Introduction to Rate Cases and Rate Design

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Introduction to Rate Cases and Rate Design

• David G. Loomis, Ph.D.
• Executive Director, Institute for Regulatory
  Policy Studies

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Review of Process and Q A
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Company and Customers

• The regulated utility is entitled to an
  opportunity to recover all costs prudently
  incurred in providing services
• The customer has an obligation to reimburse the
  utility at rates that will provide such an
  opportunity

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Revenue Requirement

• The amount of money a utility must collect from
  its customers to pay expenses and provide a fair
  return to investors
• Incremental revenue requirement is positive if
  current revenues are insufficient negative if
  current revenues are excessive

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Fundamental Rate-of-Return Equation

• Revenue Requirement OC T d r(V-D)
• OC Operating Costs
• T Taxes
• d Annual depreciation expense
• r Rate of return
• V Value of physical and financial capital
• D Accumulated depreciation
• r(V-D) is called the return portion and V-D is
  called rate base

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Regulatory authority must

• Determine the allowed expenses, allowed rate base
  and allowed rate of return (revenue requirements)
• Determine mix of prices that will achieve that
  revenue requirement (rate design)

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Process

• Select a test year
• Determine the revenue requirement
• Determine whether existing prices would yield
  more or less that the revenue requirement
• Adjust prices accordingly
• Rates set for the future - no retroactive rate
  making

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Traditional RegulationRecap

• Commission sets the just and reasonable price
  level
• Once determined, price level remains fixed until
  commission sets a new price level
• Utility is provided an opportunity to earn a
  reasonable return - but is not guaranteed one
• No retroactive rate making

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Traditional RegulationConcerns

• Rate cases can be long and costly
• adjusting rates to reflect rapidly changing costs
• adjusting rates to meet the competition
• The incentives effect
• inducement to over invest in capital
• perpetuation of a cost mentality
• little financial encouragement to find operation
  efficiencies
• financial disincentive for demand-side energy
  efficiency and conservation programs

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Rate Design

• The bulk of utility costs are fixed costs
• Once fixed costs are incurred, everyone wants to
  walk away from them
• Trick is to shift fixed costs to other customer
  classes and to other customers
• There is no right way to allocate fixed costs

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Questions?