About four months ago, at a conference at Stanford University’s Center for International Development, the economist and utility industry expert Frank Wolak turned heads with a not-so-new but very...
The Utah Test
Defining a test period to overcome controversies and inaccuracies.
The selection of a test period and an associated test year continue to generate controversy within the framework of rate-base regulation. Some controversial issues associated with the test period and related test year for energy utilities in Utah stem from the inherent uncertainty about the future and the need to rely on imperfect predictions for forecast test periods. Issues of accountability and process have arisen in part due to the problems with forecasts; specifically those related to updating them and accuracy issues.
A framework is required for selecting a test period based on the evidence that best reflects the conditions a public utility will encounter during the period when rates will be in effect.
The Utah Public Service Commission (PSC) has defined the test period as follows: A test period as used in traditional rate base, rate-of-return regulation is a 12-month period of utility operations used in setting rates that, when properly adjusted, will afford the utility a reasonable opportunity to earn its allowed rate of return. 1
An additional useful explanation of the test period is defined by Lowell Alt, former executive staff director of the PSC: “Since the revenue requirement is an annual figure, the data ( e.g., costs, revenues, and usage) used in its determination is based on a 12-month period. This 12-month period is termed the test period for a rate case.” 2
Once the test period has been selected, then the test-year results are compiled by the utility. The test year is a measure of operations and investment from some specified historical 12-month period, which then is adjusted and forecast to the forecast test period. The energy utility can select and propose a test period based on historical results with known and measurable adjustments, or a fully forecasted test year, or a combination of the two approaches.
A proposed framework ( see Figure 1 ) for test-period and test-year analysis includes the following important components: 1) principles; 2) criteria; and 3) factors and considerations. 3
Principles are related to rules and standards and include: 1) comply with regulatory statutes and rules; 2) consider precedence; 3) maintain the utility’s financial health; 4) ensure rates and prices are just and reasonable; and 5) apply matching principle concerning revenues and expenses. The test period should balance the utility’s investment, revenues, and expenses such that all aspects of the rate case match on the same level of operations.
Criteria related to how to judge a test period include: 1) accuracy and reliability of forecasted information; 2) variance showing actual data are reasonably close to forecasts;