The document discusses electric ratemaking in Texas, including how rates are determined through revenue requirements and rate structures, the regulatory process for rate cases, and recent mechanisms introduced in utility ratemaking like distribution cost recovery factors. It also covers concepts like allowed versus earned rates of return and how utilities are regulated differently within and outside the ERCOT grid.

1. Electric Ratemaking
in Texas
November 2020
Legislative advertising paid for by: Association of Electric Companies of Texas
1005 Congress, Suite 1000, Austin, TX 78701 • 512-474-6725 • www.aect.net

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AECT Utilities Within ERCOT
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Transmission & Distribution Utilities
Total ERCOT
Capacity:
94,000+ MW

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AECT Utilities Outside of ERCOT
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03
Western Electricity Coordinating
Council (WECC)
Midcontinent Independent System
Operator (MISO)
Southwest Power Pool (SPP)
Total ERCOT
Capacity:
94,000+ MW

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Steps to Electric Competition in Texas
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04
Jan. 2007
Jan. 2005
Jan. 2002
July 2001
Sep. 1999
June 1999
May 1995
Wholesale
competition
legislation
passed (SB 373)
Retail
competition
legislation
passed (SB 7)
ERCOT
electric rates
frozen
Texas Choice
pilot program
begins
Retail choice
begins in
ERCOT
Affiliate REPs
allowed to
offer non-
price-to-beat
prices
End of
price-to-beat

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ERCOT: Separate Companies Provide Retail, Transmission &
Distribution and Generation Services
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05
• In competitive markets, consumers have multiple retail electric providers (REPs) and service
plans to choose from.
• Wholesale and retail prices are set by competitive market forces, while the PUC sets transmission
and distribution rates.
Power Flow
Financial Flow
Regulated

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Outside ERCOT: A Single Utility Provides Retail, Transmission &
Distribution and Generation Services In Each Area
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06
• In fully regulated markets, the PUC sets retail rates charged to end-use customers.
• Each of service area is part of a multi-state electric grid, with differing regulations. In many
cases, vertically integrated utilities purchase wholesale power from certain unregulated entities.
Power Flow
Financial Flow
Regulated

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The Regulatory Compact
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The basic purpose of utility rate regulation is to balance the
needs of the consumer and the reliability of the utility
– Utilities are required to serve all customers in their territory
– In exchange, the utility is allowed to retain their territorial monopoly and
earn a limited profit, which is regulated by the PUC
– The PUC has historically set prices at rates that reflect the cost of building
and maintaining infrastructure, plus administrative costs and expenses that
reflect policy decisions made by the state

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Continued Transmission & Distribution and Generation Investment
Needed Long-Term
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• According to the Texas State
Data Center, 5 million new
residents are expected in Texas
by 2020.
• New generation must be
delivered effectively and
efficiently to population
centers of the state.
• Areas of Texas located outside
the ERCOT grid are also
growing, both in terms of
population and economic
development, requiring
transmission investment.
Source: ERCOT, “Report on Existing and Potential Electric System Constraints and
Needs,” December 2018 (next update will be December 2020)

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Two Basic Components of a Rate Case
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Determination of Revenue Requirements
The amount of gross revenues needed by a utility to
cover its operating expenses, depreciation, taxes and
other expenses
Determination of Rate Structure
The rates paid by each customer class to provide the
necessary revenue as determined in the revenue
requirements
1.
2.

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Statutory Timeline of a Rate Case
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Day 1 Day 185Day 35 Day 135
Utility files a statement of intent to file a rate case with Original Jurisdiction authorities (either its cities or
the PUC). Original Jurisdiction authorities also have the authority to demand the utility file a rate case.
After the rate case is filed, the PUC may suspend the effective date of proposed
rates by an additional 150 days beyond the notification period
After filing the rate case, PUC Staff, cities, affected ratepayer groups and
OPUC may intervene and begin sending discovery requests to the utility.
• Rate cases are almost always referred to SOAH, where an ALJ establishes a
procedural schedule to allow the PUC to decide the case before the deadline.
• Intervenors then file written testimony on the rate application.
• The utility may then file testimony rebutting intervenor testimony.
• About 70% of rate cases are settled without a hearing. If a hearing occurs, it’s
normally around 100 days after filing.
• The ALJ will issue a proposed order (if no hearing) or a proposal for decision (if
contested) and refer the case back to the PUC.
The PUC must approve or deny the case by day 185, or the case is
deemed approved. The utility may voluntarily extend the timeline.

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Determination of Revenue Requirements
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Operating Expenses include only those
expenses the utility has incurred to
provide the regulated services.
Depreciation – the loss of asset value
over time due to wear and tear -- is
separated from the net book value, and
thus not multiplied by the rate of return
described below.
Net Book Value of the utility’s capital
assets includes those capital assets used
by the firm specifically to provide the
regulated service.
Rate of Return is the post-tax rate of
return the utility is permitted to earn. It is
based on a weighted average of the cost
of debt and equity financing.
Revenue
Requirement
Operating
Expenses
+
+
+
=
Depreciation
Taxes
Net Book Value
x
Rate of Return

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Determination of Revenue Requirements: Guiding Concepts
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o Public Interest: Regulators should take a long-term view to ensure appropriate
prices and reliability of the system by considering service as well as price.
o Used and Useful: Assets must be deemed necessary or beneficial to the
provision of utility service.
o Just and Reasonable: The PUC may take into consideration issues such as
availability of required assets, technical obsolescence of equipment, expense of
operation, physical or other values of assets, including business operations of the
utility.
o Known and Measurable: Rate adjustments should have a strong measure of
certainty and the ability to be measured relatively accurately.
o Watching for Gold-plating: Facilities used for all aspects of operations should
be reliable and adequate but should not be extravagant or extreme.

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Determination of Revenue Requirements: Additional Guiding
Concepts
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o Matching: Plant, depreciation, taxes, revenues must be matched for the period
being examined.
o Limiting Overcapitalization: Ensuring the utility is not making unnecessary
investments.
o Studying Acquisitions: Adjustments based on the difference between original
costs and purchase prices – often reviewed on a case-by-case basis.
o Limiting Regulatory Lag: The utility cannot change prices instantaneously to
absorb cost increases; this must be taken into account by the PUC when
determining rates.
o Efficient Regulation: Given the costs and timelines of rate cases, and resulting
strain on both the utility and the PUC, effective regulation would result in fewer
rate cases.

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Determination of Rate Structure: Customer Classes
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o The PUC works with stakeholders to determine rates for different classes of
customers:
– Residential and Small Commercial
– Large Commercial
– Industrial
– Governmental
– Other classes, such as low-income customers, private academic and
community institutions
o The total estimated usage from each customer class, multiplied by the
rate for regulated charges must meet the revenue requirement

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Charges Included in Utility Rates
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o The following charges may be included in rates:
– Rate case expenses
– Federal income tax costs or credits
– Nuclear decommissioning charges, if applicable
– Transmission to competition charges
– Energy efficiency cost recovery factor
– Advanced metering cost recovery factor
– ERCOT fee
o These surcharges allow utilities to recover the costs of meeting
customer growth, regulatory requirements and specific public policy
goals set by elected officials

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Newest Mechanisms in Utility Ratemaking in Texas
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Distribution Cost Recovery Factor for ERCOT TDUs
o Allows utilities to periodically adjust their rates, specifically for non-controversial
investments in the distribution network, such as poles, wires, software and
telecommunications equipment
Improvements in Ratemaking for Non-ERCOT Utilities
o Non-ERCOT utilities can update rate case filings to reflect more current
investments
o “Relate-back” provisions allow rates to be made effective on the 155th day after
filing; a surcharge can be used to collect or refund changes in rates

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Rates of Return: Allowed vs. Earned
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Allowed Rate of Return
The level of return used to establish a fair rate
level that is high enough to allow the utility to
attract capital while allowing a reasonable profit,
as determined by the regulator and the
stakeholder process.
The determination of the allowed rate of return,
including legal standards for the term, are
complex, but the goal is meeting that
reasonableness standard.
Earned Rate of Return
The amount of money a
utility earns, over and
above its expenses,
expressed as a percentage
of the rate base.
The Allowed Rate of Return is a target for the utility to attempt to
achieve through efficient operations – it is not a guaranteed profit

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How to Reach Us
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AECT.net
@aectnet
AECT Advocacy
The AECT App