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Rate-Case Mania: Lessons for a New Generation

Fortnightly Magazine - February 2006

of usage.

Methods used in cost allocation include:

  • Functional or average use;
  • Peak responsibility (coincident and non-coincident);
  • Commodity-demand;
  • Base-extra capacity or average-excess;
  • Embedded-direct;
  • Fully-distributed; and
  • Marginal-cost.

A key issue is establishing which rates are the default rates for standard service and which are for optional rates. Default rates become part of the obligation to serve.

Good rate design involves making tradeoffs between competing objectives and consulting customers through an open and transparent public process. To accommodate different situations, electric utilities often will provide customers with variety of optional rates. These include:

  • Uniform or single-tariff pricing (consolidated, regional, or equalized rates);
  • Budget billing (equalized payments across the months to ensure a constant monthly bill);
  • Lifeline rates (first block priced affordably, often below marginal cost);
  • Excess-capacity rates (discounted rates to encourage off-peak consumption);
  • Economic-development rates (discounted rates to encourage certain types of economic activity);
  • Negotiated rates (for large-volume users);
  • Flexible rates (for large-volume users);
  • Excess-use (based on an allowable electricity consumption budget per customer);
  • Value-of-service pricing (can be based on value);
  • Quality differentiated (level of treatment or reliability); and
  • Spatially differentiated rates (zonal or district according to cost differences).

Each of these rate designs serves a different objective. For example:

  • Uniform rates accomplish the goal of simplicity in rate design;
  • Inverted block rates, seasonal rates, and TOU rates reduce growth in peak loads;
  • Lifeline rates improve affordability;
  • Marginal-cost pricing encourages efficiency;
  • Penalties can induce conservation;
  • Zonal rates achieve better efficiencies in spatial cost allocation;
  • Single-tariff pricing promotes economic growth in high-cost areas; and
  • Negotiated rates address economic development, customer retention, and (sometimes) competition.

To meet multiple objectives, a rate might jointly consider the objectives of affordability, equity, and efficiency:

  • For affordability, attention is paid in particular to designing the first block;
  • For efficiency, price variation in the tail block can be used to reflect significant differences in marginal cost; and
  • For equity, rate averaging can be used across multiple customers and systems to recognize commonality and encourage beneficial regionalization.

A lifeline rate provides a subsidy to low-income customers who meet specified program criteria. The first electric usage, generally considered “essential” usage, is priced below the marginal cost of electric service. The difference required to fund the subsidy is recovered in subsequent blocks. Such a rate closely resembles some conservation-oriented rates.

In practice, choosing a rate structure can be a challenge, particularly given the many available options. When choosing a rate, regulators and utility decision-makers should:

(a) establish clear and explicit goals, priorities, and preferences;

(b) select a rate design that best achieves objectives, while maintaining consistency with accepted ratemaking principles; and

(c) involve stakeholders (particularly ratepayers or customers) to the greatest extent possible.

Involving key stakeholders is an important part of the ratemaking process. Some of the relevant stakeholders include:

  • Residential customers;
  • Commercial customers;
  • Industrial customers;
  • Consumer advocates;
  • Environmental advocates;
  • Business leaders; and
  • Media representatives.

Rate structures can evolve with the needs and priorities of electric systems, as well as their capabilities. Strategies for implementing a change in rates or the rate structure include:

  • Communicate goals clearly to all stakeholders;
  • Recognize tradeoffs explicitly;
  • Follow