Pricing Off the Tariff: How to Figure the Maximum Supportable Electric Rate Discount

Fortnightly Magazine - May 15 1997
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A simple formula method shows utilities exactly how much to discount prices. Electric utilities have drawn attention recently (and criticism from some quarters) for granting off-the-tariff discounts to customers deemed at risk for migration to lower-priced competitive alternatives. Typically, utilities have offered discounts to high-load customers in exchange for a long-term purchase commitment providing either more certain earnings, higher expected earnings, or both. How much utilities should discount rates depends, among other things, upon the likelihood and timing of retail access, the spread between existing tariffs and market power prices, and the likely level of stranded cost recovery.

Utility managers should consider rate discounts as a marketing strategy. They will want to do so to maintain sales, revenues and margins. In fact, a well-crafted agreement can protect a utility against substantial margin losses from market upheavals, such as retail choice for consumers. However, managers and their analysts must define the bounds of such a strategy and ensure that any discounting proposals will prove economically beneficial and consistent with their view of how competition will unfold in the future.

A simple, analytical framework can evaluate the effectiveness of offering discounted rates in exchange for long-term purchase commitments. A numerical example can derive the utility's maximum supportable discount, or MSD. A utility might offer this maximum discount in exchange for long-term purchase commitments. However, the MSD will vary with changes in underlying assumptions.

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