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Making Sense of Peak Load Cost Allocations

Fortnightly Magazine - March 15 1995

example above. If the fourth root relationship is used instead, the peak period rates would total only 38 percent above the offpeak rates.

The Case Against Customer Charges

These results may simply confirm the logic of a "minimum system" approach to distribution cost allocation: Economies of scale flow from the high fixed costs associated with any distribution system, no matter what its design capacity. This view holds that delivery system costs are fixed and should be collected not on the basis of peak demands but through monthly fixed "access" charges that are not usage-sensitive.

The alternative view finds these costs incurred to sell profitable volumes of commodity throughout the year. Most utility line-extension policies confirm this cost-causal utility motivation, tying the investment the utility is willing to make to the revenues the utility expects to receive on sales volumes throughout the year. Advocates for this approach would point out that a competitive economy rarely enables any business to collect high fixed costs through fixed "per-customer" charges. Almost all competitive businesses must collect their "fixed overhead" costs in usage-sensitive charges. Competition tends to bid down any customer "access" fee such as entrance charges or annual service charges. Only businesses with significant monopoly power can cover their fixed costs through a fixed customer charge.

If regulation seeks to reproduce the results of a competitive economy, rate designs containing high fixed charges are inappropriate. Usage-sensitive rate design would then be appropriate for collecting delivery system costs. Because of the substantial economies of scale, even after accounting for the impact of peak loads, the cost allocation would largely resemble a volumetric or commodity allocation. This may explain the significant role that volumetric allocations have always played in utility rate design. t

Thomas Michael Power, PhD, is a professor and chairman of the economics department at the University of Montana in Missoula.

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