Utility Distribution Company Ratemaking

For years, many have been lamenting the ever-increasing number of rate mechanisms which fall outside of the base rate review process for utility distribution companies. There are roughly a dozen reconciliation charges, trackers and automatic adjustment charges on the bill for each gas and electric utility. Call them what you will, they all do the same thing: allow utilities to recover 100 percent of certain costs of providing service separate from their total cost of service.

This is a problem because as individual costs are pulled out of the total cost of service, regulators don’t see the total picture for determining the appropriate level of rate of return for the company. Rate of return looks at the total enterprise, not just certain cost components, and the process involves looking at comparable utilities to see what level of return they need to attract capital. These comparisons can be distorted if those utilities do not have guaranteed cost recovery mechanisms like Massachusetts utilities do. Yet these companies get the same level of return (making the reward higher than the risks). The basic regulatory construct is that utilities should be given the opportunity to make their allowed rate of return, not a guarantee.

The slippery slope of this approach to ratemaking actually started in the early 1970s with the first oil embargo. Believe it or not, utilities bore all of the risk of the cost of fuel then, and it was simply part of their cost of service. Imagine a business enterprise having to take responsibility for all of its cost of doing business and always trying to reduce those costs or mitigate risks.

The move to fuel adjustment clauses made sense, though, as the volatility in the markets made it impossible to predict costs in the rate-setting process and benefited customers as much as it benefited the utilities. But today these charges recover pensions and medical benefits, storms, energy efficiency program costs and various true-ups to ensure the utility brings in the revenue that they are supposed to make.

The absurdity of how far the use of this mechanism has gone is most evident in the current Eversource rate case. It involves the Storm Fund. After years of trying to deal with the costs of hurricanes and big snow storms, the Storm Fund was created to fund these expenses outside of the cost of service—again, makes sense because the costs are not recurring and they’re hard to predict. But costs should be directly related to big storms, not just every little weather disturbance. In its rate case, Eversource grouses about the threshold of spending to allow recovery from the Fund ($1.2 million). They want to recover the costs of simply getting ready for a storm that doesn’t come to fruition if the costs fall below the threshold. They complain that they incur additional costs which are not recoverable from the Storm Fund and, therefore, have to absorb them.

The proposal is indicative of a mentality of dependency on these automatic recovery mechanisms to the point where management cannot think about the total enterprise. This is a company with revenues of $7.64 billion. It’s hard to believe that management can’t figure out a way to cover these costs by just managing the rest of their costs. For every cost that’s higher than they anticipated in their rate case, there undoubtedly are costs that are lower or could be reduced. It’s called running a business.

It’s time to get back to basics. Get rid of the clauses that allow automatic recovery for the basic running of the business and make the managers of the utilities earn their salaries. That means running the business with some skin in the game, and occasionally losing a little sleep at night—especially during storms.

1 thought on “Utility Distribution Company Ratemaking”

  1. Dennis Villanueva

    Well said Cindy, the formulation for cost recovery and rate calculation has become so nebulous that there is a disconnection between the actual costs paid, and the actual assets represent. little by little they have made changes that increase their revenue (and customer’s cost) at every turn those changes might seem imperceptible, for example, in the past, it was common practice that a facility with multiple feeds, and meters would be aggregated into one account, a few years back that practice was changed resulting to a one meter, one account policy, which has resulted in higher costs due to non-coincidental peak demand charges. I takes a Ph. D, and then some, to try to tie that to the actual size of the wires to satisfy demand. With the proposed changes and the current trend to shift costs from energy to demand, and eliminating the tiered and TOU rates, the utility is going against the direction needed to provide the end-user, more specifically the residential sector, with price signals to influence consumption behavior. The time has come to redesign the system from scratch, easier said than done.

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