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A Brief History of Rate Base: Necessary Foundation or Regulatory Misfit?

Regulators today must define earnings for energy retailers virtually bereft of fixed assets.

Fortnightly Magazine - July 2006

energy-service companies based on the value of the services provided to customers.

Two measures of return are given some primacy in retail businesses. These are: “margins on sales” and “margins on cost of goods sold.” The former is based on the full retail purchase price. The second is based on the “cost of goods sold,” which for an energy-services company would include the energy and perhaps the delivery charges for distribution and transmission that would be passed through to the consumer.

Not all retail industries are comparable to energy service companies. Nevertheless, those industries that are comparable can form the basis for establishing return margins for energy service companies.

Initially, two factors seem particularly relevant in determining which industries and companies are comparable to energy service companies: (1) skills and functions; and (2) sales to total assets. The first is a qualitative factor that involves judgment. The second is an often reported financial metric.

Most traditional utilities have a corporate structure centered on engineering skills, financing skills, and building complex capital-intensive vertically integrated utility systems. Competition and restructuring have broken the traditional vertically integrated utility monolith. Choice and market forces establish different prices and risk-related packages. One important result is that “customers” and their “needs” are the focus of these new entities.

The best approach for regulating energy service companies would replace return on investments with an adder-to-sales or margin-on-sales approach. The margin would reflect both return/profit and elements of risk not recovered elsewhere with explicit cost-of-service adders. Consumers expect to pay a mark-up for wholesale/retail sales. Industries such as grocery, department, restaurant, sports, and entertainment are predicated on a retail mark-up. Energy service companies are in the retail customer-service business. Customers have other choices. In competitive markets, if a retailer, regulated or not, is to stay in business, it must recover a profit margin. A margin approach such as the one we propose here would look to margins in other retail-oriented competitive industries to establish a reasonable sales margin for energy service companies.

 

Endnotes:

1. See In the Matter of the Commission’s Inquiry into the Competitive Selection of Electricity Supplier/Standard Offer Service, Order No. 78400, Case No. 8908, Maryland Public Service Commission, 2003 Md. PSC Lexis 5; 224 P.U.R. 4th 185 (April 29, 2003); Formal Case No. 1017. A settlement established a wholesale competitive procurement methodolgy to implement Maryland’s standard offer service (SOS). The settlement approved by the MPSC adopted a per kilowatt-hour of SOS load administrative charge. For example, the residential administrative charge was set at 4 mills (4 cents) per kWh. The administrative charge was broken into four components: (1) a utility return component; (2) an incremental cost component; (3) uncollectibles; and (4) an administrative adjustment component. See also In the Matter of the Development and Designation of Stanard Offer Service in the District of Columbia, Order No. 13268. Public Service Comission of the District of Columbia, Order No. 1017-E-275 (Aug. 19, 2004). The Public Service Commission of the District of Columia (PSCDC) determined the appropriate compo- nents of the administrative charge and a calculation methodology for Potomac