“Design Considerations for Multiyear Public Utility Rate Plans,” Utilities Policy: Strategy, Performance, Regulation, August 2019.
Original Posting
Kenneth W. Costello,
Design considerations for multiyear Public Utility rate plans,
Utilities Policy,
Volume 59,
2019,
100923,
ISSN 0957-1787,
https://doi.org/10.1016/j.jup.2019.05.009.
(https://www.sciencedirect.com/science/article/pii/S0957178719300360)
Abstract: Regulatory experts generally agree that good regulation leads to high economic efficiency, fairness, and moderate regulatory costs. These three features have characterized good regulation going back to the beginning of the previous century. This paper will try to show that wellstructured and executed multiyear rate plans (MRPs) can be more compatible with the public interest, compared with the traditional rate-of return approach to setting utility rates. Substandard MRPs, however, can produce worse outcomes for utility customers.
Abstract
Regulatory experts generally agree that good regulation leads to high economic efficiency, fairness, and moderate regulatory costs. These three features have characterized good regulation going back to the beginning of the previous century. This paper will try to show that wellstructured and executed multiyear rate plans (MRPs) can be more compatible with the public interest, compared with the traditional rate-of return approach to setting utility rates. Substandard MRPs, however, can produce worse outcomes for utility customers.
Section snippets
Criticisms of traditional ratemaking in the United States
Rate-of-return ratemaking (hereinafter “traditional ratemaking”) refers to the application of cost-of-service principles for setting rates that determine the utility’s authorized rate of return. Features include: (1) rates remain fixed until the regulator approves new rates following a general rate case; (2) the utility has a reasonable opportunity to earn its authorized rate of return; (3) the balancing of utility shareholder and ratepayer interests is an overriding goal; (4) the selected test
Primary features
An MRP is a comprehensive regulatory pricing mechanism that allows base rates to change outside of a general rate case and have the following features:
- 1. Predetermination of rate changes either in dollars or according to a formula beyond the test period (for example, three to five years);2. A process for setting a utility’s rates and revenue requirements for longer than a single 12-month period;3. Fixed frequency of general rate cases (i.e., regularized regulatory lag);4. Forward-looking that commits the
Major arguments for multiyear rate plans (MRPs)
Support for MRPs derives from four sources. First, from the perspective of utilities new market and operating conditions, namely, rising average cost and the slowdown of demand growth, argues for a ratemaking mechanism to address earnings erosion beyond the test period. Under traditional ratemaking, no matter how much the actual utility’s costs and revenues deviate from their test-year levels, base rates remain fixed until the regulator approves new ones in a future rate case. The exception is
The downsides of MRPs
Utility regulators must set reasonable rates that allow a utility making prudent decisions to operate successfully, maintain its financial integrity, attract capital, and compensate investors in line with actual risks.5 Regulation can be undermined by ideology, ignorance, and inertia. Basing ratemaking policies on political leanings, inadequate information, and past conditions
Information asymmetry
The classic problem for regulators is that they observe only a utility’s performance, not the effect of management effort on cost, service quality, and other outcomes affecting customer welfare. This means, among other things, that regulators lack the ability to determine the minimum level of costs compatible with a utility operating efficiently (Joskow, 2014).
Because of this limitation, if given the chance, utilities have an incentive to engage in strategic behavior producing a zero-sum game
MRP outcomes
A sound MRP accounts for the concerns discussed here and promotes the public interest. Although economic and political factors in a given jurisdiction are pertinent factors, this section focuses on design features, both primary and secondary as discussed earlier, and their ability to foster predefined regulatory objectives.9
Conclusion
MRPs have features with potential benefits to both utilities and ratepayers. MRPs are especially appealing in a dynamic world where utilities face rising average cost or attrition of a utility’s earnings over time. This condition inevitably leads to utilities frequently filing rate cases, which impose high costs to both regulators and utilities.
Either utilities or their regulators can take the initiative in proposing an MRP. The design considerations provided in Table 1 can provide guidance. It
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