High industrial electricity rates are often blamed upon current regulation. Some state regulators respond with broad-based reforms; others simply reallocate system costs from industrial rate classes to rates for more inelastic customers (em namely, residential users. Regulators base such allocations on rate-of-return (ROR) regulation, which holds that rates for all consumers should match the cost of serving them.
The cost-of-service debate came first to the telephone industry, where costs were shifted from competitive toll calling to monopoly local service (em a job made easier by a shrinking revenue requirement. Now the same issue appears in electric and gas cases. The challenge there will lie in applying cost-of-service principles to two distinct markets (em industrial and residential (em when one sector (industrial) exerts market power and the other (residential) may remain captive.
The cost-shifting trend may be leading some regulators to consider the possibility that ordinary residential customers are inadequately represented in the ratemaking process.
A recent rate settlement in Kentucky is a case in point. Late last year, the Kentucky Public Service Commission (PSC) concluded a long-standing case governing rate treatment of Louisville Gas & Electric's investment in the Trimble county generating facility. Under the approved agreement, the utility will refund current customers $22 million, with $5.3 million reserved to special contract customers and the rest refunded to all other customers over a five-year period. The utility agreed to pay an additional $4.5 million to fund energy assistance programs for low-income customers over the same five-year period.
In a separate concurring opinion, Commissioner Linda K. Breathitt expressed concern that residential customers would have to wait five years, while certain industrial customers would receive immediate payments. She noted that the agreement reflected a recent trend in settlement agreements presented to the PSC: The utility, its large industrial customers, and low-income customers benefit from ardent representation at the bargaining table, while the vast majority of customers appear to have a much smaller voice in the process. Re Louisville Gas and Electric Co., Case No. 10320, Dec. 8, 1995 (Ky.P.S.C.).
Class Rates of Return
Increasing rates for customers that produce only a small profit on investment, while decreasing rates for major contributors, is frequently supported by the principle that rates for all consumers should match the cost of serving them.
Perhaps the most straightforward example of this phenomenon occurred recently in a rate proceeding for Alabama Power Co. According to the Alabama Public Service Commission (PSC), the company's 1994 cost-of-service study placed the residential return on investment at 4.6 percent, as compared to a nonresidential group return of 10.68 percent. Noting that Alabama Power's residential rates were among the lowest in the country, the PSC adjusted rates to increase the residential customer-service charge while raising nonresidential rates by an equal amount if return from the residential class should fall below 90 percent of the overall ROR. The PSC also approved interim measures to lower nonresidential rates, including a waiver of automatic rate adjustments scheduled for 1995 and 1996 due to completion of new generating facilities. Re Alabama Power Co., 162 PUR4th 171 (Ala.P.S.C. 1995).
Other states across the country are adjusting rate structures for their electrics in much the same way. While approving a 2-percent rate increase for Indiana Gas and Electric Co., the Indiana Utility Regulatory Commission (URC) moved to correct the subsidization of residential customers by industrial and commercial users. (In a prior rate case, the URC had ordered the utility to reduce subsidies between rate classes by at least 25 percent.) To reduce rate shock for residential customers, no customers will receive significant rate decreases, and the increase to residential classes will be close to the overall increase approved for the utility. Re Indiana Gas and Electric Co., 1 PUR4th Cause Nos. 39871 and 40078, June 21, 1995 (Ind.U.R.C. 1995).
While granting Niagara Mohawk Power Corp. an electric base rate increase of $187.7 million, the New York Public Service Commission (PSC) has moved part of the revenue requirement away from the industrial and commercial classes and reassigned it to the residential class. The PSC capped the overall residential increase at 3.9 percent and estimated that the revenue shift would equal $16 to $20 million. Re Niagara Mohawk Power Corp., Case Nos. 94-E-0098, et al., April 21, 1995 (N.Y.P.S.C.).
The Question of Fairness
How far and how fast can a commission go in revamping long-standing cost relationships among customer classes?
In a case involving a major rate restructuring for local telephone service, an Illinois appeals court has ruled that state regulators failed to properly balance the interests of shareholders and ratepayers. More specifically, and unusually, the court found that the Illinois Commerce Commission (ICC) erred in failing to properly analyze the effect of a major shift in cost allocation on individual customer groups. Citizens Utility Board v. Illinois Commerce Commission, Nos.
1-94-2270, 1-94-2370, Nov. 9, 1995 (Ill.App.Ct.).
The dispute arose after the ICC decided to restructure rates for Central Telephone Co. of Illinois, a telecommunications local exchange carrier (LEC), by eliminating most of its flat-rate calling plans and replacing them with usage-sensitive offerings. The order also permitted a general shift of costs away from business users and onto the residential customer class. While the restructuring would decrease rates for some customers, others would experience a doubling or tripling of monthly bills if their calling patterns remained constant.
The court found insufficient the ICC's contention that the restructuring would eliminate the "complexity, cross-subsidies, inequities and inefficiencies" of the LEC's existing rate design. The court went directly to the cost studies presented in the case, and found that the prices of all calls exceeded their long-run incremental costs and that the prices approved for residential local calling far exceeded the level needed to reassign costs.
The Arkansas Court of Appeals, on the other hand, upheld a decision by state regulators permitting Arkansas Louisiana Gas Co., a natural gas local distribution company, to allocate to residential users the total amount of a recent rate increase. According to the Arkansas Public Service Commission (PSC), the cost-shifting was appropriate to prevent system bypass by larger customers, and consistent with prior efforts at removing interclass subsidies. (See, Bryant v. Arkansas Public Service Commission, 907 S.W.2d 140 (Ark.Ct.App.1995), affirming, Re Arkansas Louisiana Gas Co., a division of Arkla, Inc., 150 PUR4th 333 (Ark.P.S.C. 1994).)
The court rejected claims that the bypass risk associated with larger customers justified a higher return from that class, concluding that the record supported the PSC's policy goal of retaining large customers for the benefit of the system as a whole. The court cautioned, however, that its decision should not be read as "advocating an inexorable march" toward absolute equalization of class ROR. Rather, utility shareholders must share responsibility for business risks, leaving ratepayers unharmed where imprudence on the part of the utility is to blame for the lost contributions of industrial users. Arkansas Louisiana Gas Co. v. Arkansas Public Service Commission, No. CA 94-487, Aug, 30, 1993 (Ark.Ct.App.)
Is the Service Competitive?
A 1994 telephone rate design case in Maine provides a unique example of how the cost-of-service argument does not always work for utilities seeking to move costs away from services viewed as competitive. It also demonstrates the limits of the allocation argument in the face of the growing trend toward incentive ratemaking as a replacement for traditional cost-of-service pricing. Re New England Telephone Co., 152 PUR4th 1 (Me.P.U.C. 1994).
New England Telephone Co. had asked the Maine Public Utilities Commission (PUC) to reduce its overall intrastate toll revenues 8.5 percent by increasing rates for residential local exchange service 25 percent. The LEC claimed that current toll rates were substantially above the marginal cost of service, and that long-distance calls were subject to competition. As it turned out, all parties agreed that both toll and local rates were priced above marginal costs.
The PUC found that the LEC's cost studies did not provide a sound basis for a significant change in revenue recovery between rate classes nor sufficient evidence of toll bypass to justify the increase in residential rates. The PUC went on to say that the proposal might be termed a "short-sighted response to growing competition" because it fails to "take into account the significant potential for future competition in the local (and even residential) markets." On the issue of overall cost, the PUC concluded that cost-allocation arguments were inappropriate to support increases to residential rates, given that costs for all services seemed to be declining.
Rather than continue to review "complex cost studies brought forward to support controversial proposals to shift costs among customer groups," the PUC opted to open an incentive regulation proceeding in the near future. One goal of that proceeding would be to develop a regulatory framework designed to help the LEC respond to competition while maintaining stability in the rates of core or captive customers. According to the PUC, the LEC would have "the opportunity" to use cost savings from operational efficiencies and new technologies to lower its rates for competitive services without burdening local exchange ratepayers.
Ultimately, the PUC approved a new "price cap" plan for New England Telephone Co., emphasizing that one objective of recently enacted state law governing telecommunications rate reforms was to keep local rates as low or lower than they would be under traditional ROR regulation.
The law "may well prohibit" a proportional increase to basic service rates that is greater than the proportional increase in costs, the PUC added. The new price-cap plan allows a rate increase for basic service only if an identified price index (inflation less productivity, plus or minus exogenous changes) is positive, and then only by the amount of increase in the overall index. Re New England Telephone and Telegraph Co. dba NYNEX, 162 PUR4th 38 (Me.P.U.C. 1995).
Does the telephone industry provide some analogy as to what might happen to energy rates as market restructuring proceeds? The Connecticut Department of Public Utility Control (DPUC) examined that question when investigating whether to promote wheeling services for retail electric consumers: "While the beneficial effects of telecommunications competition may someday be experienced in the electric industry, the [DPUC] finds that there are fundamental differences between the technologies." The DPUC cited rapid innovation in technology, which opened new markets and increased usage for telecommunications companies. Their enhanced financial position allowed the companies to risk investment in new technologies and to recover stranded investment more readily, but the same is not true of electricity, the DPUC observed. While gas turbine improvements mark an engineering breakthrough, such a development does not make the industry ripe for full-fledged competition. Re Investigation into Retail Electric Transmission Service, 155 PUR4th 209 (Conn.D.P.U.C. 1994). t
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