NARUC Energy Regulatory Partnership Program

1
Tariff Development II Rate Design

• NARUC Energy Regulatory Partnership Program
• The Georgian National Energy Regulatory
  Commission
• and
• The Vermont Public Service Board

by Ann Bishop Vermont Public Service Board June
28, 2008
2
Overview

• What is rate design?
• Rate design objectives
• Steps in developing a rate design
• Determine customer groups
• Allocate costs among customer groups
• Assign costs to individual rate components
• Issues with tariff design

3
What Is Rate Design?

• Rate design is the structure of a utilitys
  rates rate design determines the prices
  customers pay for utility services
• Rate designs vary from utility to utility
• All rate designs address
• Customer classes
• Types of charges (customer, energy, demand)
• Some rate designs also address
• Time (real-time, time-of-day, season of year,
  etc.)
• Rate design is highly technical and detailed, but
  it is more art than science

4
Rate Design Objectives

• Rate design has a variety of objectives, some of
  which conflict with each other
• Revenue-related objectives
• Rates should yield the total revenue requirement
• Rates should provide stable and predictable
  revenues

5
Objectives of Rate Design

• Cost-related objectives
• Rates should be set to promote economically
  efficient consumption
• Rates should apportion costs fairly among
  customers and customer classes
• Rates should avoid undue discrimination
• Rates should promote innovation in supply and
  demand

6
Objectives of Rate Design

• Practical considerations
• A rate design should be, to the extent possible,
  simple, understandable, acceptable to the public,
  and easily administered
• A rate design should provide for rate stability

7
Revenue-Related Issues

• Rates should give a utility a reasonable
  opportunity to
• Recover prudently incurred expenses, including
  investment
• Earn a fair rate of return on the remaining costs
  (the undepreciated portion) of its prudent
  investment
• Such rates enable a utility to cover its
  debt-service obligation, pay dividends to
  shareholders, and attract new capital investment

8
Cost-Related Issues

• Will rates set at average cost per unit be
  economically efficient?
• Average cost vs. marginal cost
• Long run vs. short run
• Private financial vs. total social cost
• Cost of environmental damage from electricity
  production and delivery
• Who pays what costs?
• Principle of cost causation

9
Developing a Rate Design

• Basic principle assign costs to customers who
  cause a utility to incur them
• Steps
• Determine customer groups
• Allocate utility costs among the customer groups
• For each customer group, assign allocated costs
  to individual rate components (customer, kWh, kW
  charges)

10
Determining Customer Groups

• Generally based on usage characteristics
• Number of customer groups varies among utilities
• Common groups
• Residential
• Commercial
• Industrial
• Street lighting
• Agricultural

11
Determining Customer Groups

• Sometimes groups may be designated for public
  policy reasons
• For example, low income or elderly
• Occasionally one customer with very unique usage
  characteristics is a group

12
Class Cost-of-Service Study

• Utility performs a class cost-of-service study
• Embedded or fully allocated cost study
• Incremental or marginal cost study
• Sometimes a utility performs both studies

13
Embedded Cost Study

• Uses capital and operating costs that have been
  historically embedded (spent or invested)
• Built on accounting cost data generated in the
  day-to-day operations of the utility
• Need fairly detailed accounting records so costs
  can be categorized into generation, transmission,
  distribution, billing, etc.

14
Embedded Cost Study

• Uses a variety of allocation factors to assign
  costs to each customer group
• Sample allocation factors winter kWh, system
  peak month coincident peak, average monthly
  customers
• Some costs cannot be easily allocated (for
  example, administrative)
• Often allocated in proportion to all other costs
• Other options include
• Considering other policy goals
• Allocating them in some reasonable manner

15
Embedded Cost Study

• Most simple embedded cost allocation
• Revenue requirement number of customers rate,
  billed annually, semi-annually or quarterly
• Complexities arise due to desire to distinguish
  between
• Types and amount of service
• Types of customers

16
Embedded Cost Study

• Advantages
• Based on actual costs
• Automatically reconciled with the revenue
  requirement
• Perceived to be fair
• Disadvantages
• Hard to allocate joint and common costs
• Does not reflect current market trends
• May produce inefficient prices

17
Marginal Cost Study

• Allocates the cost of providing additional
  service
• Based on marginal cost pricing which equals the
  economic costs of providing the next increment of
  service
• Forward-looking study of resource costs

18
Marginal Cost Study

• Challenges
• What is the appropriate increment of output, or
  margin, to measure?
• Generating capacity costs /kW-yr
• Energy costs /kWh
• Transmission and distribution costs /kW-yr
• How can marginal-cost prices be reconciled with
  the revenue requirement
• What kinds of pricing distortions are acceptable?
• Should the incremental costs of environmental
  damage be reflected in rates?

19
Marginal Cost Study

• Advantages
• Forward looking, economic costs
• Promotes economic efficiency
• Exception The problem of second best
• Those who cause the costs pay the costs
• Disadvantages
• Definitions more contentious
• Hard to reconcile with revenue requirement
• Requires forecasted demand and costs
• Potential for rate volatility

20
Cost Allocation Issues

• Are all classes equally risky to serve?
• If cross-subsidies between classes exist, how
  quickly should they be eliminated?
• Potential for rate shock and irate ratepayers
• Impact on vulnerable customers (for example, low
  income)

21
Cost Allocation Issues

• How should public policy considerations be
  factored in to cost allocation?
• Rates can provide assistance to specific customer
  classes
• Economic-development or business-retention rates
• Residential lifeline rate
• Rates can promote social objectives
• Conservation/environmental considerations
• Universal service

22
Designing Tariffs

• Primary tariff price components
• Customer charge
• Energy charge
• Demand charge
• Interaction of these components sends price
  signals

23
Tariff Components

• Customer charge
• Recover costs that do not vary with consumption
  (for example, metering and billing)
• Can be fixed amount per day, month, or other
  billing period
• Energy charge (kWh)
• Recover costs that vary with consumption (for
  example, energy)
• Can vary depending on usage patterns

24
Demand Charge

• Demand charge (kW)
• Recover cost of building capacity to provide
  energy
• Reflects fact that utility must have power
  available to serve customer
• Encourages reduced usage at peak periods
  (especially load shifting)
• Typically only larger customers pay a demand
  charge
• Often includes a ratchet

25
Demand Charge

• Ratchet customers are billed the higher of
  either their highest demand from the current
  month, or some percentage of their highest demand
  from some previous period
• Advantages encourages customers to reduce their
  peak usage, helping to reduce the need for new
  utility infrastructure
• Disadvantages if the ratchet does not change
  after the customer reduces demand, the ratchet
  could be a disincentive to the installation of
  on-site generation or energy efficiency measures

26
Usage Patterns
Declining Block Rates
Flat Rates
Price/ Unit
Quantity Consumed
Inclining Block Rates
Time-Based Rates
Price/ Unit
Offpeak Peak Offpeak
27
Usage Patterns

• Flat
• Declining block
• Based on assumptions that it is cheaper to serve
  large customers and that marginal cost is less
  than average cost
• Encourages consumption, discourages conservation,
  so is particularly important to ensure prices are
  right

28
Usage Patterns

• Inclining block
• Marginal cost is greater than average cost
• Discourages consumption and encourages
  conservation
• Peak and off-peak rates
• Encourage customers to use less power during peak
  periods

29
Usage Patterns

• Time-based rates
• Can be based on season, time of day, or real-time
• Provide more accurate price signals
• Rates that change based on time of day or
  real-time require special metering capabilities
• Many large customers already have meters with
  these capabilities
• Most smaller customers do not
• Board is currently investigating whether
  utilities should provide meters with these
  capabilities to more customers

30
Usage Patterns

• Customers with their own generation options may
  want utilities to provide stand-by service
• If generator is down for any reason, utility
  would supply power to customer
• Considerable debate over what are appropriate
  stand-by tariffs
• Utility must build capacity to serve customer
• Least-cost for society might not be least-cost
  for the customer
• Sometimes customer-owned generation is the
  least-cost option for the utility but, if
  stand-by rates are too high, the customer may opt
  not to install the generation

31
Issues with Tariff Design

• Uniform tariffs are easier to administer but can
  result in subsidies within rate classes
• Does the rate design appropriately balance all
  the objectives?
• Sometimes adjustments are made to better meet
  certain objectives (for example, make the kWh
  price closer to the utilitys marginal cost of
  power)
• Does the rate design significantly increase rates
  for any customer group?
• Sometimes the rate design is phased-in over
  multiple years to minimize rate shock

32
Customer-Specific Tariffs

• Individual customer cost-based tariffs
• More precise (assuming can identify separate
  costs)
• Generally not used in VT and most of U.S., except
  where customer has very clear distinguishing
  characteristics
• Difficult to calculate
• What are the cost differences in an integrated
  electrical system?
• For most customers, costs outweigh benefits

33
Other Items in Tariffs

• Tariffs also include terms and conditions of
  service
• Some examples
• Late fees
• Disconnection policies and fees
• Line extension policies