In several recent utility rate cases, regulators have disallowed portions of utility compensation expenses, on the basis that difficult local economic conditions justify pay cuts. However, when...
Big City Bias: he Problem with Simple Rate Comparisons
Looking beyond ranking utilities on price.
It's tempting to compare rates between utilities- to use those simple rankings as regulatory carrots and sticks-but those who do may play a dangerous game. While such rankings may appear compelling, they can add an inappropriate bias to the regulatory process and penalize well-performing electric utilities that operate in high-cost service territories, such as large metropolitan areas.
In fact, the cost disadvantage faced by utilities serving our large cities is quite pronounced. As a result, the average electric rates paid by consumers in large metro areas consistently exceed the average rates of small metro areas by at least 10 to 20 percent, throughout the country.
To make matters worse, this bias is often magnified for high-profile utilities-firms that are highly visible to the public and state politics, closely scrutinized by local media, and supplying power to a large portion of the state's economy.
As it happens, the utilities that furnish service to major metropolitan areas often face both of these challenges: A perception of high rates, and the intense public and political scrutiny associated with being a high-profile utility.
The Appeal of Simple Comparisons
In today's world, state public utility commissions (PUCs) and their staffs generally monitor the rates of utilities under their jurisdiction and employ within-state, regional, or nation-wide comparisons and rankings. Such comparisons and rankings often are featured prominently by the media, and can become important factors in state politics and in public relations efforts by various interest groups. They offer a seemingly quick and easy tool to evaluate the performance of utilities, the PUCs themselves and, for that matter, the effectiveness of consumer advocates and interest groups. Needless to say, however, such rate comparisons can easily lead to bias in the regulatory process.
Even where PUCs succeed in keeping politics at bay, there can be little doubt that rate comparisons often play an important role in regulation, since parties on all sides have reason to introduce such comparisons to serve their own motives.
Utilities themselves may use simple rate comparisons to document superior operational performance in hopes of gaining favorable treatment. Likewise, intervenors and consumer advocates may present rate comparisons to support demands for rate reductions. Even the regulators themselves may unwillingly succumb to the allure of simplistic comparisons and rankings. If the commissioners a utility's rates as low, PUCs or their staffs may delay in opening up a rate case. And once begun, a case may turn in favor of the utility at the top of the rankings. If rates are perceived to be high, quite the opposite may result.
From an economic perspective, setting rates fully or partially based on rate comparisons is often appealing because, at least in theory, such comparisons can help identify efficient utilities, reward superior performance, and create incentives more akin to those found in competitive markets. However, the general proposition that regulation should take into consideration rate comparison and other performance benchmarks is sound only if it can accurately reflect relative company efficiencies and management performance. That requires explicit consideration of the costs that different service