Cost of Service, Rate Cost of Service, Rate Design, Design, and Price Efficiency and Price Efficiency Bruce Chapman Christensen Associates Energy Consulting October 3, 2012 Wisconsin Public Utility Institute Wisconsin Public Utility Institute Fundamental Course: Energy Utility Basics Fundamental Course: Energy Utility Basics
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Cost of Service, Rate Design, and Price Efficiency Bruce Chapman Christensen Associates Energy Consulting October 3, 2012 Wisconsin Public Utility Institute.
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Cost of Service, Rate Design,Cost of Service, Rate Design, and Price Efficiency and Price Efficiency
Bruce ChapmanChristensen Associates Energy
ConsultingOctober 3, 2012
Wisconsin Public Utility InstituteWisconsin Public Utility InstituteFundamental Course: Energy Utility BasicsFundamental Course: Energy Utility Basics
October 3, 2012 2
AgendaAgenda
Regulation and Ratemaking Cost of Service Rate Design
Regulation and RatemakingRegulation and Ratemaking
October 3, 2012 4
Rationale for RegulationRationale for Regulation
Not all markets for electricity services are “workably competitive,” capable of producing competitive outcomes
Rate regulation tries to approximate competition: Price ≈ Marginal Cost
In practice, regulation strives to satisfy many goals
October 3, 2012 5
Goals of Public Utility Ratemaking: Goals of Public Utility Ratemaking: A Balancing ActA Balancing Act
Reasonable rates for consumers Fair return for investors, comparable
to return earned by other businesses with corresponding risk
Rates that reflect cost Minimization of subsidies Protect customers from large bill
Energy and demand forecast Revenue requirements Rate of return and return on equity Cost of service:
Allocate costs to jurisdiction, customer class and rates within each customer class
Rate design: Design rate structures and set prices
Cost of ServiceCost of Service
October 3, 2012 8
Why Compute Cost of Service? Why Compute Cost of Service?
Per the National Association of Regulatory Utility Commissioners (NARUC), the cost-of-service standard remains the primary criterion for reasonableness of rates
What is an embedded Cost-of-Service Study? An analysis in which a utility's embedded cost
of providing service (i.e., revenue requirements) is determined by jurisdiction and customer classes or other groupings within jurisdiction
Embedded costs are the accounting costs on the company’s balance sheet and income statement, adjusted for regulatory conventions
Production (Generation) Process of converting other forms of energy
into electricity Transmission
Process of sending the electricity generated at the centralized power station through wire at high voltage to the substation where it is transformed to low voltage
Distribution Process of delivering electricity to customer
meters through low voltage lines General plant support and other
October 3, 2012 14
Cost-of-Service StepsCost-of-Service Steps
Compile Functionaliz
e Levelize Classify Assign Allocate Determine
Return
Step 3
Identify rate base, expenses, and customers (and their usage) with voltage service levels:
Customers are responsible for costs at their level and higher.
October 3, 2012 15
Develop Levelized Demand Develop Levelized Demand and Energy Allocatorsand Energy Allocators
Service Level Designation and Power Flow Diagram
1
2
3
4
5
Transmission Line46kW to 500 KW lines
Generation and Territorial Input
Transmission to Distribution Transformation
Primary Distribution Lines25kV and lower
Line Transformers
Indicates power flow
Service Level
October 3, 2012 16
Cost-of-Service StepsCost-of-Service Steps
1. Compile
2. Functionalize
3. Levelize
4. Classify
5. Assign
6. Allocate
7. Determine Return
Step 4
Classify rate base and expense items by cost causative (and observable) characteristics:
a. Energy-relatedb. Demand-relatedc. Customer-relatedd. Revenue-related
COS analysis distributes rate base, revenues, and costs across tariff groups according to a well-defined set of rules: Create rows for each function and voltage
level Classify each row by cost causation factor Spread across columns of rates according to
assignment and allocation COS Results: essentials for rate design
Revenue requirement (target: 12%, actual 8.94%)
Unit costs and current rate of return by tariff
October 3, 2012 27
Common Criticisms of Common Criticisms of Cost-of-Service RatemakingCost-of-Service Ratemaking
Incentives to utilities: Cost-plus: cost coverage except for
expenditures deemed imprudent by regulator
Potential to distort utility capital decisions
Pricing outcomes: Use of accounting/embedded costs means
that prices will not necessarily be close to marginal cost
Inefficiency of price signals can encourage excessive/needlessly low consumption
Rate DesignRate Design
October 3, 2012 29
Bonbright PrinciplesBonbright PrinciplesCriteria of a Sound Rate StructureCriteria of a Sound Rate Structure
Simple and acceptable Freedom from controversy Yield total revenue requirements Revenue stability Rate stability Fair Avoid undue discrimination Encourage efficient use
From James C. Bonbright, Principles of Public Utility Rates, 1968. Although dated, many still look to these for guidance in setting public utility rates.
October 3, 2012 30
Goal CompatibilityGoal Compatibility
How do we resolve competing goals? Examples:
Rate simplicity vs. price pattern matching cost pattern.
Cost responsibility vs. customer incomes.– Customer charges are typically below fixed
costs
Revenue recovery of embedded cost vs. price efficiency of marginal cost
Desire to promote conservation and renewables vs. pursuing least cost
October 3, 2012 31
ConsiderationsConsiderations
Does the approach recognize all costs?
Can revenue recovery be separated from pricing to some degree?
Can we achieve with pricing what we first try to achieve with rules and regulations? Prices are self-policing. Can prices be used to support
regulations and rules?
October 3, 2012 32
Rate Design Flow ChartRate Design Flow Chart
Rate Design Process
ChooseAlternative
Designs
VerifyRevenues
BillImpact
Analysis
Resulting Rate Design
Metering & Billing Data
AccountingInformation
EmbeddedCOSS
MarginalCOSS
Load Research
& Analysis
MarketResearch
Competitive Forces
Strategic Goals
TacticalGoals
Post RolloutEvaluation
Rate Design Process
ChooseAlternative
Designs
VerifyRevenues
BillImpact
Analysis
Resulting Rate Design
Metering & Billing Data
AccountingInformation
EmbeddedCOSS
MarginalCOSS
Load Research
& Analysis
MarketResearch
Competitive Forces
Competitive Forces
Strategic Goals
Strategic Goals
TacticalGoals
TacticalGoals
Post-RolloutEvaluation
October 3, 2012 33
Types of Charges Types of Charges
Three major ways to bill a customer Customer or base charge:
$/customer/month Demand (highest level of measured
Customer billed via customer and energy charges. Energy price is a single number applying to all consumption in period.
The flat rate is a guaranteed price for a product which depends on: Load-weighted average of embedded cost Hourly cost volatility Customer load volatility Hourly cost volatility/ customer load correlation
Provider offers risk management of electricity service costs to customers
October 3, 2012 36
Blocked RatesBlocked Rates
Energy price varies with amount consumed Surpassing a block threshold causes the marginal
price for energy to change Beyond the first block, the average price paid
differs from the marginal price There can be multiple thresholds; n thresholds
results in n+1 blocks
Block prices can be set to be decreasing, increasing, u-shaped, or n-shaped with load
Moving block prices in the direction of marginal cost can improve price efficiency e.g., high summer tail block price for air
conditioning
October 3, 2012 37
Blocked Tariff PricingBlocked Tariff Pricing
Hour of the Day
Monthly Consumption (kWh)
Price
HourlyConsumption
(kWh)
I
II
III
III
III
HighCost
700 1400
1 24
October 3, 2012 38
Demand and Energy RatesDemand and Energy Rates
Hopkinson demand rate: Bills customers for maximum measured
demand and for energy usage, plus customer charge
Example:– $10.00 per kW of maximum demand per month– $0.08 per kWh usage in a given billing month– $200 per month customer charge
Rates can have declining or inverted block demand and/or usage charges
October 3, 2012 39
Wright Hours-of-Use RateWright Hours-of-Use Rate
Requires measurement of monthly demand (kW) and usage (kWh), but
Charges customers according to usage per demand unit: (HOU = kWh/kW)
Acts as a customer-specific blocked rate Provides blocked pricing efficiency under
traditional metering Example:
e.g., 5 ¢/kWh for first 300 “hours of use,” 4¢/kWh thereafter
Watch out! Increase your peak demand and you push kWh back across the block boundary.
Hours of Use = kWh/(kW)(max = 720 (100% load factor))
Hour of the Day1 24
October 3, 2012 41
SummarySummary
Regulation and Ratemaking Leads to embedded cost-based COS
Cost of Service Seven steps yield costs and rate of return by
rate; provide basis for revenue request and rate setting
Rate Design Rates serve multiple objectives, leading to
trade-offs– Revenue recovery and pricing efficiency are central
Innovative rates add pricing efficiency and complexity
Appendix 1. Illustrative COS TablesAppendix 1. Illustrative COS Tables
October 3, 2012 43
Typical Power CompanyTypical Power CompanyCost-of-Service StudyCost-of-Service Study
Total Small Large High Total Total UnitLine Electric General General Load Outdoor Retail All Other PowerNo. Description System Residential Services Service Factor Lighting Service Service Sales1 2 3 4 5 6 7 8 9 10 11
Investment
1 Electric Gross Plant 1,591,960 825,803 295,638 154,890 61,577 30,527 1,368,435 36,340 187,1852 Accumulated Depreciation 630,023 339,107 124,597 68,486 26,438 8,127 566,755 16,147 47,1213 Net Plant 961,937 486,696 171,041 86,404 35,139 22,400 801,680 20,193 140,0644 Materials and Supplies 62,495 28,685 13,877 9,392 3,649 576 56,179 1,866 4,4505 Cash Working Capital 44,079 20,200 9,443 6,402 2,646 487 39,177 1,226 3,6766 Other Rate Base Items 20,856 8,288 2,893 1,464 589 352 13,586 343 6,9277 Total Electric Investment 1,089,367 543,869 197,254 103,662 42,023 23,815 910,622 23,628 155,117
Typical Power CompanyTypical Power CompanyCost-of-Service StudyCost-of-Service Study
Total Small Large High Total Total UnitLine Electric General General Load Outdoor Retail All Other PowerNo. Description System Residential Services Service Factor Lighting Service Service Sales1 2 3 4 5 6 7 8 9 10 11
Automatic, pre-scheduled review of a company’s earnings Defined formula for evaluations Provides rates of return or margin coverage Usually specific about allowed cost and