we are a longtime member and top taxpayer of the communities where our plants and mines call home, and we remain concerned about their overall success. We are still the top property taxpayer in our communities, and we are always committed to paying our fair share.