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Regulatory Uncertainty: The Ratemaking Challenge Continues

Ratemaking Special Report
Fortnightly Magazine - November 2004

these issues can be addressed, including generic or rulemaking proceedings, technical workshops, and periodic informal meetings between utility management and regulators.

The basis upon which a utility determines the amount of revenue increase it will request in a rate case is its total revenue requirement (or total cost of service). Recognizing the natural adversarial roles that exist between the utility, regulator, and other stakeholders in the rate-case environment, it was expected that survey respondents would see a number of components in the utility's total revenue requirement as controversial (). The more controversial components of the utility's total revenue requirement include rate of return on equity, administrative and general expenses, capital structure, and non-fuel related operating expenses. Administrative and general expenses may have made the "most controversial list" since this expense category (which frequently has higher expense levels compared to other direct operating expense categories) often contains costs associated with shared services received from other utility affiliates, salaries and wages of senior management, and other corporate overheads that are not always presented with the same level of detail as other utility expenses. Additionally, the added focus on this expense category by the regulator and other stakeholders is explained, in part, by the fact that many of these common or joint costs must be allocated to the regulated utility, and this creates a concern that cross-subsidies may exist between the various corporate affiliates.

The less controversial components include working capital, income taxes, fuel/purchased gas expenses, and other taxes. Typically fuel and purchased gas expenses are addressed in a separate regulatory proceeding rather than as part of a utility's general rate case, so it follows that it would not be viewed as controversial within that context.

Besides the controversy surrounding a utility's total revenue requirement, other parts of the respondent utilities' rate cases were seen as creating much controversy among interested parties. The most controversial issues include the allocation of the proposed revenue increase by rate class, the level of pension and other post-employment benefits (OPEB) expenses, ratemaking proposals, major capital additions, and review of affiliate transactions.

Interestingly, other parts of the rate case that were not seen as controversial include outsourcing or discontinuing services or functions, fuel/price volatility, risk management, resource planning and portfolio mix, and unregulated operations. Upon further review, however, there may be valid reasons why these topics and issues are not seen as controversial by the respondent utilities. First, as pointed out earlier, these issues may be important, but not always debated and resolved within a utility's general rate-case environment. Second, certain of these issues likely received a great deal of attention in past rate cases because of where we were in the evolution of the energy market, and due to the existence then of market participants that do not exist today (e.g., mega energy marketers, midstream energy suppliers).

Trends in Utility Ratemaking Proposals

Certain ratemaking mechanisms or rate-design concepts appeared frequently as pricing proposals in the respondent utilities' rate case proceedings. These include (in order of frequency):

  • Disproportionate increases in the level of the monthly service or customer charges;
  • Block