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Distribution Utilities: Forgotten Orphans of Electric Restructuring

Fortnightly Magazine - March 1 1999

however, assumes away the very difficulties likely to be encountered: multiple beneficiaries and joint costs. Lastly, any mixed cost-allocation scheme will be scrutinized by those identified as specific beneficiaries, much as there often are disputes about cost allocations among different customer classes.

A Workable Solution

In the context of what is equitable, unique cost-allocation solutions simply do not exist. What is fair for one local area customer may not be perceived as fair by another, especially if those customers consume fundamentally different disco services.

Historically, regulators used traditional fully allocated cost (FAC) rules to share investment costs among customers. Regulators further addressed equity concerns by adjusting prices; commonly, "ready-to-serve" charges were set much lower than their "true" cost, because minimum bills several times larger than current levels have not been politically viable.

Yet, cost-allocation decisions can and should be separate from rate structure decisions. Thus the first step in any cost-allocation scheme is to adjust prices correctly: Ready-to-serve charges should be raised to their real levels, and regulated volumetric charges, if any, should reflect only those disco services that truly vary with consumption. This will allow consumers to make efficient choices about their electric consumption and allow discos to plan more effectively for future capacity needs.

If electric restructuring is to be successful, any chosen cost-allocation scheme should be judged by its affect on overall economic efficiency. The best allocation scheme will meet specific and well-defined equity goals with the least adverse impact on economic efficiency. Although the existing FAC system has a proven track record, it was designed for a fully regulated and integrated system. As that system is replaced with a mixed competitive-regulated framework, it will be faced with new types of costs, customers and suppliers, none of which may fit within the traditional framework.

Lastly, an allocation mechanism also should account for transactions costs. Cost allocations should be as straightforward as possible, so as to minimize the regulatory and legal costs necessary to determine them.

Allocating distribution costs in the newly restructured world will require a careful balancing act that recognizes the conflicting incentives of retail energy suppliers, customers and discos. Not to give additional attention to these issues will be a disservice to customers and retail suppliers, and likely will reduce the potential benefits of competitive generating markets.

Jonathan Lesser, Ph.D., is a senior project manager at REED Consulting Group. Previously, Lesser was manager of economic analysis at Green Mountain Power Corp. He helped develop an innovative new approach to distribution system investment planning with staff from the Electric Power Research Institute, and directed all of GMP's "distributed utility" planning efforts. Lesser has authored and co-authored numerous publications, which have been published in The Energy Journal, The Electricity Journal, Public Utilities Fortnightly and the Journal of Regulatory Economics, among others. He also is the author of a textbook, Environmental Economics and Policy, published in 1997 by Addison Wesley Longman.

1 This example is adapted from a case of a major expansion at a ski area service territory, which the author addressed while employed at Green Mountain Power Corp.,