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Regulation by Formula

Tools to facilitate changing utility economics.

Fortnightly Magazine - March 2010

10.8 percent establishing a 10-percent to 10.8-percent dead band with all earnings going to shareholders; the earnings from an ROE of 10.8 percent to 11.3 percent are shared 50:50 between customers and shareholders; an ROE of 11.3 percent to 12.3 percent is shared 60-percent customers, 40-percent shareholders; and all additional earnings above 12.3 percent go to customers.

Sharing an earnings deficiency works the same way, but deals with earnings below the allowed ROE. For example, for an earnings deficiency between Target 1 and Target 3, shareholders absorb all of the earnings deficiency; deficient earnings from Target 3 less an additional 0.5 percent share the deficiency 50:50 with customers and shareholders; and the deficiency in earnings from Target 3 minus 0.5 percent down to 1 percent are absorbed 40 percent by shareholders, and 60 percent by customers. Additional earnings deficiencies below Target 3, less 1.5 percent, are all made up by customers. For example, between 10 percent to 9.2 percent, all of the earnings deficiency is absorbed by shareholders; the portion of the earnings deficiency from 9.2 percent to 8.7 percent is made up 50:50 between customers and shareholders; the earnings deficiency between 8.7 percent to 7.7 percent is made up 60 percent by customers, 40 percent by shareholders; and any earnings deficiencies below 7.7 percent are all made up by customers.

The process depends on an annual audit and review by commission staff. Hearings or settlement talks would be triggered if there are intervenors. The filing requirements would include an earnings monitoring report using book amounts as adjusted based on the results of the utility’s most recently completed general rate case and subsequent settlements resulting from the annual audits. The filing should include: 1) schedules for regulated income showing revenue and expenses by FERC Uniform System of Accounts; 2) a cost-of-service study to allocate expenses and rate base; and 3) cost of capital calculated on an end-of-year basis. To simplify the refunds to, or recovery from, customers, revenue adjustments might be allocated to each applicable rate class based on that class’ base revenue as a percentage of total base revenues eligible for refund or recovery of deficiency from customers if a symmetrical plan is used.

The revenue side of ratemaking by formula provides for recovery or refund of incremental costs and revenue requirements for a limited number of items. Examples include additions to capacity; significant changes in sales both positive and negative; purchased power capacity costs; and the loss of any revenue from interruptible rate programs. Thus, the process acts like a fuel adjustment clause in regard to revenue in that other cost changes are ignored as long as earnings Target 2 is not exceeded. The key word is incremental in that the process is sort of a mini-rate case for new additions (or deletions) in the revenue requirements associated with certain predefined cost elements, such as:

• Purchased power capacity: the revenue requirement associated with the capacity costs portion of purchased-power agreements and interruptible contracts if excluded from base rates;

• Lost revenue (if any) from conservation programs;

• Environmental costs: