Alternative Electricity Ratemaking Mechanisms Adopted by Other States

Categories: Rate Design -    View PDF

May 25, 2016

Mat Morey

Laurence Kirsch

Electricity rates have traditionally been set according to utilities’ costs of service. Over the past forty years, however, the electric power industry and its regulators have developed and experimented with a range of ratemaking mechanisms that depart from traditional embedded cost-based ratemaking. The development of these non-traditional ratemaking mechanisms has been spurred by the need to deal with uncertainties in input prices (like fuels) that are beyond utility control, by a desire to improve utilities’ performance incentives, by the opportunities created by the restructuring of and competition in wholesale electricity markets, by public policy support for renewable energy, by technological progress in generation and information technologies, and by declining rates of electricity sales growth. In short, the evolution of the electric power industry is having and will continue to have substantial impacts on utility costs and on the considerations that influence how electricity should be priced.

In Alternative Electricity Ratemaking Mechanisms Adopted by Other States, Laurence Kirsch and Mat Morey identify and analyze eleven types of alternative ratemaking mechanisms adopted by various states, particularly those that allow electric transmission and distribution utilities to seek timely recovery of infrastructure costs while preserving incentives to achieve other goals that might be fostered by appropriate rate design. The alternative ratemaking mechanisms are all variants of traditional cost-of-service ratemaking, so they all rely on a determination of an initial revenue requirement through a cost-of-service study. But while traditional regulation generally allows rate changes relatively infrequently, the alternatives generally update the revenue requirement at regular intervals in response to changes in utility costs, sales, and profits. This updating mitigates the potential for rate shock and conflict among parties that sometimes accompany the relative infrequency of traditional rate cases.

The report was prepared at the behest of the Public Utility Commission of Texas.