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Rate Shock: A Matter of If, or When?

Fortnightly Magazine - January 2006

have many of the skills or the infrastructure to pursue such cases. In addition, most customers under the age of 35 are unfamiliar with significant increases in rates from their electric providers.

Another contributing factor to rate shock is the degree to which many utilities and state regulators have embraced forms of energy or fuel cost adjustments.

In light of current natural-gas prices and wholesale electric costs, customers in many states will receive energy or fuel charge adjustments that are larger than any increases in electric rates in 2006. And these mechanisms typically “pass through” faster than rate-based changes.

Assuming an environment of rising costs will lead to higher prices, will the impact be substantial enough to constitute “rate shock”? What constituted “rate shock” the last time the phrase was popular?

Using historical data in Figure 3, on an inflation-adjusted basis, rate shock appeared around 1973-1974 in some areas when a double-digit percentage spike in prices occurred, and in the early 1980s, when there were consecutive years of real increases exceeding 5 percent. With fuel and energy cost adjustments layered on rate increases, it is easy to envision such a spike in 2006 reaching nominal and real precedents, and the potential for several years of 5% real increases in 2005-2007. This can be even higher when one-time events, such as the end of a regulatory transition, or storm-related costs also pass-through to customers.

Utilities will face two challenges. The more traditional challenge is mitigating long-term price trends and finding lowest-cost, long-term solutions. This is not a trivial task, given the structural dynamics and the absence of a single, preferred supply alternative (as natural gas was in the 1990s and nuclear was in the 1970s). The second challenge will be to ensure that customers understand the value of their electric service and the efforts of utilities to deliver low-cost, reliable, and environmentally responsible service.

Perception vs. Reality

Ultimately rate shock is a matter of perception. What a customer sees is a higher bill: rates plus fuel charges plus increased per-customer usage plus structural charges and taxes. Unfortunately, in general, utilities have not done a good job of translating total bill and “customer wallet share” perspectives into internal performance reporting. Nor do these perspectives receive the airtime of a metric like reliability, which is measured frequently, extensively, and precisely.

Utilities typically do a poor job of communicating value despite its importance in shaping perception. Major components of future electric increases are attributable to increased value, including environmental improvements, increased reliability and security, and better customer service. In an era of rising and volatile costs, the perception of control also is a key value driver. Investments in communications infrastructure and demand response programs will enable customers to better manage their costs. And from a relative cost perspective, electricity is now even more competitive against natural gas and oil.

Some utilities already are taking action to prepare for a rising cost scenario. And some best practices are emerging from their actions that can minimize the potential for rate shock:

1. Take the time to build the