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Electricity Facts
Utility Economics
A brief description of the structure of the utilities on the United States is required to provide the context for utility operation in the United States. Normally monopolies are illegal; customers must have a choice of suppliers. To allow capital intensive electrical generators to exist (tied to expensive, immobile transmission grids), the regulated monopoly of the public utility has been created. The public utility can be privately or publicly owned. Most large utilities are owned by private investor groups and are called “Investor Owned Utilities” or IOUs.
In a few cases a city or county may own a utility, but this is less common. These publicly owned utilities are called “Publics.” Both the IOUs and the Publics are regulated by the same regulatory agency, the Public Utility Commission or PUC. The PUC is run by a set of Commissioners appointed by the local state government. Therefore, utilities are regulated primarily by the state government. The PUC sets the profitability of the IOUs and the Publics in several principal ways:
- The PUC sets the “allowed rate of return” on the total value of the assets employed by the utility, both the IOUs and the Publics.
- To add assets (generation resources or transmission lines or to enter into large long-term Power Purchasing Agreements (PPAs), the utility (both the IOUs and the Publics) must file a transparent Public Planning Document commonly called an “Integrated Resource Plan” or IRP . Normally the PUC requires an IRP every five years. Once the IRP is filed by the utility and acknowledged by the PUC, the utility can go about its business of buying fuel for its plants, generating and distributing electricity and serving its residential, commercial and industrial customers.
If the utility feels it is not making enough money, the only recourse is to file a Rate Case with its PUC. Rate Cases are a long, complicated and expensive process, popular with neither the utility nor the PUC. But other than cutting costs and becoming more efficient, the only way a utility can earn more money is to raise rates via a Rate Case.
- In a Rate Case, the PUC sets the tariffs or rate schedules for the utility such that the utility may earn, but not exceed, its allowed rate of return. The tariffs or rate schedules for the utility are divided among the utility’s various customer classes (residential, commercial, and numerous industrial classes), so that if a new residential, commercial or industrial customer enters the service territory allocated to the utility by the PUC and requests electric service, the utility must comply and provide all of the electricity required by this new residential, commercial or industrial customer. The utility looks up the appropriate filed tariff and the electricity rate (price) is established for the customer.
How the Utility Changes Rates
The important definitions in understanding the regulated electricity rate change process are:
- Assets employed: The value of all assets that are “used and useful” by the utility in its generation and distribution of electricity in serving its residential, commercial and industrial customers.
Purchase of these assets was allowed under an earlier IRP.
- Allowed Rate of Return: The annual percentage return on assets employed granted by the PUC.
- Net Power Costs: The net of the cost of the fuel (coal and natural gas) used to run the generation plants used by the utility in its generation and distribution of electricity to serve its residential, commercial and industrial customers, plus the cost of purchased electricity used to supplement resources and required to serve its residential, commercial and industrial customers, less the revenue received from selling any surplus electricity not required to serve its residential, commercial and industrial customers.
- Tariff Revenue (revenue from tariff sale of electricity): The utility estimates the quantity of electricity demanded by each class of tariff customer. The utility calculates the tariff revenue by summing the estimated revenue from each tariff customer.
- All other Expenses: This includes items such as buildings, vehicles and staff costs.
The utility will petition the PUC in a Rate Case to set the tariff schedules of the utility such that: the tariff revenue minus the net power costs minus all other expenses is sufficient such that the residual “profit” when divided by assets employed is equal to or greater than the allowed rate of return. In the Rate Case, the PUC scrutinizes assets employed and purchased electricity costs for conformity to approved IRPs, scrutinizes all other expenses for prudency, and reviews tariff sale electricity quantity estimates for reasonableness.
The PUC will often disallow items which will lower the tariff schedules. A Rate Case is difficult, tedious and risky for the utility since the utility must expose its entire financial structure to the PUC; therefore the utility will file a Rate Case only when absolutely necessary. It often happens that if a utility has engaged in cost saving and efficiency programs, the utility is “rewarded” by the PUC in a Rate Case with lower tariffs. This means that the Tariff Schedules are not likely to change for several years, perhaps many years, and when it does change, the change is controlled by the PUC.
1The most important constraint on these regulated utilities is their “Obligation to Serve.” This means that when a residential, commercial or industrial customer within the defined service territory petitions the utility for service, the utility must provide 100% of the customer requirement as long as the customer pays the approved tariff rates and obeys the other pertinent tariff covenants.
2The IRP is a mandated public process, where the various political interest groups have an opportunity to influence utility planning. For example, groups opposed to more coal-fired plants will attend the public meetings and lobby against inclusion of more coal-fired plants. Groups opposed to more nuclear plants will attend the public meetings and lobby against inclusion of more nuclear plants. The PUC will consult with these same interest groups and consider their opinions prior to IRP approval. The utility must have IRP approval prior to investing in additional assets (see Rate Case discussion below).
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