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The Regulatory Assistance Project 50 State Street, Suite 3
Montpelier, VT 05602
Phone: 802-223-8199
www.raponline.org
Regu...
Brief History of Regulation
2
Medieval England Accommodations
• Business
“affected with
the public
interest.”
• Prices
regulated due
to monopoly
stature...
US Origin: Munn v. Illinois (1877)
• Grain elevators
charging monopoly
prices to farmers.
• Supreme Court
ruled “affected
...
Bluefield Water Works (1935)
• Prudent
investment rule.
• Utility entitled to
a return
comparable to
companies with
simila...
Hope Natural Gas (1944)
• “Just and
reasonable”
standard upheld.
• End result, not the
method employed.
• Intervenors have...
The Roaring 60’s and the Scary 70’s
• Load Growth
• + Inflation
7
Result: Big Rate Increases
8
Centralia 1972
Trojan 1975
WPPSS 1979
Colstrip 3&4: 1983/85
Centralia (1972):
$200/kW
Colstri...
Public Utility Regulatory Policies Act: 1978
• Avoided Cost for Independent Power
• Right of Intervention
• PURPA Ratemaki...
The PURPA Right of Intervention
• Any subject utility: 750 million kWh/year
• Any consumer may intervene
– Right to presen...
11
Overcapacity and Abandoned Plant
• Sharp rate increases led to low growth.
• Abandoned projects in the PNW include:
• Nucl...
Regulatory Treatment of Excess Capacity
and Abandoned Plant
• High rates drove down loads
• High rates drove out aluminum ...
Integrated Resource Planning
• 1975: Seattle City Light Energy 1990
• 1977: NRDC Alternative Scenario
• 1980: NW Power Act...
Break
15
The Basics of Rate Regulation
• Revenue Requirement
– Rate Base
– Rate of Return
– Operating Expenses
– Cost Allocation
– ...
Revenue Requirement
Rate Base
X Rate of Return
+ Operating Expenses
= Revenue Requirement
÷ Sales
= Rate per kWh
Traditional Rate of Return Regulation
• Rate Base
– Total Plant in Service at Original Cost
– Less Accumulated Provision f...
Plant In Service At Original Cost
• Generation
• Transmission
• Distribution
• General Plant
• Total Plant in Service
• $4...
Rate Base Calculation
• Plant in Service
• - Accumulated Depreciation
• = Net Plant in Service
• + Working Capital
• + Reg...
Traditional Rate of Return Regulation
Cost of Capital
• Rate of Return
– Cost of Common Equity
– Equity Capitalization Rat...
Rate of Return Calculation
• Equity Ratio
• x Allowed Return on Equity
• = Weighted Equity Cost
• Debt Ratio
• x Cost of D...
Operating Expenses
• Production
• Transmission
• Distribution
• Administrative and General
• Taxes
• Total Expenses:
• $10...
Traditional Rate of Return Revenue
Requirement
• Rate Base
• x Rate of Return
• = Return Requirement
• + Operating Expense...
What Does The Commission “Regulate”
in a simple rate case
• Rate Base: Providing service or not? Prudently incurred?
• Rat...
What Else Does the Commission Regulate?
• Accounting Policies
• Securities Issuance
• Service Standards
• Service Policies...
Regulatory Rate Proceedings
• Filing Requirements
• Procedure for Deciding a Rate or Tariff
Adjustment
– Discovery
– Evide...
Filing Requirements
• Historical Cost Data
• Projected Cost Data
• Historical and Projected Usage and
Customer Data
• Deta...
Issues In A Rate Filing
• Amount of Revenue Requirement
• Cost Allocation Between Classes
• Rate Design Within Classes
• S...
Hearing Procedure
• Notice of Intent to File
• Filing by Utility: 0 - 3 months
• Discovery: 1 - 3 Months
• Evidence Filed ...
Other Trigger Points for Regulation
• Budget Process
• Integrated Resource Plan
• Rulemakings
• Legislature
• Formal Compl...
Cost Allocation Between Classes
• “Cost of Service” is almost meaningless
• Embedded cost methods
• Marginal cost methods
...
Embedded Cost
of Service
• Functionalization
• Classification
• Allocation
33
Pro Forma Results of Operations by Customer ...
Key Issues in Embedded Cost of Service
• Production
– Classification of costs between “demand” and
“energy.”
– Differentia...
Key issues in Embedded Cost of Service
• Transmission
– Long-distance lines serving baseload resources
(Colstrip)
– Long-d...
Key Issues In Embedded Cost Studies
• Distribution
– Classification of distribution
infrastructure
• Poles, wires, transfo...
Straight
Fixed /
Variable:
100% of
Distribution
System
Classified
as
Customer-
related
37
Minimum
System
Method:
~50% of
Distribution
System
Classified
as
Customer-
related
38
Basic
Customer
Method
ONLY
customer-
specific
facilities
classified
as
customer-
related
39
Comparing Methods
40
Cost Category
Straight
Fixed /
Variable
Minimum
System
Method
Basic
Customer
Method
Poles $10 $5 -$
W...
Cost Allocation of Smart Grid Costs:
Smart Grid Benefits
Reliability Improvement: distribution
automation
Peak load reduct...
Cost Allocation of Smart Grid Costs
42
Smart Grid Element
Pre-Smart Grid
Element
"Traditional"
FERC
Account
Traditional
Cl...
Marginal Cost Methods
(Oregon, Montana)
Production
• Peaker or Demand Response as the proxy
for “capacity”
• 1 hour, 12 ho...
Marginal Cost Methods (continued)
Transmission
• For all capacity needs, or only baseload?
• How many hours?
Distribution
...
Bottom Line: NO CORRECT ANSWER
• As many methods to calculating “cost of
service” as analysts performing studies
• Devil i...
The Throughput Incentive
All costs vary in
the long run.
Not all costs
are in rates.
Few costs vary
in the short-
run with...
How Changes in Sales
Affect Earnings: It’s Significant
12.31%11.88%$11,076,180$1,176,180$1,809,5081.00%
13.61%23.76%$12,25...
Addressing the Throughput Incentive
Revenue Regulation (decoupling)
Alternatives
Lost Margin Recovery
Shared Savings Incen...
Break
49
Residential Rate Design
Three Guiding Principles
For Smart Rate Design
• A customer should be able to connect to the
grid for no more than the cos...
Key Issues
Fixed Charges
TOU Rates
Demand Charges
Inclining Block Rates
Single-Family vs. Multi-Family
Fixed Charges: The Utility Perspective
a) Costs are fixed
b) Therefore these costs should be recovered
in fixed charges.
T...
Repeating
Myself:
Where Did The
Idea that High
Fixed Charges
are Appropriate
Come From?
54
Pro Forma Results of Operations...
Straight
Fixed /
Variable:
100% of
Distribution
System
Classified
as
Customer-
related
55
Minimum
System
Method:
~50% of
Distribution
System
Classified
as
Customer-
related
56
Basic
Customer
Method
ONLY
customer-
specific
facilities
classified
as
customer-
related
57
Comparing Methods
58
Cost Category
Straight
Fixed /
Variable
Minimum
System
Method
Basic
Customer
Method
Poles $10 $5 -$
W...
What About Other Industries?
59
We Pay For Other “Grids”
In Volumetric Prices
60
The Line Extension Policy
Part of the tariff – Avista/Idaho:
61
Key Arguments on Fixed Charges
1) Small vs. Large
2) Urban vs. Rural
3) Apartments vs. Single-Family
4) What costs really ...
Time of Use Rates
• Increasingly common.
• More justified now than before.
• Low-income and low-use customers will
general...
Paying On The Basis of Usage
64
Off-Peak
Baseload Generation,
Transmission, Distribution
Mid-Peak
Intermediate Generation,...
Best Alternative: TOU Rate
Rate Element Amount
Billing and Collection $4.00/month
Transformer Demand Charge $1.00/kVA/mont...
Residential Demand Charges
Newest rate due to
fixed charge
backlash.
Common in
commercial rates.
Terrible idea.
66
Problems with Demand Charges
1) Normally measure non-
coincident peak, which is
irrelevant to anything but
the final line
...
Individual Load Shapes Vary
68
0
0.5
1
1.5
2
2.5
3
12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11
Customer 3: 38% L...
All the Utility Sees Is The Combined Load of
Multiple Customers With Different Shapes
69
Lots of Diversity at the Transformer
26-Unit Apartment Complex, L.A. Area
70
0
20
40
60
80
100
120
140
160
1 2 3 4 5 6 7 8...
Some Loads Are Controllable
71
Inclining Block Rates
Avista, Washington Residential Rate:
72
The Most Common Residential Rate
Design: Inclining Block
• Goals include:
• Allocation of low-cost resources
• BPA Tiered ...
“Subsidies”
Utilities argue that net-billing is a “subsidy”
or that “large users are subsidizing small
users.”
Rate design...
Single-Family
Sprawl Zone:
4 customers
/circuit-mile
75
Studio
Apartments:
4,000 customers
/circuit-mile
76
RAP Publications on Rate Design
• Smart Rate Design for a Smart
Future (2015)
• Designing Distributed Generation Tariff...
Lunch
77
Current Hot-Topics In Regulation
Rates for PV Customers
Terminated Projects
78
Rates for PV Customers
• Simple Net-Metering
• Buy-All / Sell-All
• Directional Pricing
• Bi-directional Pricing
• Demand ...
80
NWEC Headwaters Awardee: Sam Garst
Simple Net-Metering
• Utility measures “net” monthly flows of
power.
• Customer pays regular retail rate for “net”
consump...
Buy-All / Sell-All (Value-of-Solar Tariff)
Customer pays
regular retail rate for
all consumption.
Utility pays a
contractu...
Directional Pricing
When taking power FROM the utility, the
customer pays the retail rate.
When delivering power TO the ut...
Illustrative Directional Pricing
Customer Charge: $20.00/month
Energy Charge: $.12/kWh
Power Supply Credit: $.06/kWh
84
Bi-Directional TOU Pricing
Customer pays a grid-connection fee of
some kind.
All power used, and all power delivered, is
p...
Illustration: Bi-Directional Pricing
86
Rate Element Amount
Billing and Collection $4.00/month
Transformer Demand Charge $...
Demand Charges for PV Customers
• $/kW based on size of installed PV array
• Recovers distribution system costs as a
fixed...
Exit Fees
Fees imposed on customers who disconnect
from the grid.
Rare, and generally require prior written
agreement.
We ...
Utility
Average Cost
of Service Retail Rates
Traditional Ratemaking View
Lost Revenues
from
Net Metering
Short-run Fuel and
Purchased Power
Costs Avoided By Net
Metering
Critical View of Net Mete...
Solar Advocate View of Net Metering
Lost Revenues
From Net
Metering
Long-Run Avoided Cost for
Generation, Trans, Dist
+ Re...
Utility Average
Cost of Service
Long-Run Avoided Cost for
Generation, Trans, Dist
+ Avoided Emission Cost
+ Avoided RPS Ob...
All Kilowatt-Hours Are Not Equal
93
Local Organic
Tomatoes $3.00/lb.
California Tomatoes
$2.00lb.
We Buy Local Organic Tom...
Terminated Project Costs
94
Three Kinds of Terminated Projects
• Facilities started, but never finished
– WPPSS #3, Skagit, Pebble Springs
• Facilitie...
History on Abandoned Projects
• Skagit
• Pebble Springs
– Washington
– Oregon
• WPPSS #3
– Washington
– Idaho
• Trojan (17...
Issues With Coal Termination
• Plants near or beyond original 35 to 40-
year accounting lifetime.
– Dave Johnston: 1959
– ...
Interesting Regulatory Challenge
• If you do not allow sunk cost recovery,
incentive is to keep the plant alive.
– Even if...
Salvage Value and Cleanup Costs
• Nuclear: external sinking fund required
for decommissioning.
• Not required for coal.
– ...
Alternatives
• Full recovery, with a return on the balance
• Partial recovery: amortization without a
return on the balanc...
Class Cost Allocation of
Abandoned Plant Costs
• Baseload plants: allocate in same manner
as other baseload resources
– Av...
The Utility Business Model
and where innovation comes from
• How utilities make money
• Important to understand what motiv...
What Society Asks the Utility to Do
• Deliver and Operate
• Plan and Design
• Procure and Invest
• Be Fair
• Do it all at ...
How Utilities Earn Net Income (profit)
• We are relying on Jim’s Regulatory Basics
this morning
– Especially: revenue requ...
Investment Earnings
Rate Base 1,000,000,000$
X Rate of Return 10%
= Return 100,000,000$
+ Operating Expenses 100,000,000$
...
How Utilities Earn Net Income (profit)
• Rate Base is the structural source of utility
profit
• Other sources
– Cost cutti...
Net Income ≠ Revenue
• Take care to keep each straight
– Decoupling focuses on getting revenue right
• Without decoupling,...
The Throughput Incentive
and its insidious effects
• When (in short run) price > cost…
• Each added unit sold adds free ca...
A utility may deny the throughput incentive
• By saying the any margins will be lost in
the next rate case when everything...
Throughput incentive produces pushback
against customer resources
• A little bit of EE is not noticeable and is
good publi...
Solutions to the Throughput Incentive
• There are two that reduce revenue risk
for utility
– Decoupling or revenue regulat...
Capital Bias
• If net income comes from capital
investment, makes sense to invest more
capital
– Even if customer side sol...
113
Build Stuff Earnings
Build Big Stuff
More Earnings
114
Build Really Big Stuff
Really Big Earnings
115
Capital Bias + Throughput Incentive Affect
on Non-Wires Solutions to Grid Needs
116
Except for
a
minimum
amount to
address...
Cheaper = Less Profitable
117
Customer Builds Stuff:
No Earnings
118
Efficient Investment:
What if the best source of investment is customers?
• Eliminate the throughput incentive with
decoup...
NY’s Reforming the Energy Vision
120
Value
Markets Performance
Rates Cost Planning
Enable Public Policy, Notably:
energy-e...
Ways Utilities Can Earn
• Return on Investment
• Return on Performance
– Energy efficiency already common
• Services
– Eme...
New Revenue Model
Current Future
Return Of
Traditional
Operating
Expenses
Delivery
Customers
Return Of
and Return
On
Tradi...
New Revenue Model
Current Future
Return Of
Traditional
Operating
Expenses
Delivery
Customers
Return Of
and Return
On
Tradi...
Utility Performance Incentive
Mechanisms: A Handbook for
Regulators, Synapse Energy
Economics for Western Interstate
Energ...
Rate Utilities on Performance
125
Service Reliability
and Quality
126
SAIDI
SAIFI
Voltage
Frequency
Customer Service
127
Keeping customer bills low
128
Emissions Performance
129
Energy Efficiency Performance
130
Renewable Energy Performance
131
Illustrating a Zero-Based
Performance System
• ROE is 10%
• Debt rate is 8%
• What if the
return on equity
investment = th...
New Performance Based Outcomes and Metrics:
An Illustration
• A zero-based approach
– Before performance is
considered, ut...
Straight A’s = High Earnings
134
Reflecting value
society got
Poor Grades = Debt-Only Return
No Shareholder Earnings
135
Is a return on performance the icing?
An addition to ROE of a few % or basis points or
cents per share?
Is return on perfo...
NewCo Allowed Revenue
Debt Return 40,000,000$
Operating Expenses 100,000,000$
Total Allowed Revenue 200,000,000$
Estimated...
True Up For Sales
Allowed Revenue 200,000,000$
Estimated Sales 2,000,000,000
Established Rate 0.1000$
Actual Sales 1,950,0...
139
Where the net income comes from…
Competitive Advantage and Mitigation Tools
• If utilities are allowed into competitive
business lines
– PV, heat pumps
• O...
Separations
• The regulator can direct that some
operations must be separated from the
core monopoly service
– Functional ...
Codes of Conduct
• Addresses how the monopoly relates to
competitors and how it addresses its own
or affiliated competitor...
The Case of Con Ed Solutions
• When retail competition came to New
York, Con Ed wanted to create a retail
energy provider,...
Prohibitions
• The utility is barred from certain business
lines
144
Wall Street Issues
• Source of capital
– We want the utility system to have access to
reasonably priced (investment grade)...
The outcome?
• With distributed resources emerging
– Society is asking the utility business to do
different things, to inn...
About RAP
The Regulatory Assistance Project (RAP) is a global, non-profit team of experts that
focuses on the long-term ec...
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2015 NWEC - Rate Design Workshop Materials

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Powerpoint presentation prepared and presented by Jim Lazar and Richard Sedano of the Regulatory Assistance Project.

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2015 NWEC - Rate Design Workshop Materials

  1. 1. The Regulatory Assistance Project 50 State Street, Suite 3 Montpelier, VT 05602 Phone: 802-223-8199 www.raponline.org Regulatory Training Workshop Northwest Energy Coalition Olympia August 14, 2015 Presented by Rich Sedano and Jim Lazar Month dd, yyyy
  2. 2. Brief History of Regulation 2
  3. 3. Medieval England Accommodations • Business “affected with the public interest.” • Prices regulated due to monopoly stature 3 New Inn, Gloucester, 1454
  4. 4. US Origin: Munn v. Illinois (1877) • Grain elevators charging monopoly prices to farmers. • Supreme Court ruled “affected with the public interest” and subject to price regulation. 4
  5. 5. Bluefield Water Works (1935) • Prudent investment rule. • Utility entitled to a return comparable to companies with similar risks. 5
  6. 6. Hope Natural Gas (1944) • “Just and reasonable” standard upheld. • End result, not the method employed. • Intervenors have limited rights. 6
  7. 7. The Roaring 60’s and the Scary 70’s • Load Growth • + Inflation 7
  8. 8. Result: Big Rate Increases 8 Centralia 1972 Trojan 1975 WPPSS 1979 Colstrip 3&4: 1983/85 Centralia (1972): $200/kW Colstrip 1&2 (1975): $300/kW Trojan (1975): $700/kW Colstrip 3&4 (1983/85) $1,300/kW WPPSS #2 (1985) $3,000/kW
  9. 9. Public Utility Regulatory Policies Act: 1978 • Avoided Cost for Independent Power • Right of Intervention • PURPA Ratemaking Standards 9 Rate Design Standards Cost of Service Time of Day Seasonal Interruptible Declining Block Lifeline Utility Service Standards Master Metering Fuel Adjustment Clauses Information to Consumers Termination of Service Advertising
  10. 10. The PURPA Right of Intervention • Any subject utility: 750 million kWh/year • Any consumer may intervene – Right to present evidence – Right to reasonable rules of discovery – Right to intervenor compensation if no consumer advocate is funded. 10
  11. 11. 11
  12. 12. Overcapacity and Abandoned Plant • Sharp rate increases led to low growth. • Abandoned projects in the PNW include: • Nuclear: – Skagit 1&2 (Puget) – Pebble Springs 1&2 (Portland GE) – WPPSS 1, 3, 4, 5 (Public Power) • Coal – Creston (Avista) – Pioneer (Idaho Power) 12
  13. 13. Regulatory Treatment of Excess Capacity and Abandoned Plant • High rates drove down loads • High rates drove out aluminum industry • Efficiency further reduced load growth • Hotly contested in 1985 – 1995 – Abandoned Plant: ~65% recovery – Excess Capacity: ~90% recovery 13
  14. 14. Integrated Resource Planning • 1975: Seattle City Light Energy 1990 • 1977: NRDC Alternative Scenario • 1980: NW Power Act • 1981: Initiative 394 • 1982: “Model Plan” • 1983: First Power Plan 14
  15. 15. Break 15
  16. 16. The Basics of Rate Regulation • Revenue Requirement – Rate Base – Rate of Return – Operating Expenses – Cost Allocation – Rate Design • Regulatory Proceedings • Trigger Points
  17. 17. Revenue Requirement Rate Base X Rate of Return + Operating Expenses = Revenue Requirement ÷ Sales = Rate per kWh
  18. 18. Traditional Rate of Return Regulation • Rate Base – Total Plant in Service at Original Cost – Less Accumulated Provision for Depreciation – Adjustments • Working Capital • Allowance for Funds Used During Construction • “Regulatory Assets” such as abandoned plant • Deferred Taxes
  19. 19. Plant In Service At Original Cost • Generation • Transmission • Distribution • General Plant • Total Plant in Service • $40,000,000 • $10,000,000 • $60,000,000 • $20,000,000 • $130,000,000
  20. 20. Rate Base Calculation • Plant in Service • - Accumulated Depreciation • = Net Plant in Service • + Working Capital • + Regulatory Assets • - Deferred Taxes • = Rate Base • $130,000,000 • ($30,000,000) • $70,000,000 • $ 5,000,000 • $ 1,000,000 • ($6,000,000) • $100,000,000
  21. 21. Traditional Rate of Return Regulation Cost of Capital • Rate of Return – Cost of Common Equity – Equity Capitalization Ratio – Cost of Debt – Debt Ratio – Preferred Stock and Short Term Debt as appropriate
  22. 22. Rate of Return Calculation • Equity Ratio • x Allowed Return on Equity • = Weighted Equity Cost • Debt Ratio • x Cost of Debt • = Weighted Debt Cost • Sum = Rate of Return • 50% • 10% • 5% • 50% • 6% • 3% • 8%
  23. 23. Operating Expenses • Production • Transmission • Distribution • Administrative and General • Taxes • Total Expenses: • $10,000,000 • $ 1,000,000 • $ 5,000,000 • $ 2,000,000 • $ 2,000,000 • $20,000,000
  24. 24. Traditional Rate of Return Revenue Requirement • Rate Base • x Rate of Return • = Return Requirement • + Operating Expenses • = Revenue Requirement • $100,000,000 • x 9% • $9,000,000 • $20,000,000 • $29,000,000
  25. 25. What Does The Commission “Regulate” in a simple rate case • Rate Base: Providing service or not? Prudently incurred? • Rate of Return: What is the appropriate capital structure? The appropriate return on equity? • Operating Expenses: Which expenses are allowable for ratemaking? Imprudent? Not related to providing service? Political? • Cost Allocation: How much of the revenue requirement is paid by each customer class Operating Expenses: Which expenses are allowable for ratemaking? Imprudent? Not related to providing service? Political? • Rate Design: How shall costs be divided between customer charges, energy charges, and other types of charges.
  26. 26. What Else Does the Commission Regulate? • Accounting Policies • Securities Issuance • Service Standards • Service Policies • Resource Planning • Energy Efficiency • Low-Income Programs • Any Issue Assigned by Legislature • Any issue brought by complaint 26
  27. 27. Regulatory Rate Proceedings • Filing Requirements • Procedure for Deciding a Rate or Tariff Adjustment – Discovery – Evidence – Hearing – Closing Argument – Decision
  28. 28. Filing Requirements • Historical Cost Data • Projected Cost Data • Historical and Projected Usage and Customer Data • Detail on Expenses • Detail on Additions to Rate Base • Proposed Rates and Tariffs
  29. 29. Issues In A Rate Filing • Amount of Revenue Requirement • Cost Allocation Between Classes • Rate Design Within Classes • Service Policies • Service Quality • Resource Planning • Other Tariff Issues
  30. 30. Hearing Procedure • Notice of Intent to File • Filing by Utility: 0 - 3 months • Discovery: 1 - 3 Months • Evidence Filed by Others 1 - 3 months • Hearing before Commission - 1 - 3 months • Decision: 1-3 months • Total Time: 4 - 15 months
  31. 31. Other Trigger Points for Regulation • Budget Process • Integrated Resource Plan • Rulemakings • Legislature • Formal Complaints 31
  32. 32. Cost Allocation Between Classes • “Cost of Service” is almost meaningless • Embedded cost methods • Marginal cost methods • Different approaches for – Production – Transmission – Distribution 32
  33. 33. Embedded Cost of Service • Functionalization • Classification • Allocation 33 Pro Forma Results of Operations by Customer Group ELECTRIC COST OF SERVICE STUDY FLOWCHART TransmissionProduction Common Energy / Commodity Related Customer Related Demand / Capacity Related Residential Small General Large General Extra Large General Pumping Street & Area Lights Allocation Pro Forma Results of Operations Functionalization Distribution and Customer Relations Classification Direct Assignment Number of Customers Weighted Number of Customers Direct Assignment Coincident Peak Non-Coincident Peak Direct Assignment Generation Level mWh's Customer Level mWh's
  34. 34. Key Issues in Embedded Cost of Service • Production – Classification of costs between “demand” and “energy.” – Differential treatment of baseload, intermediate, peaking, and variable renewables – Allocation of demand-related costs across 1- hour, 12-hours, 200-hours or a different metric – Allocation of costs over TOU periods 34
  35. 35. Key issues in Embedded Cost of Service • Transmission – Long-distance lines serving baseload resources (Colstrip) – Long-distance lines serving interconnections to other regions (California, Utah, BC) – Peaking resources are close to load centers and may not need any transmission – Demand Response does not need transmission 35
  36. 36. Key Issues In Embedded Cost Studies • Distribution – Classification of distribution infrastructure • Poles, wires, transformers – Classification of Smart Grid costs 36
  37. 37. Straight Fixed / Variable: 100% of Distribution System Classified as Customer- related 37
  38. 38. Minimum System Method: ~50% of Distribution System Classified as Customer- related 38
  39. 39. Basic Customer Method ONLY customer- specific facilities classified as customer- related 39
  40. 40. Comparing Methods 40 Cost Category Straight Fixed / Variable Minimum System Method Basic Customer Method Poles $10 $5 -$ Wires $20 $10 -$ Transformers $14 $7 -$ Services $1 $1 $1 Meters $1 $1 $1 Billing $3 $3 $3 Customer Service $3 $3 $3 Total $52 $30 $8 $/month/customer
  41. 41. Cost Allocation of Smart Grid Costs: Smart Grid Benefits Reliability Improvement: distribution automation Peak load reduction through Time of Use and Critical Peak Pricing Loss reduction: Voltage Control, Power Factor Correction, phase balancing Remote shut-off and turn-on Reduced O&M Expense for meter reading 41
  42. 42. Cost Allocation of Smart Grid Costs 42 Smart Grid Element Pre-Smart Grid Element "Traditional" FERC Account Traditional Classification Smart Grid Classification Smart Meters Meters 370 Customer Demand / Energy / Customer Distribution Control Devices Station Equipment 362 Demand Demand / Energy Data Collection System Meter Readers 902 Customer Demand / Energy / Customer Meter Data Management System General Plant 391 - 397 Subtotal PTDC Demand / Energy / Customer Smart Grid Managers Customer Accounts Supervision 901 Customer Demand / Energy Energy Storage Devices (Batteries; Ice Bear) Installations on Customer Premises 371 Customer Demand / Energy
  43. 43. Marginal Cost Methods (Oregon, Montana) Production • Peaker or Demand Response as the proxy for “capacity” • 1 hour, 12 hours, 200 hours for peak? • Long-run marginal costs (construction + operation) or only operating costs for the “energy” component? 43
  44. 44. Marginal Cost Methods (continued) Transmission • For all capacity needs, or only baseload? • How many hours? Distribution • “Customer” vs. “Commitment” costs • Apportioning Smart Grid costs and benefits 44
  45. 45. Bottom Line: NO CORRECT ANSWER • As many methods to calculating “cost of service” as analysts performing studies • Devil in the details • A bad cost of service study often leads to bad rate design. 45
  46. 46. The Throughput Incentive All costs vary in the long run. Not all costs are in rates. Few costs vary in the short- run with sales. 46 Avoided Reserves
  47. 47. How Changes in Sales Affect Earnings: It’s Significant 12.31%11.88%$11,076,180$1,176,180$1,809,5081.00% 13.61%23.76%$12,252,360$2,352,360$3,619,0152.00% 14.92%35.64%$13,428,540$3,528,540$5,428,5233.00% 16.23%47.52%$14,604,720$4,704,720$7,238,0314.00% 17.53%59.40%$15,780,900$5,880,900$9,047,5385.00% 11.00%0.00%$9,900,000$0$00.00% 4.47%-59.40%$4,019,100-$5,880,900-$9,047,538-5.00% 5.77%-47.52%$5,195,280-$4,704,720-$7,238,031-4.00% 7.08%-35.64%$6,371,460-$3,528,540-$5,428,523-3.00% 8.39%-23.76%$7,547,640-$2,352,360-$3,619,015-2.00% 9.69%-11.88%$8,723,820-$1,176,180-$1,809,508-1.00% Actual ROE% ChangeNet EarningsAfter-taxPre-tax % Change in Sales Impact on EarningsRevenue Change
  48. 48. Addressing the Throughput Incentive Revenue Regulation (decoupling) Alternatives Lost Margin Recovery Shared Savings Incentive / Penalty Mechanisms Fixed/Variable Rate Design Alternatives / Complements Rate of Return Incentive Third-Party Administration of EE Programs 48
  49. 49. Break 49
  50. 50. Residential Rate Design
  51. 51. Three Guiding Principles For Smart Rate Design • A customer should be able to connect to the grid for no more than the cost of connecting to the grid. • Customers should pay for power supply and grid services based on how much they use and when they use it. • Customers supplying power to the grid should receive full and fair compensation – no more and no less. 51
  52. 52. Key Issues Fixed Charges TOU Rates Demand Charges Inclining Block Rates Single-Family vs. Multi-Family
  53. 53. Fixed Charges: The Utility Perspective a) Costs are fixed b) Therefore these costs should be recovered in fixed charges. Two Problems With This: a) These “fixed” costs were incurred to deliver kilowatt-hours of electricity. b) The line extension policy already provides assurance of cost recovery.
  54. 54. Repeating Myself: Where Did The Idea that High Fixed Charges are Appropriate Come From? 54 Pro Forma Results of Operations by Customer Group ELECTRIC COST OF SERVICE STUDY FLOWCHART TransmissionProduction Common Energy / Commodity Related Customer Related Demand / Capacity Related Residential Small General Large General Extra Large General Pumping Street & Area Lights Allocation Pro Forma Results of Operations Functionalization Distribution and Customer Relations Classification Direct Assignment Number of Customers Weighted Number of Customers Direct Assignment Coincident Peak Non-Coincident Peak Direct Assignment Generation Level mWh's Customer Level mWh's
  55. 55. Straight Fixed / Variable: 100% of Distribution System Classified as Customer- related 55
  56. 56. Minimum System Method: ~50% of Distribution System Classified as Customer- related 56
  57. 57. Basic Customer Method ONLY customer- specific facilities classified as customer- related 57
  58. 58. Comparing Methods 58 Cost Category Straight Fixed / Variable Minimum System Method Basic Customer Method Poles $10 $5 -$ Wires $20 $10 -$ Transformers $14 $7 -$ Services $1 $1 $1 Meters $1 $1 $1 Billing $3 $3 $3 Customer Service $3 $3 $3 Total $52 $30 $8 $/month/customer
  59. 59. What About Other Industries? 59
  60. 60. We Pay For Other “Grids” In Volumetric Prices 60
  61. 61. The Line Extension Policy Part of the tariff – Avista/Idaho: 61
  62. 62. Key Arguments on Fixed Charges 1) Small vs. Large 2) Urban vs. Rural 3) Apartments vs. Single-Family 4) What costs really change with the number of customers. 5) It’s already addressed in the line extension policy.
  63. 63. Time of Use Rates • Increasingly common. • More justified now than before. • Low-income and low-use customers will generally benefit. • Identifying time periods is important. 63
  64. 64. Paying On The Basis of Usage 64 Off-Peak Baseload Generation, Transmission, Distribution Mid-Peak Intermediate Generation, Transmission, Distribution On-Peak Peaking Generation, Distribution Critical Peak Demand Response
  65. 65. Best Alternative: TOU Rate Rate Element Amount Billing and Collection $4.00/month Transformer Demand Charge $1.00/kVA/month Power Supply and Distribution (both directions) Off-Peak $.07/kWh Mid-Peak $.10/kWh On-Peak $.15/kWh Critical Periods $.75/kWh Costs to Connect to the Grid
  66. 66. Residential Demand Charges Newest rate due to fixed charge backlash. Common in commercial rates. Terrible idea. 66
  67. 67. Problems with Demand Charges 1) Normally measure non- coincident peak, which is irrelevant to anything but the final line transformer. 2) Reward customers that contribute to the peak every day, vs. those whose use varies. 3) Lack of customer understanding. 67
  68. 68. Individual Load Shapes Vary 68 0 0.5 1 1.5 2 2.5 3 12 1 2 3 4 5 6 7 8 9 10 11 12 1 2 3 4 5 6 7 8 9 10 11 Customer 3: 38% Load Factor Customer 3
  69. 69. All the Utility Sees Is The Combined Load of Multiple Customers With Different Shapes 69
  70. 70. Lots of Diversity at the Transformer 26-Unit Apartment Complex, L.A. Area 70 0 20 40 60 80 100 120 140 160 1 2 3 4 5 6 7 8 9 10 11 12 Individual Demand Total Grouped Demand Total
  71. 71. Some Loads Are Controllable 71
  72. 72. Inclining Block Rates Avista, Washington Residential Rate: 72
  73. 73. The Most Common Residential Rate Design: Inclining Block • Goals include: • Allocation of low-cost resources • BPA Tiered Wholesale Rate • IOU mix of hydro/coal/gas/renewables • Recognition of load factor • Encouragement of conservation • Essential needs at affordable cost • Low-income benefits 73
  74. 74. “Subsidies” Utilities argue that net-billing is a “subsidy” or that “large users are subsidizing small users.” Rate design is full of subsidies Apartments vs. Single-Family Urban vs. Rural Overhead service vs. underground 74
  75. 75. Single-Family Sprawl Zone: 4 customers /circuit-mile 75 Studio Apartments: 4,000 customers /circuit-mile
  76. 76. 76 RAP Publications on Rate Design • Smart Rate Design for a Smart Future (2015) • Designing Distributed Generation Tariffs Well (2014) • Rate Design Where AMI Has Not Been Fully Deployed (2014) • Time-Varying and Dynamic Rate Design (2013) • Pricing Do’s and Don’ts (2011)
  77. 77. Lunch 77
  78. 78. Current Hot-Topics In Regulation Rates for PV Customers Terminated Projects 78
  79. 79. Rates for PV Customers • Simple Net-Metering • Buy-All / Sell-All • Directional Pricing • Bi-directional Pricing • Demand Charges • Fixed Charges • Exit Fees 79
  80. 80. 80 NWEC Headwaters Awardee: Sam Garst
  81. 81. Simple Net-Metering • Utility measures “net” monthly flows of power. • Customer pays regular retail rate for “net” consumption. • No special metering required. • Example: Puget Sound Energy 81
  82. 82. Buy-All / Sell-All (Value-of-Solar Tariff) Customer pays regular retail rate for all consumption. Utility pays a contractual rate for all production. Two meters required. Example: Austin Energy 82 $0.00 $0.12 $0.24 2014 2018 2022 2026 2030 Net Metering Value of Solar
  83. 83. Directional Pricing When taking power FROM the utility, the customer pays the retail rate. When delivering power TO the utility, the customer received a lower rate, typically only power supply. Example: Perdenales Electric Cooperative 83
  84. 84. Illustrative Directional Pricing Customer Charge: $20.00/month Energy Charge: $.12/kWh Power Supply Credit: $.06/kWh 84
  85. 85. Bi-Directional TOU Pricing Customer pays a grid-connection fee of some kind. All power used, and all power delivered, is priced at the same TOU rate. 85
  86. 86. Illustration: Bi-Directional Pricing 86 Rate Element Amount Billing and Collection $4.00/month Transformer Demand Charge $1.00/kVA/month Power Supply and Distribution (both directions) Off-Peak $.07/kWh Mid-Peak $.10/kWh On-Peak $.15/kWh Critical Periods $.75/kWh Costs to Connect to the Grid
  87. 87. Demand Charges for PV Customers • $/kW based on size of installed PV array • Recovers distribution system costs as a fixed monthly fee. • Significantly reduces PV economics • Also called “standby charges” • Example: Arizona Public Service ($.70/kW) [but they wanted $5/kW/month] 87
  88. 88. Exit Fees Fees imposed on customers who disconnect from the grid. Rare, and generally require prior written agreement. We will see these where the line extension policy was used to justify a free extension. 88
  89. 89. Utility Average Cost of Service Retail Rates Traditional Ratemaking View
  90. 90. Lost Revenues from Net Metering Short-run Fuel and Purchased Power Costs Avoided By Net Metering Critical View of Net Metering
  91. 91. Solar Advocate View of Net Metering Lost Revenues From Net Metering Long-Run Avoided Cost for Generation, Trans, Dist + Reduced Emissions + Avoided Fuel Cost Risk + Avoided Fuel Supply Risk + Local Economic Development + Future Carbon Costs + Shading Benefits on AC Load + Much, much more
  92. 92. Utility Average Cost of Service Long-Run Avoided Cost for Generation, Trans, Dist + Avoided Emission Cost + Avoided RPS Obligation + Avoided Fuel Cost Risk + Avoided Fuel Supply Risk Balanced Net Metering View
  93. 93. All Kilowatt-Hours Are Not Equal 93 Local Organic Tomatoes $3.00/lb. California Tomatoes $2.00lb. We Buy Local Organic Tomatoes: $2.00lb.
  94. 94. Terminated Project Costs 94
  95. 95. Three Kinds of Terminated Projects • Facilities started, but never finished – WPPSS #3, Skagit, Pebble Springs • Facilities operated, but terminated for economic reasons prior to full amortization. (Trojan) • Facilities operated, but terminated for technical reasons prior to full amortization. (San Onofre) 95
  96. 96. History on Abandoned Projects • Skagit • Pebble Springs – Washington – Oregon • WPPSS #3 – Washington – Idaho • Trojan (17 years) 96
  97. 97. Issues With Coal Termination • Plants near or beyond original 35 to 40- year accounting lifetime. – Dave Johnston: 1959 – Colstrip 1 & 2: 1975 • Plants not fully depreciated. – Boardman: 1980 (but will be by 2020) 97
  98. 98. Interesting Regulatory Challenge • If you do not allow sunk cost recovery, incentive is to keep the plant alive. – Even if it is uneconomic. [PSNH] • If you DO allow sunk cost recovery, you are violating the “used and useful” principle of rate making. 98
  99. 99. Salvage Value and Cleanup Costs • Nuclear: external sinking fund required for decommissioning. • Not required for coal. – Prudent? – Cost-sharing? • Mojave Coal Plant (Nevada): – Land was valuable – Unused SO2 credits valuable 99
  100. 100. Alternatives • Full recovery, with a return on the balance • Partial recovery: amortization without a return on the balance • No recovery • Performance-based regulation 100
  101. 101. Class Cost Allocation of Abandoned Plant Costs • Baseload plants: allocate in same manner as other baseload resources – Avoid “%” tariff riders on all bills • Effectively a surcharge on distribution, not power – Avoid “peak demand” allocation • Plants were not built to meet peak; when they were built, all peaking needs were met with hydro 101
  102. 102. The Utility Business Model and where innovation comes from • How utilities make money • Important to understand what motivates senior management – That can motivate everyone else • Alignment – Public and private interests can be in more or less alignment – Innovation in the public interest lags in the traditional utility business model 102
  103. 103. What Society Asks the Utility to Do • Deliver and Operate • Plan and Design • Procure and Invest • Be Fair • Do it all at Reasonable cost – Manage risk • Do next year what you did last year 103
  104. 104. How Utilities Earn Net Income (profit) • We are relying on Jim’s Regulatory Basics this morning – Especially: revenue requirement, rate base, rate of return 104
  105. 105. Investment Earnings Rate Base 1,000,000,000$ X Rate of Return 10% = Return 100,000,000$ + Operating Expenses 100,000,000$ = Revenue Requirement 200,000,000$ / Expected Sales 2,000,000,000 = Average Rate 0.10$ Rate Base 1,000,000,000$
  106. 106. How Utilities Earn Net Income (profit) • Rate Base is the structural source of utility profit • Other sources – Cost cutting between rate cases – Added revenue/free cash flow between rate cases • Off system sales of excess power • More sales, unless decoupling is in place • Competitive revenues, if allowed 106
  107. 107. Net Income ≠ Revenue • Take care to keep each straight – Decoupling focuses on getting revenue right • Without decoupling, revenue depends on sales – Net income is an input to the revenue requirement based on rate base – Net income is an outcome after a year’s worth of revenues and costs are toted – The rational utility cares most about net income 107
  108. 108. The Throughput Incentive and its insidious effects • When (in short run) price > cost… • Each added unit sold adds free cash flow (profit) – This is the throughput incentive, because a business in this situation wants more net income, and more sales gets more revenue and more net income • What will this business say to energy efficiency and distributed generation? 108
  109. 109. A utility may deny the throughput incentive • By saying the any margins will be lost in the next rate case when everything is reset – The utility will avoid a rate case • And if there is a chronic condition, the state will intervene – A few states will do this, most will not • Nearly all utility managers appreciate the throughput incentive 109
  110. 110. Throughput incentive produces pushback against customer resources • A little bit of EE is not noticeable and is good public relations • A lot of EE is noticeable but just shaves the growth rate – Complaints, but not a real problem • Growing DG eats up sales in chunks • What if EE and DG are the best investments for the grid? 110
  111. 111. Solutions to the Throughput Incentive • There are two that reduce revenue risk for utility – Decoupling or revenue regulation • Reconcile rates to recover previously found revenue requirement – Straight fixed variable rate design • Collect all embedded fixed costs in the customer charge 111
  112. 112. Capital Bias • If net income comes from capital investment, makes sense to invest more capital – Even if customer side solutions would address needs cheaper with less risk – Con Edison pilot to avoid a $1.2 B substation with cheaper distributed resources required state initiative and to agree to adjustments to how associated expenses are recovered (10 yr amortization) 112
  113. 113. 113 Build Stuff Earnings
  114. 114. Build Big Stuff More Earnings 114
  115. 115. Build Really Big Stuff Really Big Earnings 115
  116. 116. Capital Bias + Throughput Incentive Affect on Non-Wires Solutions to Grid Needs 116 Except for a minimum amount to address policy directivesStill looking for where innovation comes from
  117. 117. Cheaper = Less Profitable 117
  118. 118. Customer Builds Stuff: No Earnings 118
  119. 119. Efficient Investment: What if the best source of investment is customers? • Eliminate the throughput incentive with decoupling • Eliminate the capital bias with a new system of earning net income and a focus on total expenses • Planning to identify best investments • Rates that signal value to customers • Performance incentives that guide utility to societally important outcomes 119
  120. 120. NY’s Reforming the Energy Vision 120 Value Markets Performance Rates Cost Planning Enable Public Policy, Notably: energy-environment nexus, protect vulnerable customers
  121. 121. Ways Utilities Can Earn • Return on Investment • Return on Performance – Energy efficiency already common • Services – Emerging into competitive space • Fees – Enabling value-added services by others – i.e. Data analytics 121
  122. 122. New Revenue Model Current Future Return Of Traditional Operating Expenses Delivery Customers Return Of and Return On Traditional Rate Base Return Of Traditional Operating Expenses Delivery Customers Return Of and Return On Traditional Rate Base Data Analysis and Interconnect Fees Platform Customers Customer Portal and Transaction Fees Unbundled Value Added Services Delivery Customers Earnings Impact Mechanisms TBD Return Of and On Non- Traditional REV Investments Delivery Customers NY DPS Staff
  123. 123. New Revenue Model Current Future Return Of Traditional Operating Expenses Delivery Customers Return Of and Return On Traditional Rate Base Return Of Traditional Operating Expenses Delivery Customers Return Of and Return On Traditional Rate Base Data Analysis and Interconnect Fees Platform Customers Customer Portal and Transaction Fees Unbundled Value Added Services Delivery Customers Earnings Impact Mechanisms TBD Return Of and On Non- Traditional REV Investments Delivery Customers DPS Staff
  124. 124. Utility Performance Incentive Mechanisms: A Handbook for Regulators, Synapse Energy Economics for Western Interstate Energy Board, March 9, 2015
  125. 125. Rate Utilities on Performance 125
  126. 126. Service Reliability and Quality 126 SAIDI SAIFI Voltage Frequency
  127. 127. Customer Service 127
  128. 128. Keeping customer bills low 128
  129. 129. Emissions Performance 129
  130. 130. Energy Efficiency Performance 130
  131. 131. Renewable Energy Performance 131
  132. 132. Illustrating a Zero-Based Performance System • ROE is 10% • Debt rate is 8% • What if the return on equity investment = the Debt rate? • How does utility meet earning expectations? 132 8% 8% 3% 0% 2% 4% 6% 8% 10% 12% EarnedRateofReturn Incorporating a Performance Compoenent into the Rate of Return 10% 2% 8%
  133. 133. New Performance Based Outcomes and Metrics: An Illustration • A zero-based approach – Before performance is considered, utility earns 8% based on rate base • You can also start at normal return and go up and down • Normally allowed return consistent with compliance- based performance • Higher return available for increasing, exemplary level of measured performance 8% 8% 3% 0% 2% 4% 6% 8% 10% 12% EarnedRateofReturn Incorporating a Performance Compoenent into the Rate of Return Normal Return
  134. 134. Straight A’s = High Earnings 134 Reflecting value society got
  135. 135. Poor Grades = Debt-Only Return No Shareholder Earnings 135
  136. 136. Is a return on performance the icing? An addition to ROE of a few % or basis points or cents per share? Is return on performance a significant % of total earnings? Is this sufficient to induce action motivate utilities to exemplary performance?
  137. 137. NewCo Allowed Revenue Debt Return 40,000,000$ Operating Expenses 100,000,000$ Total Allowed Revenue 200,000,000$ Estimated kWh Sales 2,000,000,000 Rate per kWh 0.10$ Metric Grade Shareholder Return Customer Service C $ 8,000,000 Reliability A $ 16,000,000 Emissions B $ 12,000,000 Energy Efficiency B $ 12,000,000 Renewable Energy C $ 8,000,000 Low Bills D $ 4,000,000
  138. 138. True Up For Sales Allowed Revenue 200,000,000$ Estimated Sales 2,000,000,000 Established Rate 0.1000$ Actual Sales 1,950,000,000 Required Rate 0.1026$ True-Up Adjustment + $.0026
  139. 139. 139 Where the net income comes from…
  140. 140. Competitive Advantage and Mitigation Tools • If utilities are allowed into competitive business lines – PV, heat pumps • Or are allowed to sell value add services – Data analytics • There are tools to manage market power – Separations – Codes of conduct and Affiliate Transaction Rules – Prohibitions 140
  141. 141. Separations • The regulator can direct that some operations must be separated from the core monopoly service – Functional separation allows the utility into these activities, but walls off the competitive operation with rules about conduct between – Structural separation requires sensitive activities into an affiliate, separate from the utility with rules about conduct between 141
  142. 142. Codes of Conduct • Addresses how the monopoly relates to competitors and how it addresses its own or affiliated competitor • Affiliate transaction rules govern how the monopoly and the competitive unit exchange services and under what circumstances the competitive unit can trade on its relationship 142
  143. 143. The Case of Con Ed Solutions • When retail competition came to New York, Con Ed wanted to create a retail energy provider, Con Ed Solutions – NY could have barred this as an overwhelming competitive advantage – NY could have forced Con Ed Solutions to compensate Con Ed for the value of the name • Revenue would be credited to utility customers – NY did neither 143
  144. 144. Prohibitions • The utility is barred from certain business lines 144
  145. 145. Wall Street Issues • Source of capital – We want the utility system to have access to reasonably priced (investment grade) capital • Ratings are important • Perceptions of Risk – Include judgment about regulation – Regulation response to trends will reflect on the utility 145
  146. 146. The outcome? • With distributed resources emerging – Society is asking the utility business to do different things, to innovate • Let’s be explicit about that! • Just where rates are high? Innovation valuable – Indicates reassessment of utility compensation is timely – Collaboration may be needed to tap the innovation in regulators and utilities 146
  147. 147. About RAP The Regulatory Assistance Project (RAP) is a global, non-profit team of experts that focuses on the long-term economic and environmental sustainability of the power and natural gas sectors. RAP has deep expertise in regulatory and market policies that:  Promote economic efficiency  Protect the environment  Ensure system reliability  Allocate system benefits fairly among all consumers Learn more about RAP at www.raponline.org rsedano@raponline.org jlazar@raponline.org

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