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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

from fair value to rate base is one that represents a regulatory “shift from the realm of the appraisal engineer to the realm of the accountant.”

Further, Bonbright et al. observe that the “value of the property in any definitive sense of the term ‘value’ cannot qualify as an acceptable measure of rate base.” To this, we add the observation: and vice versa.

In a more positive way of explaining what matters here, Bonbright et al. conclude:

For ratemaking purpose, the value of corporate assets must cease to be identified with their market value, or their value in private property to the corporation or to its investors.

Instead, the relevant values must refer to the potential values of the assets as instruments for the performance of service to the community of ratepayers. If these assets were not utterly irreplaceable, their value to the ratepay- ers would be set by whatever rates of charge for service the ratepayers would be willing to pay rather than go without—set, in short, by what the traffic would bear. But if the assets are replaceable, their potential value to the consuming public is limited by their replacement costs.

These choices and reasoning are precisely how tax and other fair-market appraisals conceptually are defined and evaluated. Bonbright et al. observe, in effect, that original-cost rate base, which rejects all the above metrics and concepts, is devoid of any meaningful measure of value. When combined with other factors to establish regulated tariffs, rate base becomes an input to the process, not an end result measure of value since, in effect, there is no rate base that reflects an energy-service provider’s or energy marketer’s true value to retail energy consumers, owners, or society.

Why did rate-base regulation rule for so long? Four factors are most relevant.

• First, in the last century, growth in utility sales meant more energy for people and the economy. Quality of life and economic progress were viewed as important benefits. The engineering focus of energy utilities meant that we could simply “live better” with more electricity.

Jackson’s logic that the benefits provided should be the regulatory focus of how utility returns should be set was adopted implicitly. This was because utility investments expanded energy supplies and use. Consumers and the economy benefited as utility companies invested capital. Utility earnings increased as utilities invested more and the amount the utilities invested increased and tracked societal benefits to the invested capital. Developing countries over the latter part of the 20th century understand that each percentage increase in electricity investment/output will be matched to a 1 percent growth in GDP and national quality of life and economic benefits.

• Second, vertically integrated, traditional utility companies are capital intensive. One measure of this is that annual sales to total assets, or invested capital, are typically less than 1.0. Another measure is that in the late 1970s and early 1980s, electricity and natural-gas utility companies frequently invested more new capital each year than all other industries combined in the United States. When rate base is no longer the focus of