Overview and Introduction Introduction to Cost of Service Concepts & Techniques

Overview and Introduction

Introduction to Cost of Service Concepts & Techniques

Objectives

Understanding and appreciation of different cost of service perspectives

Our challenges: Cost of service is not a science, it

is an art derived from processes viewed from differing perspectives

Steps in the Overall Ratemaking process

STEP 1 Study Preparation

STEP 2 Review Policies, Objectives and Strategies

STEP 3 Determine Utility Revenue Requirement

STEP 4 Functionalize Costs and Services into Business Units

STEP 5 Classification of Costs

STEP 6 Allocate Costs to Rate Classes

STEP 7 Interpret Cost of Service Results and Develop Rate Design

Steps in the Analytical Ratemaking process

STEP 1

Determine the revenue requirement of the utility

REVENUE REQUIREMENT DETERMINATIO

N

Step 2

Functionalize costs and services (production, transmission, distribution, etc.) COST

ALLOCATIONStep 3

Classify costs (demand,energy, customer costs, etc.)

Step 4

Allocate costs amongcustomer classes

Step 5

Design rates RATE DESIGN

Overview of Cost of Service Process

Introduction to Cost of ServiceConcepts and Techniques

Cost of Service Team Policy-Makers Finance Planning and Engineering Customer Service Accounting Others

Legal Marketing Conservation and DSM Economic Development

Stakeholders – Identification Customers Regulators Economic development interests Environmental community Special interest for social

concerns The utility Bankers, vendors, employees,

unions Mystics

Study Preparation


Study Preparation

Introduction Successful cost of service

analysis requires preparation and planning to ensure achievable results

Preparation time may be substantial

Four Important Considerations

1) Understand Study objectives, policies and strategies

What is the desired outcome from: Utility perspective Customer perspective Regulator perspective

Four Important Considerations (cont’d)

2) The reasonableness and defensibility of a Study is directly proportional to quality of data and thoroughness of analyses

Identify weaknesses or “Flash Points” likely to create controversy in your analysis


3) In the absence of quality data, it is better to make reasonable assumptions rather than to “walk away” from the issue Avoid getting lost in the

numbers Numbers are not a “crutch” Use “reasonableness” and

“common sense”


4) Know your system! Corporate/Legal/Jurisdictional Infrastructure Operations

Revenue Requirement


Steps in the Rate Design Process

STEP 1



N

Step 2


ALLOCATIONStep 3


Step 4


Step 5


Revenue Requirement

Definition – Revenue Requirement

For a utility system, the revenue requirement equals the total cost of serving customers in various rate classes

For each rate class, properly designed rates will generate sufficient revenues to equal the revenue requirement

Revenue Requirement

Revenue Requirement includes: Reasonable operating expenses Fair return on investment Consideration of other revenue

sources

Revenue Requirement

Definition – Test Year A 12-month period that reflects

financial and operating conditions that are expected to occur into the future

Historical Fiscal Year Accounting and Operating InformationAudited Financial Statements

Test Year reflects anticipated conditions

Revenue Requirement

Definition: Known and Measurable

Adjustments Financial and/or operating

adjustments to actual historical utility performance. Adjustments are based on proven changes that have occurred or are expected to occur in the near future

Revenue Requirement

Known and Measurable Adjustments Examples include:

Extraordinary capital projects Financing Re-organization, re-structuring Power supply

– Load changes

– Resource changes

Revenue Requirement

Definition: Used and UsefulAn investment or business activity that provides value to customers

Revenue Requirement

Revenue Requirement Components Operation and maintenance

expense Other cash or non-cash expenses Cost of capital Taxes or in lieu of taxes Return Less: other non-rate income

sources

Revenue Requirement

Utility Approach – Applicable to IOUs, Cooperatives and Municipal Utilities Industry standard for IOUs and

Cooperatives Occasionally used for Municipal

Utilities

FERC Uniform System of Accounts

100–199 Assets and other debits

200–299 Liabilities and other credits

300–399 Plant accounts

400–432, Income accounts

434-435

FERC Uniform System of Accounts (cont’d)

433, Retained earnings accounts436-439

440–459 Revenue accounts

500–599 Production, transmission and distribution expenses

900–949 Customer accounts, customer service and informational, sales, and general and administrative expenses

Example

Utility Approach (IOU) Revenue Requirement Example COS 5-1

Revenue Requirement

Definition: Rate Base (IOU) Investment upon which a utility

can earn a rate of return

Revenue Requirement Rate Base Components

Gross Plant in Service Accumulated Depreciation Accumulated Provision for

DeferredIncome Taxes

Electric Plant Held for Future Use Construction Work in Progress Allowance for Funds Used During

Construction Working Capital

Revenue Requirement

Return on Rate Base (IOUs) Appropriateness

Cost of debt Cost of equity Business risk

Consistency

Revenue Requirement

Return on Rate Base (IOUs) Weighted Average Cost of Capital

(WACC) A regulated utility is allowed to earn a

return on its investment. The return included in the revenue requirement is the Rate Base multiplied by a percentage rate of return (ROR)

Example:– Rate Base = $100 million– Allowed ROR = 9.85%– Allowed Return = $9.85 million per year

Revenue RequirementWeighted Average Cost of Capital (WACC) (cont’d) The overall ROR consists of amounts to cover

the costs of long-term debt and preferred stock, plus a return on stockholder equity comparable to that of other investments of similar risk

Example:Item % of Capital Cost Weighted Cost

Long-Term Debt 40% 7% 2.80%

Preferred Stock 5% 9% 0.45%

Equity 55% 12% 6.60%

TOTAL 100% N/A 9.85%

Revenue Requirement

Return on Rate Base (IOUs) Cost of Debt

Long Term Debt Short term borrowing Preferred Stock - Equity securities

that pay a fixed dividend regardless of corporate earnings and offer preferential rights in regard to distribution of assets upon liquidation

Straight forward calculation

Revenue Requirement

Return on Rate Base (IOUs) Cost of Equity

Industry average– Value Line

History Unique circumstances

Example

Utility Approach (IOU) Rate Base Example COS 5-2

Cost Allocation Methodologies


Cost Allocation Cost allocation is the process

of taking the total revenue requirements and spreading it over the various classes of customers

The ultimate goal is to allocate costs in a fashion which reflects the cost of providing services to each class (a cause-and-effect relationship)

Steps in the Ratemaking process

STEP 1



N

Step 2


ALLOCATIONStep 3


Step 4


Step 5


Functionalize Costs

Typical cost functions include:

Production (and/or purchased power)

Transmission Distribution Customer Care

Classify Costs Typical cost classifications include: Demand Costs

Costs that vary with the kW demand imposed on the system

Energy Costs Costs that vary with the energy or kWh sold or

purchased Customer Costs

Costs that are related to the number of customers served

Revenue Related Costs Costs that vary with revenue

Direct Assignment Costs specifically assigned to a particular

customer or group of customers

Allocate Costs Costs are allocated based on a

combination of function, classification, and other attributes

Allocation factors are developed for each cost classification Demand (CP, 12CP, NCP, etc.)

Energy (kWh)

Customers (unweighted, weighted)

Others (revenue, labor, blended/derived allocation factors)

Allocation factors are used to spread costs among customer classes (residential, commercial, industrial, lighting)

Common Approaches to Cost Allocation

Embedded Marginal

Definition – Embedded Cost

Average system costs assuming all utility resources spread across all customers

Generally based on historical or known costs

Definition – Marginal Cost

Costs experienced or avoided when a unit of output is added or forgone.

MC =

∆ Total Cost∆ Quantity

Common Approaches to Cost Allocation (cont’d)

Bundled Approach

Unbundled Approach

Bundled Approach Cost Allocation

Mirrors utility accounting practices

Cost of service results are bundled and presented from the utility’s perspective

Limits rate design

Bundled Approach

RevenueReqs.

Ops. &Maintenance

Expense

Depreciation

Taxes

Return onRatebase

Other

COST OF SERVICECOST OF SERVICEBY RATE CLASSBY RATE CLASS

Resid

entia

l

Smal

l

Comm

ercial

Larg

e

Comm

ercial

Ligh

ting

Unbundled Approach Cost Allocation

Mirrors utility products, services and activities

Cost of service results are unbundled and presented from the customer’s perspective

Flexible rate design

Unbundled Approach

RevenueReqs.

Ops. &Maintenance

Expense

Depreciation

Taxes

Return onRatebase

Other

COST OF SERVICECOST OF SERVICEBY RATE CLASSBY RATE CLASS

Res

iden

tial

Smal

l

Com

mer

cial

Larg

e

Com

mer

cial

Ligh

ting

RevenueReqs.

Prod.

Trans.

Distrib.

Customer

Prod

uction

Cust

omer

Tran

smis

sion

Dis

trib

utio

n

Functionalization of Costs


Steps in the Rate Design Process

STEP 1



N

Step 2


ALLOCATIONStep 3


Step 4


Step 5


What Business Are You In?

GeneratingStation

ResidentialCustomer

CommercialCustomer

DistributionSubstation

IndustrialCustomer

High VoltageTransmission

TransmissionSubstation

Four Common Business Units

Production Transmission Distribution Customer Care

Allocating Costs to Business Units

Unbundle Test Year Revenue Requirement into Business Units Direct Assignments Derived Allocation

Allocation representing the sum, average or weighted effect of differing underlying allocation methods

Example: Direct Assignment – Distribution

FERCAcct.

Description

AllocMetho

d

Amount

ProdTran

sDist Cust

582 Station Exp. Direct1,000,00

00 0 1,000,000 0

Allocation % 100% 0% 0% 100% 0%

Example: Derived Allocation – Administration and General Salary Expense

What are the underlying activities impacting the level of Administration and General Salary Expense in your organization?

Support and Management of the Labor Force

Strategic Planning Regulatory


Cost Drivers associated with management of the Labor Force

Employee Salaries Number of Employees


Cost Drivers associated with Strategic Planning Rate Base Capital Improvement Plan


Cost Drivers associated with Regulatory Activities Rate Base Outside Services Employed


A&G Salary Allocation Based on Labor Salaries

Labor SalariesBusiness

Unit Total Prod Trans Dist Cust

Production 3,000,000 3,000,000 0 0 0

Transmission 1,000,000 0 1,000,000 0 0

Distribution 5,000,000 0 0 5,000,000 0

Customer 500,000 0 0 0 500,000

Total 9,500,000 3,000,000 1,000,000 5,000,000 500,000

% Allocation 100% 32% 11% 52% 5%


FERCAcct.

Description

AllocMetho

dAmount Prod Trans Dist Cust

920A&G Salaries

Derived1,000,00

0320,00

0110,000 520,000

50,000

Allocation %

100% 32% 11% 52% 5%

Classification of Costs


Development of Allocation Factors

STEP 1



N

Step 2


ALLOCATIONStep 3


Step 4


Step 5


Basic Cost Categories

Fixed Cost Variable Cost

Fixed Costs

Do not vary materially with electricity use or number of customers Examples:

Labor Insurance Depreciation Interest

Variable Costs

Vary with production or electricity use Examples:

Fuel Variable production costs

Typical Cost Classifications

Demand Energy Customer Revenue Direct Assignments

Demand-Related Costs

Costs that vary with the kilowatt demand imposed on the System Examples:

Demand portion of production Transmission Demand component of distribution

plant

Energy-Related Costs

Costs that vary with the energy or kilowatt-hours provided by the utility Examples:

Fuel Variable production costs

Customer-Related Costs

Costs that are related to the number of customer services Examples:

Customer billing Meter reading Customer service Capital cost of meters and services O&M costs of meters and services

Revenue-Related Costs

Costs that vary with revenue Examples:

Taxes Public benefit charges

Direct Assignments

Costs assigned directly to a particular customer or Class of customers Examples:

Line extensions to specific customer Street and security lighting

Summary of Cost Functions and Classifications

Production: Demand RelatedEnergy Related

Transmission: Demand RelatedDirect Assignments

Distribution: Demand RelatedCustomer RelatedDirect Assignments

Customer Service: Customer Related

Typical Cost Classifications

Typical CostFunctions

Rate Class Determination


Issues

Are Rate Classes needed? Why do we have them? What are they? Changes in approach

Number of classes Type of classes Classes within classes Cost of service support

Why Have Rate Classes?

Different load characteristics Different service voltages Different costs to serve

Load density Reliability requirements Other (discussion)

Desire for different returns

Typical Classes Residential Small Commercial Large Commercial Industrial Agricultural Municipal Streetlighting Security Lighting Net Metering? Off-System Sales (Market Driven)

Changes in Approach – Industry Restructuring

Rate Design’s impact on rate class determination

Time-of-Use rates can compensate for different load characteristics

Real-Time pricing even better Need for different ROIs Need for Non-Demand vs. Demand

Rates Use service voltage discounts to

reduce number Small number of classes is preferable Other



Steps in Ratemaking Process

STEP 1



N

Step 2


ALLOCATIONStep 3


Step 4


Step 5



How do you develop allocation factors? Which allocation factors are

needed? What are allocation factors based

on? Information and data needs? Who has the information?


Allocation Methodology must align with Cost Classification

Demand-Related Coincident Peak Non-Coincident Peak Sum of Max Demands

Energy-Related kWh Sales Net Energy for Load


Demand/Energy Hybrids Average and Excess Demand Other


Customer-Related Number of customers Weighted number of customers

Revenue-Related Direct Assignment

Coincident Peak

Definition: Class demand at the time of the System Peak Annual Monthly Hourly

Class Contribution to Coincident Peak

Class Contribution to Peak Demand – Annual Peak

0

200

400

600

800

1,000

1,200

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Dem

and

(MW

)

Class A Class B Class C

Class A PeakNon-Coincident Peak

Class B PeakNon-Coincident PeakClass C Peak

Non-Coincident Peak

Annual Coincident Peak

Non-Coincident Peak

Definition: Maximum demand of a customer class, regardless of when it occurs.

Class Non-Coincident Peak Compared to Contribution to System Coincident Peak

Class Contribution to Peak Demand – Monthly

0

200

400

600

800

1,000

1,200

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Dem

and

(M

W)

Class A Class B Class C

Class A PeakNon-Coincident Peak

Class B PeakNon-Coincident Peak

Class C PeakNon-Coincident Peak

Annual Coincident Peak

Sum of Maximum Demands

Definition: Sum of demands measured at the meter

Load profile meter Billed Demand

Beware of ratchets! Estimated Demands

Load factors Load research study results

Concept of Coincidence and Diversity

Sum of Maximum Demands

Totalized Class Peak Demands (Class NCP)

System Coincident(Class CP) Peak Demands

Residential

Commercial

Industrial

Demand Cost Allocation – Typical Methods

Coincident Peak (CP) Method Based on the theory that the

demand costs are most strongly influenced by class demands imposed on the system at the time of the system peak

Variations of the Coincident Peak (CP) Method

1 CP – Based on class CP demands for the month in which the annual system peak occurs.

2 CP, 3 CP, 4 CP, etc. – Based on class CP demands for each of the months of highest system demands.

Examples: A summer peaking system might allocate demand

costs on the basis of class CP demands in each of the 4 months June through September.

A winter peaking system might allocate demand costs on the basis of class CP demands in each of the 3 or 4 winter months.

A system with significant summer and winter peaks might allocate demand costs on the basis of class CP demands in each of 1 to 4 summer months and 1 to 4 winter months.

12 CP – Based on class CP demands for each of the 12 months of the year.

Examples of Demand Cost Allocation Methods Data Sheet

Monthly Coincidental Peaks (kW)

Class A Class B Class C Total

Jan 300 250 280 830 Feb 310 240 250 800 Mar 320 200 250 770 Apr 300 200 250 750 May 300 220 250 770 Jun 430 230 240 900 Jul 460 240 240 940 Aug 470 290 240 1,000 Sep 430 240 250 920 Oct 310 200 250 760 Nov 310 200 250 760 Dec 320 230 250 800 Total

4,260 2,740 3,000 10,000

Annual Non-CoincidentalPeaks (kW)

480 310 285 1,075

Annual Energy (kWh)

1,270,000

1,051,000

1,752,000

4,073,000

Demand Costs ($)

$100,000

Monthly CoincidentalPeaks (kW)


Jan 300 250 280 830Feb 310 240 250 800Mar 320 200 250 770Apr 300 200 250 750May 300 220 250 770Jun 430 230 240 900Jul 460 240 240 940Aug 470 290 240 1,000Sep 430 240 250 920Oct 310 200 250 760Nov 310 200 250 760Dec 320 230 250 800Total 4,260 2,740 3,000 10,000

Annual Non-Coincidental Peaks (kW)

480 310 285 1,075

Annual Energy (kWh) 1,270,000 1,051,000 1,752,000 4,073,000

Demand Costs ($) $100,000

Allocation Based on 1 CPMethod Demand Used for Alloc. 470 290 240 1,000 Allocation Percentage 47.00% 29.00% 24.00% 100.00% Allocated Demand Cost $47,000 $29,000 $24,000 $100,000

Examples of Demand Cost Allocation Methods (1 CP Method)





480 310 285 1,075



Allocation Based on 4 CPMethod Demand Used for Alloc. 1,790 1,000 970 3,760 Allocation Percentage 47.60% 26.60% 25.80% 100.00% Allocated Demand Cost $47,600 $26,600 $25,800 $100,000






480 310 285 1,075



Allocation Based on 12CP Method Demand Used for Alloc. 4,260 2,740 3,000 10,000 Allocation Percentage 42.60% 27.40% 30.00% 100.00% Allocated Demand Cost $42,600 $27,400 $30,000 $100,000



Non-Coincident Peak (NCP) Methods Based on the theory that

demand costs are most strongly influenced by the highest demand of each class, whenever it occurs

Variations of the Non-Coincident Peak (NCP) Method

NCP – Based on the greatest demand of each customer class at any time during the year

12 NCP – Based on the non-coincident peak demands of each customer class for each of the 12 months of the year

NCP MethodMonthly Non-Coincident Peaks (kW) Class A Class B Class C Total

Jan 316 263 285 Feb 326 253 254Mar 337 211 254Apr 309 250 263May 309 275 263Jun 443 288 253Jul 469 257 244 Aug 480 310 244Sep 439 257 254Oct 320 214 254Nov 320 214 250Dec 330 246 258 Total of 12 NCP 4,398 3,038 3,076

Annual Non-Coincident Peaks (kW) 480 310 285


Demand Costs ($) 100,000$

Allocation Based on 1 NCP METHODDemand Used for Allocation 480 310 285 1,075 Allocation Percentage 44.6% 28.9% 26.5% 100.0%Allocated Demand Cost 44,651$ 28,837$ 26,512$ 100,000$

Allocation Based on 12 NCP METHODDemand Used for Allocation 4,398 3,038 3,076 10,512 Allocation Percentage 41.8% 28.9% 29.3% 100.0%Allocated Demand Cost 41,838$ 28,900$ 29,262$ 100,000$

864833802822847984970

1,034950788784834

10,512

1,075


Average and Excess Demand (AED) Method Based on the theory that

demand costs are influenced both by the non-coincident peak of each customer class and by the energy usage - or average demand - of each customer class





480 310 285 1,075



Allocation Based on AEDMethod Demand Used for Alloc. 438.8 286.6 274.6 1,000 Allocation Percentage 43.88% 28.66% 27.46% 100.00% Allocated Demand Cost $43,880 $28,660 $27,460 $100,000

Examples of Demand Cost Allocation Methods (AED Method)

Examples of Demand Cost Allocation Methods (AED Method cont’d)

Average and Excess Demand Method

Class A Class B Class C Total Calculation

Annual Energy (kWh) 1,270,000 1,051,000 1,752,000 4,073,000 A

Hours in Year 8,760 8,760 8,760 8,760 B

Average Demand 145 120 200 465 C = A / B

Non-Coincident Peak Demand (kW)

480 310 285 D

Average Demand (kW) 145 120 200 C

Class Excess Demand (kW) 335 190 85 610 E = D - C

System Coincidental Peak (kW) 1,000 F

System Average Demand (kW) 465 C

System Excess Demand (kW) 535 G = F - C

Excess Allocation Factors 335/ 610 190/ 610 85/ 610 H = E / E total

Allocated Excess Demand (kW) 293.8 166.6 74.6 535.0 I = G X H

Summary

Average Demand (kW) 145 120 200 465 C

Allocated Excess Demand (kW) 293.8 166.6 74.6 535 I

Total (kW) 438.8 286.6 274.6 1,000

Allocation Percentage 43.88% 28.66% 27.46% 100.00%

Allocated Demand Cost $43.880 $28.660 $27.460 $100.000

Examples of Demand Cost Allocation Methods (Summary of Results)

Demand Cost

Allocation Percentage

sClass A Class B Class C Total

1 CP Method 47.00% 29.00% 24.00% 100.0%

4 CP Method 47.60% 26.60% 25.80% 100.0%

12 CP Method 42.60% 27.40% 30.00% 100.0%

1 NCP Method 44.65% 28.84% 26.51% 100.0%

12 NCP Method

41.80% 28.90% 29.30% 100.0%

AED Method 43.88% 28.66% 27.46% 100.0%

Range41.80 – 47.60%

26.60 – 29.00%

24.00 – 30.00%

Ratio, High/Low

1.14 1.09 1.25

Energy-Related Allocation Factors

Energy Allocation Factors kWh Sales adjusted for losses

Energy-Related Allocation Factors

Annual Energy (kWh) Class A Class B Class C Total

Voltage Class Served at: Secondary Secondary Primary

At the Generator 1,270,000 1,051,000 1,752,000 4,073,000 Transmission Loss 1.5% 19,050 15,765 26,280 61,095

Sales 1,250,950 1,035,235 1,725,720 4,011,905 Primary Loss 1.5% 18,764 15,529 25,886 60,179

Sales 1,232,186 1,019,706 1,699,834 3,951,726 Distribution Loss 2.0% 24,644 20,394 NA 45,038

Allocation Percentage by Delivery Voltage At the Generator 31.2% 25.8% 43.0% 100.0%

Transmission 31.2% 25.8% 43.0% 100.0%

Distribution Primary 31.2% 25.8% 43.0% 100.0% Distribution Secondary 54.7% 45.3%

0.0%

100.0%

Sales 1,207,542 999,312 2,206,854 NA

Customer-Related Allocation Factors

Customer Allocation Factors Weighting Factors Special Studies

Customer-Related Allocation Factors

Total System Class A Class B Class C

No. of Customers 90,000 72,000 12,000 6,000

Allocation % 80.0% 13.3% 6.7%

Billing & Collection Weighting Factors

1.0 2.0 10.0

Weighted Numbers of Customers

156,000 72,000 24,000 60,000

Allocation % after Weighting 46.2% 15.4% 38.4%

Other Methods to Allocate Costs

Revenue Related Allocation Factors

Direct Assignments Note: Some costs are specifically

assigned to a particular customer or class of customers if it can be determined that those costs related only to that customer or customer class

Primary/ Transmission level customers should not be allocated distribution level costs

Interpreting Cost of Service Results


Subsidization

The act of financially supporting service to one group of customers through excess collection of revenues from another group of customers.

Overview

Subsidization Interclass Intraclass

Interclass Subsidization

One class of customers subsidizing another class of customers.


Revenues CollectedClass RevenuesResidential 50%Small Commercial 20%Large Commercial 10%General Service 20%

100%


Cost of Service ResultsRevenue

Class RequirementsResidential 55%Small Commercial 18%Large Commercial 8%General Service 19%

100%


Revenues vs. Revenue Requirements

0%

10%

20%

30%

40%

50%

60%

Residential Small Commercial Large Commercial General Service

Customer Class

Revenue Requirements Revenues

Intraclass Subsidization

Customers within a specific class subsidizing other customers in the same class based on design of the rate and differing consumption.

Intraclass Subsidization Examples

Assume for the following two examples that the Cost of Service study indicated that the respective classes (residential and general service) are contributing an adequate amount of total class revenues (no interclass subsidy exists).

Intraclass SubsidizationResidential Class

Existing Rate COS Rate

Customer Charge $5/mo. $12/mo.

Energy Charge $0.07/kWh $0.06/kWh

Intraclass SubsidizationResidential Class

$0

$10

$20

$30

$40

$50

$60

$70

$80

0 100 200 300 400 500 600 700 800 900 1000

kWh

Mon

thly

Bill


Intraclass SubsidizationGeneral Service Class


Demand Charge $6/kW-mo. $10/kW-mo.

Energy Charge $0.04/kWh $0.03/kWh

Intraclass SubsidizationGeneral Service Class

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

$1,600

$1,800

10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Mon

thly

Bill (1

0,0

00

kW

h)

Load Factor


General Ratemaking and Regulatory Principles

Introduction to Rate Design

Introduction

Bonbright — Common Reference

Industry Changes — Competition

Social Pricing Objectives The Art of Balance

Bonbright Principles Practical Uncontroversial as to

interpretation Meet revenue requirements Revenue stability Rate stability Fairness among customer classes Avoidance of undue discrimination Economic efficiency

Factors Affecting Electric Utilities and Their Customers Inflation rates Fuel costs Uncertainty of fuel availability Uncertainty of the future of nuclear power Environmental concerns Uncertainty in predicting load growth Construction delays Increasing capital requirements Regulatory requirements Conservation of electricity and natural

resources New technologies

Objectives of Utility Ratemaking Cost of service What the public wants Fairness to all consumers Marginal costs Price as a resource-control measure Competition, market forces and elasticity Need for a cushion above costs Simplicity vs. complexity Price as a taxing measure Price as a welfare measure Quality of service Differences among communities'

concerns

Factors Which Can Influence theRate-Making Objectives of an Electric Utility

Overall cost of service Types of generation and fuel Self-generation vs. purchased power The size of the utility The age of its physical plant and rate of growth

of the system Sources of capital or other funding arrangements Competition in the form of alternate fuels and/or

the rates of neighboring utilities Customer mix Time-of-Use service Weather Legislation and regulation

Four Major Reasons for Rate Adjustments

Revenue adjustment Up or Down

Cost of service realignment Competitive factors Legislative and regulatory

mandate EPAct 2005

Competing Objectives

Meet revenue requirements

Low rates

Equity and fairness

Behavior modification

Social issueresponsiveness

Ability to compete

Legislative mandates

Simplicity and understandability

Unbundling TOU and Real

Time Rate Complexity

Simplicity

Time-of-Use and Real-Time rates frustrate simplicity

Critical Peak Pricing and Load Curtailment add complexity

Unbundled rates frustrate (but also enhance) understandability

Adjustments for costs (e.g., ECAC) add to complexity

Electric Utility PricingTrends That Matter

Introduction to Rate Design

What are the Top Issues by Utilities?* (2009)

* Based on programs from 2009 NRECA, APPA and EEI conferences

ISSUE (UNRANKED)COOP

sIOUs

MUNIs

Renewables - requirements, power supply, pricing

■ ■ ■

Energy Efficiency - program design, rates ■ ■ ■

Carbon - capture/sequestration/storage, pricing

■ ■ ■

Emerging Technology - smart grid/metering, data centers, broadband over power lines

■ ■ ■

Electric vehicles - infrastructure, pricing, load impact

■ ■ ■

Finance/credit issues - stimulus money, tight credit markets

■ ■ ■

Advanced Rates - TOU, net metering ■ ■ ■

Distributed Energy - feed-in tariffs, backup ■ ■

Nuclear Power ■ ■ ■

Transmission ■

What are the Top Issues by Utilities?* (2006-07)

* Based on programs from 2006-07 NRECA, APPA and EEI conferences

ISSUE (UNRANKED)COOP

s IOUsMUN

Is

Global Climate Change/Carbon Emissions ■ ■ ■

Challenges of Building New Generation ■ ■ ■

Finances/Credit Issues ■ ■ ■

Developing the Workforce of the Future/Partnering/Recruiting/Succession Planning

■ ■ ■

Emergency Preparedness ■ ■

Efficiency of Customer Relationships Through Technology

■ ■ ■

Industry Reliability ■ ■

Hurricane Damage Response ■ ■

Rate Impact of Rising Costs ■ ■ ■

Transmission Expansion ■ ■

Growth Strategies ■ ■ ■

Renewables in the Generation Portfolio ■ ■ ■

Utility Costs Continue to Rise

Load growth (new supply) Infrastructure catch-up New infrastructure Economic environment,

increased inflation, capital costs Emissions Security Fuel

Source: Sieben Energy Associates, a Chicago-based energy consulting firm.

Pricing: The Interface of Utility Realities and Customer Expectations

Utility Realities Demand Regulations Cost of Money Technology Green Power Infrastructure

Replacement/Renewal

Workforce

Customer Expectations Low Cost

Choice

Flexibility

Responsive

Technologically Savvy

Socially Responsible

PR

ICIN

G

Rate Design Discussion

Documents

Overview and Introduction Introduction to Cost of Service Concepts & Techniques