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Distribution Utilities: Forgotten Orphans of Electric Restructuring

Fortnightly Magazine - March 1 1999

efforts, must be evaluated fairly if those resources are to be part of "least-cost" distribution systems and compete on a "level-playing field." That requires the use of newer analytical techniques that explicitly account for the strategic and dynamic characteristics of distribution system investment planning. Fortunately, these methods exist, and have been successfully tested at several utilities, including Green Mountain Power, Ontario Hydro and Wisconsin Electric Power.fn3 These same methods can be applied to other distribution investment decisions, such as whether to repair or replace aging infrastructure.

Local Capacity Investments: Who Pays?

Determining appropriate local capacity investments is a technical issue that can be solved with enough computing horsepower. Determining who should pay for those investments is tougher. One reason is that distribution systems have qualities of what economists call "public goods" and "club goods." Public goods are those where consumption by one individual does not affect consumption by another, while club goods are those that are uniformly provided by a "club" that an individual must belong to. A disco is a local club that buyers (local electricity consumers) must join (pay an access fee) to receive club benefits (electricity bought on the market from retail suppliers.)

Because individual disco customers will have different demands for the specific public goods supplied, including peak capacity, voltage quality, reliability, etc., "free-rider" issues will need to be addressed. For example, slight voltage spikes are probably of little importance to residential customers, but can severely damage some industrial production facilities, imposing significant costs. If voltage spikes are reduced by new system investments at the behest of the industrial customer, residential customers will benefit as well, even though they have not paid for the benefits. The existence of free-rider effects is one reason that distribution system improvement costs often are not paid for by individual customers.

The same arguments follow for increases in local area capacity. Simply forcing individual area customers to pay for incremental increases in local area capacity may not meet existing regulatory definitions of equity. Nor may it be efficient, because individual demand for new capacity may be less than the cost of supplying large fixed increments of capacity. Observed increases in local area peak demand may be the result of random effects, such as weather, rather than actual shifts in customer demand because of new electricity-consuming equipment. Changes in observed peak demand may also be the result of changing rate structures.

Distribution system costs historically have been allocated among all customers of a utility by customer class, rather than on an individual customer or individual area basis, in part to address these complexities. But as retail competition takes hold, this allocation system is likely to be challenged.

Cost-Allocation Schemes

There appear to be three alternative cost-allocation options for new distribution system capacity investments:

1. Preserve the existing system by which capacity investments are allocated among all distribution customers using standard cost-allocation principles;

2. Identify customers responsible (individual users) for increased local area peak demands and require them to pay all incremental expansion costs;

3. Require some customers to pay for new local area capacity,