Tariff Development II: Rate Design

NARUC Energy Regulatory Partnership Program The Georgian National Energy Regulatory Commission and The Vermont Public Service oard by

Ann Bishop
Vermont Public Service Board June 28, 2008

!vervie"

What is rate design? ate design ob!ectives Steps in developing a rate design
" #etermine customer groups " Allocate costs among customer groups " Assign costs to individual rate components

$ssues %ith tari&& design

2

#hat $s Rate %esign&

ate design is the structure o& a utilit()s rates* rate design determines the prices customers pa( &or utilit( services ate designs var( &rom utilit( to utilit( All rate designs address+
" ,ustomer classes " -(pes o& charges .customer, energ(, demand/

Some rate designs also address+

" -ime .real0time, time0o&0da(, season o& (ear, etc1/

ate design is highl( technical and detailed, but it is more art than science '

Rate %esign !b'ectives

ate design has a variet( o& ob!ectives, some o& %hich con&lict %ith each other evenue0related ob!ectives+
" ates should (ield the total revenue re3uirement " ates should provide stable and predictable revenues
2

!b'ectives o( Rate %esign

,ost0related ob!ectives+
" ates should be set to promote economicall( e&&icient consumption " ates should apportion costs &airl( among customers and customer classes " ates should avoid undue discrimination " ates should promote innovation in suppl( and demand
4

!b'ectives o( Rate %esign

Practical considerations+
" A rate design should be, to the e6tent possible, simple, understandable, acceptable to the public, and easil( administered " A rate design should provide &or rate stabilit(

Revenue)Related $ssues

ates should give a utilit( a reasonable opportunit( to+

" ecover prudentl( incurred e6penses, including investment " 8arn a &air rate o& return on the remaining costs .the undepreciated portion/ o& its prudent investment

Such rates enable a utilit( to cover its debt0service obligation, pa( dividends to shareholders, and attract ne% capital investment

Cost)Related $ssues

Will rates set at average cost per unit be economicall( e&&icient?

" Average cost vs1 marginal cost " 9ong run vs1 short run

Private &inancial vs1 total social cost

" ,ost o& environmental damage &rom electricit( production and deliver(

Who pa(s %hat costs?

" Principle o& cost causation 8

%eveloping a Rate %esign

Basic principle+ assign costs to customers %ho cause a utilit( to incur them Steps+
" #etermine customer groups " Allocate utilit( costs among the customer groups " ;or each customer group, assign allocated costs to individual rate components .customer, <Wh, <W charges/

%etermining Customer Groups

>enerall( based on usage characteristics ?umber o& customer groups varies among utilities ,ommon groups+
" " " " " esidential ,ommercial $ndustrial Street lighting Agricultural =0

%etermining Customer Groups

Sometimes groups ma( be designated &or public polic( reasons

" ;or e6ample, lo% income or elderl(

@ccasionall( one customer %ith ver( uni3ue usage characteristics is a group

==

Class Cost)o()Service Study

Atilit( per&orms a class cost0o&0service stud(

" 8mbedded or &ull( allocated cost stud( " $ncremental or marginal cost stud(

Sometimes a utilit( per&orms both studies

=2

Embedded Cost Study

Ases capital and operating costs that have been historicall( embedded .spent or invested/ Built on accounting cost data generated in the da(0to0da( operations o& the utilit(
" ?eed &airl( detailed accounting records so costs can be categoriBed into generation, transmission, distribution, billing, etc1
='

Embedded Cost Study

Ases a variet( o& Callocation &actorsD to assign costs to each customer group
" Sample allocation &actors+ %inter <Wh, s(stem pea< month coincident pea<, average monthl( customers

Some costs cannot be easil( allocated .&or e6ample, administrative/

" @&ten allocated in proportion to all other costs " @ther options include+
,onsidering

other polic( goals Allocating them in some reasonable manner

=2

Embedded Cost Study

Eost simple embedded cost allocation+

" evenue re3uirement F number o& customers G rate, billed annuall(, semi0annuall( or 3uarterl(

,omple6ities arise due to desire to distinguish bet%een

" -(pes and amount o& service " -(pes o& customers
=4

Embedded Cost Study

Advantages+
" Based on actual costs " Automaticall( reconciled %ith the revenue re3uirement " Perceived to be &air

#isadvantages+
" Hard to allocate !oint and common costs " #oes not re&lect current mar<et trends " Ea( produce ine&&icient prices =5

*arginal Cost Study

Allocates the cost o& providing additional service Based on marginal cost pricing %hich e3uals the economic costs o& providing the ne6t increment o& service ;or%ard0loo<ing stud( o& resource costs

=7

*arginal Cost Study

,hallenges+
" What is the appropriate increment o& output, or margin, to measure?
>enerating

capacit( costs+ IJ<W0(r 8nerg( costs+ IJ<Wh -ransmission and distribution costs+ IJ<W0(r

" Ho% can marginal0cost prices be reconciled %ith the revenue re3uirement " What <inds o& pricing distortions are acceptable? " Should the incremental costs o& environmental damage be re&lected in rates? =8

*arginal Cost Study

Advantages+
" ;or%ard loo<ing, economic costs " Promotes economic e&&icienc(
86ception+

-he problem o& Csecond bestD

" -hose %ho cause the costs pa( the costs

#isadvantages+
" #e&initions more contentious " Hard to reconcile %ith revenue re3uirement " e3uires &orecasted demand and costs " Potential &or rate volatilit( =:

Cost Allocation $ssues

Are all classes e3uall( ris<( to serve? $& cross0subsidies bet%een classes e6ist, ho% 3uic<l( should the( be eliminated?
" Potential &or rate shoc< and irate ratepa(ers " $mpact on vulnerable customers .&or e6ample, lo% income/

20

Cost Allocation $ssues

Ho% should public polic( considerations be &actored in to cost allocation?

" ates can provide assistance to speci&ic customer classes
8conomic0development

or business0retention rates

esidential li&eline rate considerations

"

ates can promote social ob!ectives

,onservationJenvironmental Aniversal

service

2=

%esigning Tari((s

Primar( tari&& price components+

" ,ustomer charge " 8nerg( charge " #emand charge

$nteraction o& these components sends price signals

22

Tari(( Components

,ustomer charge
" ecover costs that do not var( %ith consumption .&or e6ample, metering and billing/ " ,an be &i6ed amount per da(, month, or other billing period

8nerg( charge .<Wh/

" ecover costs that var( %ith consumption .&or e6ample, energ(/ " ,an var( depending on usage patterns 2'

%emand Charge

#emand charge .<W/

" " ecover cost o& building capacit( to provide energ( e&lects &act that utilit( must have po%er available to serve customer " 8ncourages reduced usage at pea< periods .especiall( load shi&ting/ " -(picall( onl( larger customers pa( a demand charge " @&ten includes a CratchetD

22

%emand Charge

C atchetD " customers are billed the higher o& either their highest demand &rom the current month, or some percentage o& their highest demand &rom some previous period
" Advantages+ encourages customers to reduce their pea< usage, helping to reduce the need &or ne% utilit( in&rastructure " #isadvantages+ i& the ratchet does not change a&ter the customer reduces demand, the ratchet could be a disincentive to the installation o& on0site generation or energ( e&&icienc( measures 24

Usage Patterns
lat Rates Price/ Unit Price/ Unit Declining Block Rates

Quantity Consumed

Quantity Consumed

Inclining Block Rates Price/ Unit Price/ Unit

Time-Based Rates

Quantity Consumed

Offpeak

Peak

Offpeak

25

Usage Patterns

;lat #eclining bloc<

" Based on assumptions that it is cheaper to serve large customers and that marginal cost is less than average cost " 8ncourages consumption, discourages conservation, so is particularl( important to ensure prices are right
27

Usage Patterns

$nclining bloc<
" Earginal cost is greater than average cost " #iscourages consumption and encourages conservation

Pea< and o&&0pea< rates

" 8ncourage customers to use less po%er during pea< periods
28

Usage Patterns

-ime0based rates
" ,an be based on season, time o& da(, or real0time " Provide more accurate price signals " ates that change based on time o& da( or real0time re3uire special metering capabilities
Ean(

large customers alread( have meters %ith these capabilities Eost smaller customers do not Board is currentl( investigating %hether utilities should provide meters %ith these capabilities to more customers

2:

Usage Patterns

,ustomers %ith their o%n generation options ma( %ant utilities to provide Cstand0b(D service
" $& generator is do%n &or an( reason, utilit( %ould suppl( po%er to customer

,onsiderable debate over %hat are appropriate stand0b( tari&&s

" Atilit( must build capacit( to serve customer " 9east0cost &or societ( might not be least0cost &or the customer

Sometimes customer0o%ned generation is the least0cost option &or the utilit( but, i& stand0b( rates are too high, the customer ma( opt not to install the generation

'0

$ssues "ith Tari(( %esign

Ani&orm tari&&s are easier to administer but can result in subsidies %ithin rate classes #oes the rate design appropriatel( balance all the ob!ectives?
" Sometimes ad!ustments are made to better meet certain ob!ectives .&or e6ample, ma<e the <Wh price closer to the utilit()s marginal cost o& po%er/

#oes the rate design signi&icantl( increase rates &or an( customer group?
" Sometimes the rate design is phased0in over multiple (ears to minimiBe Crate shoc<D '=

Customer)Speci(ic Tari((s

$ndividual customer cost0based tari&&s

" Eore precise .assuming can identi&( separate costs/ " >enerall( not used in V- and most o& A1S1, e6cept %here customer has ver( clear distinguishing characteristics " #i&&icult to calculate
What

are the cost di&&erences in an integrated electrical s(stem? ;or most customers, costs out%eigh bene&its

'2

!ther $tems in Tari((s

-ari&&s also include terms and conditions o& service

" Some e6amples+
9ate

&ees #isconnection policies and &ees 9ine e6tension policies

''