A Practical Guide to
Utility Ratemaking
• 130-page Workbook
• +100 Problems & Solutions
• Real Case Studies
• Most Common Errors
• Meets Mandatory Training
• Universal Implementation
Bound Hard-Copies Available
[Link]@[Link]
• The Revenue Requirement is what a utility • A Future Test Year is required for
must collect to cover costs and have an prospective ratemaking
opportunity for a reasonable rate of return
• Examining more than one issue at a time
• When the Revenue Requirement increases, avoids single-issue ratemaking
rates increase (and when the Revenue
Requirement decreases rates decrease) • Once approved in rates, removing a capital
project from rates is retroactive ratemaking
• The Rate of Return determines the Profit a
utility will earn • Memorandum and Balancing Accounts (i.e.
trackers and riders) prevent retroactive
• It is possible to compare a utility’s actual ratemaking
Rate of Return with its Authorized Rate of
Return (or compare actual Rate Base to • Including a capital project in rates provides
authorized Rate Base) the funds necessary for construction
• Lowering a utility’s Rate of Return lowers • Removing a proposed project from rates
the Revenue Requirement and the rates results in a regulatory disallowance
customers pay (all else being equal)
• Utilities require regulatory approval to
• Regulatory Accounting Follows Generally spend or build projects
Accepted Accounting Principles
• Requiring shareholder profits to be
• A Test Year must include the period in reinvested in utility infrastructure
which new rates will be in effect prevents windfall shareholder profits.
• The Revenue Requirement is what a utility • A Future Test Year is required for
must collect to cover costs and have an prospective ratemaking
opportunity for a reasonable rate of return
• Examining more than one issue at a time
• When the Revenue Requirement increases, avoids single-issue ratemaking
rates increase (and when the Revenue
Requirement decreases rates decrease) • Once approved in rates, removing a capital
project from rates is retroactive ratemaking
• The Rate of Return determines the Profit a
utility will earn • Memorandum and Balancing Accounts (i.e.
trackers and riders) prevent retroactive
• It is possible to compare a utility’s actual ratemaking
Rate of Return with its Authorized Rate of
Return (or compare actual Rate Base to • Including a capital project in rates provides
authorized Rate Base) the funds necessary for construction
• Lowering a utility’s Rate of Return lowers • Removing a proposed project from rates
the Revenue Requirement and the rates results in a regulatory disallowance
customers pay (all else being equal)
• Utilities require regulatory approval to
• Regulatory Accounting Follows Generally spend or build projects
Accepted Accounting Principles
• Requiring shareholder profits to be
• A Test Year must include the period in reinvested in utility infrastructure
which new rates will be in effect prevents windfall shareholder profits.
PG&E Resource: An
Encyclopedia of Energy
Utility Terms
Revenue Requirement:
Total Amount of money a
utility must collect from
customers to pay all
operating and capital
costs, including a fair
return on investment.
Revenue Requirement is a Budget
A utility can collect less
than its Revenue
Requirement and Exceed
its Authorized Profit
A utility can collect more
than its Revenue
Requirement and Fail to
make its Authorized Profit
If Revenue Requirement Increases
A. Rates must Increase
B. Rates must Decrease
C. Don’t Know
To Determine a Rate Change,
Need to Know Both…
Revenue Revenue at
Requirement Proposed Rates
Ability to Meet Revenue at
Revenue Requirement Present Rates
Revenue at Change in
Proposed Rates Average
- 1 x 100% =
Revenue at System
Present Rates Rates
• ∆ Revenue After a
Rate Change
• Most commonly
communicated
• Not the same as ∆
in Average Bill
What Do We Know
(or Don’t Know)
Case Study – A Water Utility’s
10% Proposed Rate Change
• Proposed a “10% Rate Increase”
• Revenue Requirement Increasing 10%
• During Drought Consumption had Fallen
• Ability to Meet RevReq Decreasing 20%
• Proposed Rate Change = 30%
Case Study #2 – A Telecom’s
Misunderstood Rate Change
• Delayed Decision – Interim Rates Authorized
• Final Decision Issued
• Revenue Requirements LESS than Previous
• Company MUST refund all interim rates
• Appellate Court Remands
Regulatory Constructs
• Rate Base x Rate of Return = Net Income
• Necessary for setting rates
• Impossible to compare to actual financials
• ROE is the bridge between Ratemaking & Financials
Example:
Authorized 10% Return on Equity, a 6% cost of debt, and a 50/50 capital structure for
an authorized Rate of Return of 8.0%
Calculating the utility’s “actual” Rate of Return next year. The result is 7.8% based on
actual cost of debt at 5%, the actual capital structure being 60% debt and 40%
equity, and an actual 12% return on equity.
“Actual” Rate of Return < Authorized Rate of Return…Increase Customer Rates?
Retroactive Ratemaking in California
• History of asserting memorandum and balancing
accounts prevent retroactive ratemaking
• Only necessary to assert if one believes that
retroactive ratemaking is unlawful
• Overly convenient to believe one is upholding the
law rather than engaging in bad policy
• Recognize when retroactive ratemaking is
necessary and explain why it is reasonable
Single-Issue Ratemaking
• Never justifiable or reasonable
• Legal standard of rates providing
an opportunity for a reasonable
return
• Single Issue Ratemaking =
Unknown Opportunity
• Need Revenue, Expense and
Capital Investment
• Safeguard when Retroactive
Ratemaking occurs
Proceeds from the Gain on Sale
• When / How Does it Occur?
• Who gets Proceeds (ratepayers
or shareholders)?
• Policy Determination - often
dependent on assets
• California Infrastructure
Investment Act
• All proceeds from the sale of
assets sold by a water utility
must be reinvested for ratepayer
benefit.
• Translated: Shareholders keep
100% of the Gain
A Practical Guide to
Utility Ratemaking
• 130-page Workbook
• +100 Problems & Solutions
• Real Case Studies
• Most Common Errors
• Meets Mandatory Training
• Universal Implementation
Bound Hard-Copies Available
[Link]@[Link]