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Regulatory Uncertainty: The Ratemaking Challenge Continues

Ratemaking Special Report
Fortnightly Magazine - November 2004
  • rate adjustments (i.e., declining, flattening, inverted, block restructuring);
  • System benefits charges (e.g., energy efficiency or DSM programs, low income assistance);
  • Unbundled or ancillary services and rates;
  • Low income rate structures;
  • Weather normalization adjustment mechanisms; and
  • Budget billing programs.

    These ratemaking proposals seek to address a number of ratemaking objectives, including: (1) recovering the fixed costs of utility service through the fixed components of its rate structure; (2) achieving cost-based rates; (3) providing energy choices and service options to customers; (4) addressing social considerations through rate design; (5) stabilizing the volatility that exists in utility margins due to weather; and (6) addressing volatility in customers' monthly energy bills.

    A number of regulatory proceedings other than general rate cases also have addressed important issues ().

    Improving Stakeholder Acceptance

    Utilities that had filed rate cases over the last 24 months were asked to indicate the single most important change to the rate case process that would improve stakeholder acceptance of the utilities' rate increase request and related proposals. The changes cross a wide range of topics, and consist of:

      1. Acceptance of post-test year adjustments;
      2. Better recognition of cost changes and cost causation;
      3. Recognition of return on equity models other than Discounted Cash Flow (DCF) and the Capital Asset Pricing Model (CAPM);
      4. A balanced position from the regulatory staff;
      5. Recognition of a proxy capital structure;
      6. A better understanding of the risks inherent in providing service as it translates into an appropriate cost of equity;
      7. Recognition of a forward-looking test year; and
      8. The allocation of revenues among classes of service, and between state and FERC jurisdictions.

    Three clear themes emerge from these responses. Changes are needed: (1) to the techniques used to derive the numbers, (2) to recognize certain principles, and (3) to the rate case process. The first theme addresses the need for adjustments to the utility's actual or per-book plant and expenses levels to reflect any known and measurable changes that are expected to occur in the first year in which rates are implemented. The allowance of such changes may also address the age-old problem of regulatory lag-the setting of rates based on costs that are outdated by the time the rates are approved by the regulator. Clearly, the use of a forward-looking or future test year can directly address this concern. Similarly, respondents recommended that certain changes be made to the techniques relied upon to derive the utility's cost of equity and capital structure.

    Regarding the "principles" theme, the respondents seem to be suggesting that it is important to view the broader aspects of the utility's business (e.g., the level and change to the cost of serving customers, the risks of doing business) when examining the detailed numbers supporting changes to its allowed revenues and rates.

    Finally, and perhaps most importantly, the process of conducting a utility rate case needs to be examined more closely, with an objective view toward understanding and better managing the inherent adversarial roles and resulting conflicts that invariably arise between the utility, regulator, and other stakeholders. However, the notion that each