Price-Responsive demand, EPA regulations, and merger policy will be on the agenda for the coming year as the Federal Energy Regulatory Commission works its way through the list of key cases that...
Flexible Pricing and PBR: Making Rate Discounts Fair for Core Customers
With competition looming, electric utilities increasingly resort to price discounts, both to retain customers and to alleviate some of the pressure to introduce retail competition. Performance-based ratemaking (PBR), which allows utilities greater flexibility in offering price discounts, is emerging as an integral component of many restructuring proposals.
However, flexible pricing can create inequity among ratepayers. Thus, regulators should allow flexible prices only when they yield net benefits for all customers. One way to increase the potential for net benefits to all customers is to encourage utilities to minimize the number and size of price discounts by requiring utility stockholders to absorb a significant portion of the lost revenues created from those discounts.
Flexible prices also mark one way of addressing strandable costs (em even though they are rarely thought of in that way.1 By receiving discounts, customers in effect bypass a share of strandable costs. Thus, as the electric industry moves toward greater competition,
regulators should provide all customers with price discounts by explicitly identifying strandable costs, and requiring that they be shared between ratepayers and stockholders.
The equity issue raised by price discounts is not as simple as it first appears. Some price discounts can produce net benefits to all ratepayers, and can therefore be considered in the public interest.
For example, if a load retention rate prevents a large customer from leaving the utility system, then the electricity sales "gained" by the discount rate will pay for a portion of the fixed costs that would otherwise have to be recovered from ratepayers that remain on the system. This type of net benefit to all ratepayers marks the primary justification offered by utilities for flexible pricing.
Whether flexible pricing serves the public interest depends in part upon the distinction between "due" and "undue" price discrimination.2 In general, "due" price discrimination yields net benefits to all customers, as in the example above. Undue price discrimination, on the other hand, benefits one customer at another's expense (em as when a customer obtains a discount even though it would not have actually left the utility's system.
Recovering Lost Revenues
For all customers to obtain net benefits, discounted rates must actually maintain an existing customer's load or attract a new customer's load. The challenge lies in demonstrating that a discounted electric rate actually affects a customer's decision to self-generate, move out of the local utility's service territory, or move into the local service territory.
Discounting in General. While a candidate for flexible rates can provide a limited amount of information to demonstrate that its electricity purchasing decisions are affected by the rate, such information is often difficult to obtain.3 More important, such a demonstration may require significant regulatory oversight (em a drawback for utilities seeking flexibility to respond to competition.
In practice, regulators may find it difficult to ensure that discounted rates are provided only in cases that truly retain or increase customer load. Therefore, utilities should be encouraged to limit price discounts to cases in which they affect decisions by customers regarding location and consumption. The most direct means of encouraging the