Much attention has been paid to revolutionary rate-reform plans advanced to meet perceived competition in energy markets. So much, in fact, that the increasing popularity of the special discount rate has gone virtually unnoticed. This traditional ratemaking mechanism has found new favor with state regulators as a tool to keep customers on the system.

Many states have allowed utilities flexibility to lower prices for large customers where they can show that the customer is likely either to move operations out of state or generate power on its own, usually through cogeneration. Gas utilities also have been granted permission to discount rates for customers with a demonstrated ability to switch to another boiler fuel, such as oil. Last year, the New York Public Service Commission (PSC) directly addressed the connection between the discount-rate phenomenon and the broader issues of industry restructuring. In an investigation of competition in electric and gas markets, the PSC adopted a set of general guidelines for electricity sales at flexible rates to customers with competitive opportunities. Re Competitive Opportunities Available to Customers of Electric and Gas Service, 154 PUR4th 19 (N.Y.P.S.C.1994). The PSC later explored a new regulatory regime for electric service in light of competitive opportunities available to customers. Re Competitive Opportunities Available to Customers of Electric and Gas Service, 154 PUR4th 35 (N.Y.P.S.C.1994).

While approving the new guidelines for flexible sales, the PSC found it "reasonable to assume" that utilities face a growing competitive threat, given the proliferation of onsite generation and plant closings. It concluded that using flexible or discount rates to retain contestable load was appropriate as long as utilities take steps to assure affordable service for captive customers and can justify any discount as necessary to meet a realistic competitive alternative. To protect customers and avoid discouraging truly economic onsite generation, the PSC set the floor price for flexible charges at the marginal cost of service plus 1 cent per kilowatt-hour (Kwh). It also warned utilities that shareholders would be called on to absorb part of any lost margins resulting from rate discounts, but added that the specific sharing percentages would reflect each utility's specific market and financial circumstances.

The Question of Authority

State regulators have embraced rate discounts with little hesitation. But, in many rate discount cases, parties have questioned the authority of state regulators to allow regulated companies to change rates without complying with full-fledged tariff procedures. Customers who do not qualify for the discounts have also made allegations of improper discrimination among rate classes. It appears, however, that state regulators have the authority to allow utilities to set special rates for clearly defined customer groups.

The Massachusetts Supreme Court recently ruled in favor of rate discounting in a case involving discounts for natural gas services. The court rejected challenges to state utility regulations allowing rate discounts to "noncore customers in the state." Massachusetts Oilheat Council v. Massachusetts Department of Public Utilities, No. S-6359, Nov. 14, 1994 (Mass.).

The Massachusetts Oil Heat Council had challenged the Massachusetts Department of Public Utilities's (DPU's) approval of a regulatory framework authorizing Boston Gas Co., a gas local distribution company (LDC), to use special contracts to sell gas at discounted prices to customers who could easily switch fuels. In its approval order, the DPU had authorized the LDC to use incremental pricing to negotiate rate contracts with customers who could demonstrate a bona fide energy alternative to purchasing service from the LDC. To protect core customers, the DPU required the negotiated rate contracts to provide a minimum contribution of 10 percent above long-run marginal costs. Under the new tariff, negotiated contracts go into effect on an expedited basis without prior substantive DPU review for those customers whose energy alternative is an unregulated fuel. The contracts would, however, be subject to post hoc prudence review in base rate cases. The DPU said that the LDC had failed to show that the negotiated rates were required to compete with regulated electricity providers. It ruled that the LDC was free to enter special contracts with such customers, provided that the contracts are submitted for substantive DPU review prior to taking effect. Re Boston Gas Co., 142 PUR4th 241 (Mass.D.P.U. 1993). On appeal, the Council argued that state law requires utilities to keep to filed rate schedules in determining prices for individual customers. It argued further that the DPU exceeded its authority in relinquishing regulation of gas sales to noncore customers, thereby "subjecting the public to unlawful abuses of monopoly." According to the Council, state law requires all gas and electric companies to file rate tariffs for all services, and to file new schedules before changing prices.

The court ruled that the state's public utility law gives the DPU broad discretion to authorize special contracting by utilities and to set requirements for contract approval. It said that the DPU's tariff plan set sufficient standards for negotiating contract rates, and that a rule restricting all rate negotiations was not in the public interest. The court also rejected allegations that the special contracts were discriminatory, finding that regulatory law clearly permitted different charges when based on reasonable classifications, such as the ability to switch fuels in a competitive energy market. The court pointed out that the rate discount tariff approved by the DPU required qualifying customers to have annual energy requirements of at least 30,000 million British thermal units (BTUs) and a bona fide energy alternative to purchasing service from Boston Gas that would foreclose service under the ordinary tariff.

The Problem of Lost Revenues

The most contentious issue in the discount cases is who should pay for the reduced revenues. One popular solution is to split the losses between the utility and its ratepayers. Other solutions range from requiring shareholders to absorb the entire loss to permitting rate increases for all remaining customers on the system (see box). Utilities have been permitted to go ahead with discounts pending later review of the results in a full rate case. In some instances, regulators have warned that a future increase in residential rates will not be allowed without a full review of the company's earnings. Such a review is found necessary to allay fears that a utility might attempt to maximize sales by discounting rates for elastic customers at the expense of their captive customers. Other commissions have required utilities to allocate revenue losses only to customers in the same rate class as those receiving the discount. Finally, some states have found that ratepayers are adequately protected as long as the discount rate does not fall below marginal cost of service.

In approving its guidelines for flexible rates, the New York PSC addressed both legal and economic aspects of the lost revenue issue. It rejected claims that requiring shareholders to absorb part of the cost of reduced revenues was illegal. Electric utilities had argued that the PSC was required to set rates based on actual or reasonably forecast expenses, revenues, and capital costs. One utility argued that ignoring part of the revenue drop under the flexible rate program while setting base rates was unconstitutional.

According to the PSC, the sharing was required as part of its mandate to set fair rates. It said that flexible rates induce a customer to remain on the system, which benefits both ratepayers and shareholders by reducing the potential for stranded investment. Because both groups benefit from maintaining a revenue stream sufficient to contribute to common costs, as opposed to the alternative of lost load and revenue margin, the PSC concluded that it was proper for both to bear a portion of the reduced margins. It called the approach a reasonable response to the "significantly changing landscape of the electric industry." t

Rate Discounting Popular in 1994

Re New York State Electric & Gas Corp., 155 PUR4th 337 (N.Y.P.S.C.1994). Orders electric and gas utility to absorb a percentage (generally 30%) of revenue shortfalls resulting from anti-bypass, load retention, and economic development rate discounts.

Re Competitive Opportunities Available to Customers of Electric & Gas Service, 154 PUR4th 19 (N.Y.P.S.C.1994); and 154 PUR4th 35 (N.Y.P.S.C.1994). Rules that utility shareholders should absorb part of any lost margins resulting from discount rates.

Re Self Generation Deferral Rates, 154 PUR4th 283 (N.C.U.C.1994). Defers ratemaking treatment for losses under self-generation deferral rates to general rate case proceedings.

Re Arizona Pub. Service Co., 153 PUR4th 396 (Ariz.C.C.1994). Permits innovative rates for "at risk" customers.

Re Valley Gas Co., 153 PUR4th 142 (R.I.P.U.C.1994). Authorizes a natural gas LDC to cut rates for large industrial service. Warns not to shift projected lost revenues to residential customers.

Re Montana Power Co., 152 PUR4th 403 (Mont.P.S.C.1994). Shares between ratepayers and shareholders the revenue shortfall resulting from a discount industrial retention rate.

Re Illinois Power, 151 PUR4th 28 at 360 (Ill.C.C.1994). Finds no shareholder responsibility required because special contract gas-service rates are designed to recover marginal cost of service and thus make a positive contribution to fixed costs.

Re Consumers Power Co., 151 PUR4th 374 at 46 (Mich.P.S.C.1994). Assigns to shareholders any initial revenue loss associated with an interruptible electric-service rate discount. Also assigns to shareholders the benefit of any associated revenue increase.

Re Central Maine Power Co., 150 PUR4th 229 (Me.P.U.C.1094). Rules that promotional pricing should be "risk-adverse"--discount rates must be set high enough to have a high probability of exceeding the relevant marginal cost.

Re Commonwealth Edison Co., 153 PUR4th 151 (Ill.C.C.1994). Approves a tariff permitting an electric utility to enter negotiated rate contracts with up to 25 large general service customers. Reserves treatment of lost revenues for a future generic proceeding.

Re Public Service Electric & Gas Corp., 150 PUR4th 314 (N.J.B.R.C.1994). Orders shareholders to absorb shortfall associated with discount in the price paid by a refinery company for electric utility service.

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Re Detroit Edison Co., 149 PUR4th 161 at 221 (Mich.P.S.C.1994). Shares between ratepayers and shareholders the costs of a load retention discount rate.

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