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Flexible Pricing and PBR: Making Rate Discounts Fair for Core Customers

Fortnightly Magazine - July 15 1996

should only recover strandable costs from its customers on a nonbypassable, nondiscriminatory basis. Discount rates, however, depart from this goal of equitable sharing among customers.

Instead of implicitly addressing strandable costs through discount rates, regulators should establish explicit policies. First, strandable costs should be identified, and utility stockholders required to absorb a meaningful portion of those costs.6 This policy would create a price discount (relative to full embedded costs) for all customers (em not just the large customers with the greatest amount of market power. All customers would pay a generation rate based on a market price plus some portion of strandable costs.7 Second, any strandable costs that are recovered from ratepayers should be collected from all ratepayers on an equitable basis through a nonbypassable wires charge, such as the competitive transition charge proposed in California.

Price Caps. In the case of PBR, the goal of establishing equitable sharing of strandable costs among customers is more complex. If PBR is established without an explicit mechanism to address stranded costs, we run a significant risk that large customers will be allowed to bypass their share of strandable costs through discounts. If, instead, PBR is applied along with a wires charge to recover strandable costs, then the generation costs subject to a price cap should be set by regulators to reflect market prices, since by definition strandable costs represent the difference between embedded costs and market prices. In this way, the utility would not be able to price generation above market to any of its customers. If the utility chooses to price below that cap for selected customers, it should bear the full cost of any associated lost revenues.

* * *

Regulators should consider whether flexible pricing practices are consistent with their overall objectives for competition in the electric utility industry. Will flexible pricing afford utilities more market-like agility, or will it provide utilities with an opportunity to cross-subsidize large customers? Will flexible pricing practices, especially PBR, allow some

customers to bypass strandable costs that are intended to be nonbypassable?

If regulators decide that price discounts are necessary to keep a utility (or a state) competitive, they should consider applying such price discounts to all customers of that utility. This could be achieved through an explicit sharing of strandable costs among ratepayers and stockholders. In this way, utilities will more likely be able to retain customer loads, avoid undue discrimination, promote competition, and lower electricity prices to all customers. t

Tim Woolf is manager of the Electricity Program at the Tellus Institute in Boston, MA. Prior to joining Tellus, he was research director for the Association for the Conservation of Energy in London. He has an MA in business administration from Boston University and a diploma in economics from the London School of Economics. Julie Michals is a research associate at Tellus. She has an MA from the Center for Energy and Environmental Studies at Boston University.

1. The term "strandable" is used here because at-risk costs are not yet actually stranded. Most utiities are still recovering these costs under traditional cost-of-service ratemaking.