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Reducing Rate Shocks

Original-cost ratemaking doesn’t suit the challenges facing utilities today.

Fortnightly Magazine - June 2013
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a clientele that values dividends, which the front-end load under OC also facilitates. Utilities might have to put more emphasis on dividend growth and less on immediate dividends under a change in ratemaking methodologies.

The key in these two areas, of course, is noted above: in the face of rate shocks, will traditional OC rates actually be recoverable? Can regulators pass the full OC capital charge along to customers if the required rate increase is high? Even if regulators do so, will demand support the required rate level? Even a statutory monopoly faces competition from other energy sources or switches to a more efficient capital stock, if prices get too high. More fundamentally, we know these two problems can be overcome, because non-OC ratemaking methods have actually been used. 

Similarly, we know the third potential problem can be solved because there has been experience in treating different assets differently for ratemaking purposes. One example is the use of CWIP in the rate base. Another example is Opinion 154-B, where the FERC treated oil pipeline equity differently from oil pipeline debt, effectively creating parallel rate bases. A utility revenue requirement could keep track of old and new assets using two different methodologies, although the details would need to be worked out carefully. Also, keeping the old methodology for old assets would help with the debt service and dividend policy issues, since a switch in approach for old assets would reduce current cash flow on the old rate base. 36 That said, the best solution to this issue also might vary with the specific context.

Adopting Alternatives

To alleviate rate shocks and send better price signals to customers, utilities should consider alternatives to the traditional original cost approach for major capital investments. Utilities and utility regulators also will benefit, because the alternatives make it easier to compensate utilities adequately in the face of customer discontent. 

Adopting such approaches now will help give utilities confidence to take advantage of today’s low interest rates, which might accelerate construction and thereby help both the local and the national economy. Of course, as with all material changes in ratemaking approach, it will be important to minimize risks due to the transition itself. This might involve legislation, project financing, or other pre-commitment mechanisms to reassure investors and thereby to minimize transition costs for customers. However, these, too, are problems that we know can be overcome, since alternatives to traditional ratemaking have been successful in other contexts.

 

Endnotes:

1. Federal Power Commission et al. v. Hope Natural Gas Co. , 320 U.S. 591; 64 S. Ct. 281; 88 L. Ed. 333; 1944 U.S. LEXIS 1204.

2. Williams Pipe Line Co., Docket Nos. OR79-1-000 and 022 (Phase I) Opinion No. 154-B; Opinion and Order on Remand , U.S. Federal Energy Regulatory Commission, June 28, 1985.

3. In the years after TOC was proposed and adopted, it became common to refer to original cost as “DOC,” for “depreciated original cost,” but this is a misnomer. Both TOC and OC rate bases are depreciated, although in different manners. We therefore retain the

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