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Course Overview and Introduction

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					Introduction to Cost of Service
Concepts & Techniques


Overview and Introduction
Objectives
    Understanding and appreciation of
     different cost of service
     perspectives
    Our challenges:
        Cost of service is not a science, it is
         an art derived from processes viewed
         from differing perspectives




                            R. W. Beck | Introduction to Cost of Service
Steps in the Overall Ratemaking
process
 STEP 1   Study Preparation

 STEP 2   Review Policies, Objectives and Strategies

 STEP 3   Determine Utility Revenue Requirement

 STEP 4   Functionalize Costs and Services into
          Business Units

 STEP 5   Classification of Costs

 STEP 6   Allocate Costs to Rate Classes
          Interpret Cost of Service Results and
 STEP 7   Develop Rate Design


                               R. W. Beck | Introduction to Cost of Service
Steps in the Analytical Ratemaking
process
             Determine the revenue                              REVENUE
    STEP 1   requirement of the                               REQUIREMENT
             utility                                         DETERMINATION

    Step 2   Functionalize costs and
             services (production,
             transmission, distribution,
             etc.)                                                 COST
                                                                ALLOCATION
    Step 3   Classify costs (demand,
             energy, customer costs, etc.)

    Step 4   Allocate costs among
             customer classes

    Step 5   Design rates                                      RATE DESIGN

                               R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques

Overview of Cost
of Service Process
Cost of Service Team
    Policy-Makers
    Finance
    Planning and Engineering
    Customer Service
    Accounting
    Others
        Legal
        Marketing
        Conservation and DSM
        Economic Development
                            R. W. Beck | Introduction to Cost of Service
Stakeholders – Identification
    Customers
    Regulators
    Economic development interests
    Environmental community
    Special interest for social concerns
    The utility
    Bankers, vendors, employees,
     unions
    Mystics
                        R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques


Study Preparation
Study Preparation
    Introduction
        Successful cost of service analysis
         requires preparation and planning to
         ensure achievable results

        Preparation time may be substantial




                           R. W. Beck | Introduction to Cost of Service
Four Important Considerations
 1) Understand Study objectives,
    policies and strategies
      What is the desired outcome from:
          Utility perspective
          Customer perspective
          Regulator perspective




                           R. W. Beck | Introduction to Cost of Service
Four Important Considerations
(cont’d)
 2) The reasonableness and
    defensibility of a Study is
    directly proportional to quality
    of data and thoroughness of
    analyses
      Identify weaknesses or ―Flash
       Points‖ likely to create controversy
       in your analysis



                        R. W. Beck | Introduction to Cost of Service
Four Important Considerations
(cont’d)
 3) In the absence of quality data, it
    is better to make reasonable
    assumptions rather than to ―walk
    away‖ from the issue
     Avoid getting lost in the numbers
     Numbers are not a ―crutch‖
     Use ―reasonableness‖ and
      ―common sense‖


                       R. W. Beck | Introduction to Cost of Service
Four Important Considerations
(cont’d)
 4) Know your system!
     Corporate/Legal/Jurisdictional
     Infrastructure
     Operations




                      R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques


Revenue Requirement
Steps in the Rate Design Process
            Determine the revenue                              REVENUE
   STEP 1   requirement of the                               REQUIREMENT
            utility                                         DETERMINATION

   Step 2   Functionalize costs and
            services (production,
            transmission, distribution,
            etc.)                                                 COST
                                                               ALLOCATION
   Step 3   Classify costs (demand,
            energy, customer costs, etc.)

   Step 4   Allocate costs among
            customer classes

   Step 5   Design rates                                      RATE DESIGN

                              R. W. Beck | Introduction to Cost of Service
Revenue Requirement
Definition – Revenue Requirement
 For a utility system, the revenue
  requirement equals the total cost of
  serving customers in various rate classes
 For each rate class, properly designed
  rates will generate sufficient revenues
  to equal the revenue requirement




                        R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   Revenue Requirement includes:
     Reasonable operating expenses
     Fair return on investment
     Consideration of other revenue
      sources




                        R. W. Beck | Introduction to Cost of Service
Revenue Requirement
Definition – Test Year
  A 12-month period that reflects
   financial and operating conditions that
   are expected to occur into the future
  Historical Fiscal Year Accounting and
   Operating Information
     Audited   Financial Statements
    Test Year reflects anticipated
     conditions

                             R. W. Beck | Introduction to Cost of Service
Revenue Requirement
Definition: Known and Measurable
Adjustments
     Financial and/or operating
      adjustments to actual historical
      utility performance. Adjustments
      are based on proven changes that
      have occurred or are expected to
      occur in the near future



                       R. W. Beck | Introduction to Cost of Service
Revenue Requirement
Known and Measurable Adjustments
     Examples include:
          Extraordinary capital projects
          Financing
          Re-organization, re-structuring
          Power supply
            – Load changes
            – Resource changes




                              R. W. Beck | Introduction to Cost of Service
Revenue Requirement
Definition: Used and Useful
  An investment or business activity that
  provides value to customers




                       R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   Revenue Requirement Components
       Operation and maintenance expense
       Other cash or non-cash expenses
       Cost of capital
       Taxes or in lieu of taxes
       Return
       Less: other non-rate income sources



                          R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   Utility Approach – Applicable to
    IOUs, Cooperatives and Municipal
    Utilities
     Industry standard for IOUs and
      Cooperatives
     Occasionally used for Municipal
      Utilities




                        R. W. Beck | Introduction to Cost of Service
FERC Uniform System of Accounts
   100–199 Assets and other debits

   200–299 Liabilities and other
           credits

   300–399 Plant accounts

   400–432, Income accounts
   434-435
                   R. W. Beck | Introduction to Cost of Service
 FERC Uniform System of Accounts
 (cont’d)

433,      Retained earnings accounts
436-439

440–459   Revenue accounts

500–599   Production, transmission and
          distribution expenses

900–949   Customer accounts, customer
          service and informational, sales,
          and general and administrative
          expenses
                         R. W. Beck | Introduction to Cost of Service
Example
   Utility Approach (IOU) Revenue
    Requirement
       Example COS 5-1




                          R. W. Beck | Introduction to Cost of Service
Revenue Requirement
Definition: Rate Base (IOU)
     Investment upon which a utility can
      earn a rate of return




                         R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   Rate Base Components
       Gross Plant in Service
       Accumulated Depreciation
       Accumulated Provision for Deferred
        Income Taxes
       Electric Plant Held for Future Use
       Construction Work in Progress
       Allowance for Funds Used During
        Construction
       Working Capital

                          R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   Return on Rate Base (IOUs)
       Appropriateness
            Cost of debt
            Cost of equity
            Business risk
       Consistency




                              R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   Return on Rate Base (IOUs)
       Weighted Average Cost of Capital
        (WACC)
            A regulated utility is allowed to earn a
             return on its investment. The return
             included in the revenue requirement is
             the Rate Base multiplied by a
             percentage rate of return (ROR)
            Example:
              – Rate Base        = $100 million
              – Allowed ROR      = 9.85%
              – Allowed Return   = $9.85 million per year
                                  R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   WeightedAverage Cost of Capital
   (WACC) (cont’d)
      The overall ROR consists of amounts to cover the costs
       of long-term debt and preferred stock, plus a return
       on stockholder equity comparable to that of other
       investments of similar risk

       Example:
          Item           % of Capital        Cost              Weighted Cost

       Long-Term Debt        40%               7%                      2.80%

       Preferred Stock        5%               9%                      0.45%

       Equity                55%             12%                       6.60%

       TOTAL                100%              N/A                      9.85%


                                        R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   Return on Rate Base (IOUs)
       Cost of Debt
            Long Term Debt
            Short term borrowing
            Preferred Stock - Equity securities that
             pay a fixed dividend regardless of
             corporate earnings and offer
             preferential rights in regard to
             distribution of assets upon liquidation
            Straight forward calculation


                                R. W. Beck | Introduction to Cost of Service
Revenue Requirement
   Return on Rate Base (IOUs)
       Cost of Equity
            Industry average
              – Value Line
            History
            Unique circumstances




                                R. W. Beck | Introduction to Cost of Service
Example
   Utility Approach (IOU) Rate Base
       Example COS 5-2




                          R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques

Cost Allocation
Methodologies
Cost Allocation
    Cost allocation is the process of
     taking the total revenue
     requirements and spreading it
     over the various classes of
     customers
    The ultimate goal is to allocate
     costs in a fashion which reflects
     the cost of providing services to
     each class (a cause-and-effect
     relationship)
                        R. W. Beck | Introduction to Cost of Service
Steps in the Ratemaking process
            Determine the revenue                              REVENUE
   STEP 1   requirement of the                               REQUIREMENT
            utility                                         DETERMINATION

   Step 2   Functionalize costs and
            services (production,
            transmission, distribution,
            etc.)                                                 COST
                                                               ALLOCATION
   Step 3   Classify costs (demand,
            energy, customer costs, etc.)

   Step 4   Allocate costs among
            customer classes

   Step 5   Design rates                                      RATE DESIGN

                              R. W. Beck | Introduction to Cost of Service
Functionalize Costs
 Typical cost functions include:
    Production (and/or purchased
     power)
    Transmission
    Distribution
    Customer Care



                      R. W. Beck | Introduction to Cost of Service
Classify Costs
    Typical cost classifications include:
    Demand Costs
        Costs that vary with the kW demand imposed on the
         system
    Energy Costs
        Costs that vary with the energy or kWh sold or
         purchased
    Customer Costs
        Costs that are related to the number of customers
         served
    Revenue Related Costs
        Costs that vary with revenue
    Direct Assignment
        Costs specifically assigned to a particular customer
         or group of customers

                                    R. W. Beck | Introduction to Cost of Service
Allocate Costs
    Costs are allocated based on a combination of
     function, classification, and other attributes
    Allocation factors are developed for each cost
     classification
        Demand (CP, 12CP, NCP, etc.)
        Energy (kWh)
        Customers (unweighted, weighted)
        Others (revenue, labor, blended/derived allocation
         factors)
    Allocation factors are used to spread costs
     among customer classes (residential,
     commercial, industrial, lighting)

                                  R. W. Beck | Introduction to Cost of Service
Common Approaches to Cost
Allocation

     Embedded
     Marginal




                 R. W. Beck | Introduction to Cost of Service
Definition – Embedded Cost
    Average system costs assuming all
     utility resources spread across all
     customers

    Generally based on historical or
     known costs




                        R. W. Beck | Introduction to Cost of Service
Definition – Marginal Cost
    Costs experienced or avoided
     when a unit of output is added or
     forgone.

             ∆ Total Cost
        MC =
              ∆ Quantity



                       R. W. Beck | Introduction to Cost of Service
Common Approaches to Cost
Allocation (cont’d)

   Bundled Approach

   Unbundled Approach




                    R. W. Beck | Introduction to Cost of Service
Bundled Approach Cost Allocation

   Mirrors utility accounting practices

   Cost of service results are bundled
    and presented from the utility’s
    perspective

   Limits rate design



                         R. W. Beck | Introduction to Cost of Service
Bundled Approach

     Revenue
      Reqs.

      Ops. &
   Maintenance
     Expense


   Depreciation
                  COST OF SERVICE
                   BY RATE CLASS
      Taxes


    Return on
    Ratebase



      Other




                        R. W. Beck | Introduction to Cost of Service
Unbundled Approach Cost
Allocation

   Mirrors utility products, services
    and activities

   Cost of service results are
    unbundled and presented from the
    customer’s perspective

   Flexible rate design


                        R. W. Beck | Introduction to Cost of Service
       Unbundled Approach

 Revenue
  Reqs.

   Ops. &             Revenue
Maintenance            Reqs.
  Expense


Depreciation           Prod.                 COST OF SERVICE
                                              BY RATE CLASS


   Taxes               Trans.



 Return on            Distrib.
 Ratebase


   Other             Customer



                            R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques


Functionalization of Costs
Steps in the Rate Design Process
            Determine the revenue                              REVENUE
   STEP 1   requirement of the                               REQUIREMENT
            utility                                         DETERMINATION

   Step 2   Functionalize costs and
            services (production,
            transmission, distribution,
            etc.)                                                 COST
                                                               ALLOCATION
   Step 3   Classify costs (demand,
            energy, customer costs, etc.)

   Step 4   Allocate costs among
            customer classes

   Step 5   Design rates                                      RATE DESIGN

                              R. W. Beck | Introduction to Cost of Service
What Business Are You In?




    Generating                            High Voltage
     Station                              Transmission




 Residential   Commercial Distribution   Industrial
  Customer      Customer Substation      Customer                Transmission
                                                                  Substation

                                         R. W. Beck | Introduction to Cost of Service
Four Common Business Units
    Production
    Transmission
    Distribution
    Customer Care




                     R. W. Beck | Introduction to Cost of Service
Allocating Costs to Business Units
    Unbundle Test Year Revenue
     Requirement into Business Units
      Direct Assignments
      Derived Allocation
            Allocation representing the sum,
             average or weighted effect of differing
             underlying allocation methods




                                R. W. Beck | Introduction to Cost of Service
Example: Direct Assignment –
Distribution


FERC                    Alloc
         Description            Amount         Prod         Trans             Dist         Cust
Acct.                  Method

582     Station Exp.   Direct   1,000,000         0            0          1,000,000         0

        Allocation %              100%           0%           0%             100%          0%




                                            R. W. Beck | Introduction to Cost of Service
Example: Derived Allocation –
Administration and General Salary Expense
     What are the underlying activities
     impacting the level of
     Administration and General Salary
     Expense in your organization?

      Support and Management of the
       Labor Force
      Strategic Planning
      Regulatory

                        R. W. Beck | Introduction to Cost of Service
Example: Derived Allocation –
Administration and General Salary Expense
    Cost Drivers associated with
     management of the Labor Force
          Employee Salaries
          Number of Employees




                           R. W. Beck | Introduction to Cost of Service
Example: Derived Allocation –
Administration and General Salary Expense
    Cost Drivers associated with
     Strategic Planning
      Rate Base
      Capital Improvement Plan




                        R. W. Beck | Introduction to Cost of Service
Example: Derived Allocation –
Administration and General Salary Expense
    Cost Drivers associated with
     Regulatory Activities
      Rate Base
      Outside Services Employed




                        R. W. Beck | Introduction to Cost of Service
Example: Derived Allocation –
Administration and General Salary Expense
A&G Salary Allocation Based on Labor
Salaries
                            Labor Salaries
Business Unit    Total        Prod       Trans               Dist               Cust

Production      3,000,000   3,000,000       0                  0                   0
Transmission    1,000,000      0        1,000,000              0                   0
Distribution    5,000,000      0            0            5,000,000                 0
Customer        500,000        0            0                  0              500,000
Total           9,500,000   3,000,000   1,000,000        5,000,000            500,000
% Allocation      100%        32%         11%                 52%                 5%




                                          R. W. Beck | Introduction to Cost of Service
Example: Derived Allocation –
Administration and General Salary Expense



FERC                    Alloc
Acct.   Description    Method    Amount       Prod          Trans             Dist           Cust
920     A&G Salaries   Derived   1,000,000   320,000       110,000          520,000          50,000

        Allocation %               100%       32%             11%              52%            5%




                                              R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques


Classification of Costs
Development of Allocation
Factors
            Determine the revenue                              REVENUE
   STEP 1   requirement of the                               REQUIREMENT
            utility                                         DETERMINATION

   Step 2   Functionalize costs and
            services (production,
            transmission, distribution,
            etc.)                                                 COST
                                                               ALLOCATION
   Step 3   Classify costs (demand,
            energy, customer costs, etc.)

   Step 4   Allocate costs among
            customer classes

   Step 5   Design rates                                      RATE DESIGN

                              R. W. Beck | Introduction to Cost of Service
Basic Cost Categories
    Fixed Cost
    Variable Cost




                     R. W. Beck | Introduction to Cost of Service
Fixed Costs
    Do not vary materially with
     electricity use or number of
     customers
        Examples:
            Labor
            Insurance
            Depreciation
            Interest



                            R. W. Beck | Introduction to Cost of Service
Variable Costs
    Vary with production or electricity
     use
        Examples:
            Fuel
            Variable production costs




                                R. W. Beck | Introduction to Cost of Service
Typical Cost Classifications
    Demand
    Energy
    Customer
    Revenue
    Direct Assignments




                      R. W. Beck | Introduction to Cost of Service
Demand-Related Costs
   Costs that vary with the kilowatt
    demand imposed on the System
       Examples:
           Demand portion of production
           Transmission
           Demand component of distribution plant




                              R. W. Beck | Introduction to Cost of Service
Energy-Related Costs
    Costs that vary with the energy or
     kilowatt-hours provided by the
     utility
        Examples:
            Fuel
            Variable production costs




                                R. W. Beck | Introduction to Cost of Service
Customer-Related Costs
    Costs that are related to the
     number of customer services
        Examples:
            Customer billing
            Meter reading
            Customer service
            Capital cost of meters and services
            O&M costs of meters and services




                                R. W. Beck | Introduction to Cost of Service
Revenue-Related Costs
    Costs that vary with revenue
        Examples:
            Taxes
            Public benefit charges




                                R. W. Beck | Introduction to Cost of Service
Direct Assignments
    Costs assigned directly to a
     particular customer or Class of
     customers
        Examples:
            Line extensions to specific customer
            Street and security lighting




                                R. W. Beck | Introduction to Cost of Service
Summary of Cost Functions and
Classifications

          Typical Cost        Typical Cost
           Functions         Classifications

      Production:         Demand Related
                          Energy Related


      Transmission:       Demand Related
                          Direct Assignments


      Distribution:       Demand Related
                          Customer Related
                          Direct Assignments

      Customer Service:   Customer Related



                              R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques


Rate Class Determination
Issues
    Are Rate Classes needed?
      Why do we have them?
      What are they?
      Changes in approach

    Number of classes
    Type of classes
    Classes within classes
    Cost of service support

                       R. W. Beck | Introduction to Cost of Service
Why Have Rate Classes?
    Different load characteristics
    Different service voltages
    Different costs to serve
      Load density
      Reliability requirements
      Other (discussion)

    Desire for different returns


                         R. W. Beck | Introduction to Cost of Service
Typical Classes
      Residential
      Small Commercial
      Large Commercial
      Industrial
      Agricultural
      Municipal
      Streetlighting
      Security Lighting
      Net Metering?
      Off-System Sales (Market Driven)
                         R. W. Beck | Introduction to Cost of Service
Changes in Approach –
Industry Restructuring
    Rate Design’s impact on rate class
     determination
    Time-of-Use rates can compensate for
     different load characteristics
    Real-Time pricing even better
    Need for different ROIs
    Need for Non-Demand vs. Demand Rates
    Use service voltage discounts to reduce
     number
    Small number of classes is preferable
    Other
                         R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques

Development of
Allocation Factors
Steps in Ratemaking Process
            Determine the revenue                              REVENUE
   STEP 1   requirement of the                               REQUIREMENT
            utility                                         DETERMINATION

   Step 2   Functionalize costs and
            services (production,
            transmission, distribution,
            etc.)                                                 COST
                                                               ALLOCATION
   Step 3   Classify costs (demand,
            energy, customer costs, etc.)

   Step 4   Allocate costs among
            customer classes

   Step 5   Design rates                                      RATE DESIGN

                              R. W. Beck | Introduction to Cost of Service
Development of Allocation
Factors
    How do you develop allocation
     factors?
      Which allocation factors are needed?
      What are allocation factors based on?
      Information and data needs?
      Who has the information?




                         R. W. Beck | Introduction to Cost of Service
Development of Allocation
Factors
    Allocation Methodology must align
     with Cost Classification
    Demand-Related
      Coincident Peak
      Non-Coincident Peak
      Sum of Max Demands

    Energy-Related
      kWh Sales
      Net Energy for Load
                         R. W. Beck | Introduction to Cost of Service
Development of Allocation
Factors
    Demand/Energy Hybrids
      Average and Excess Demand
      Other




                       R. W. Beck | Introduction to Cost of Service
Development of Allocation
Factors
    Customer-Related
      Number of customers
      Weighted number of customers

    Revenue-Related
    Direct Assignment




                         R. W. Beck | Introduction to Cost of Service
Coincident Peak

 Definition: Class demand at the
  time of the System Peak
    Annual
    Monthly
    Hourly




                     R. W. Beck | Introduction to Cost of Service
Class Contribution to Coincident
Peak

                            Class Contribution to Peak Demand – Annual Peak


                                                 Annual Coincident Peak                  Class B Peak
              1,200
                                                                                         Non-Coincident Peak
                                  Class C Peak
              1,000
                                  Non-Coincident Peak
Demand (MW)




               800
               600
               400
               200                                                                    Class A Peak
                                                                                      Non-Coincident Peak
                 0
                      Jan   Feb      Mar    Apr      May    Jun    Jul      Aug       Sep      Oct     Nov       Dec



                                  Class A                     Class B                          Class C




                                                                        R. W. Beck | Introduction to Cost of Service
Non-Coincident Peak

 Definition: Maximum demand of a
 customer class, regardless of when
 it occurs.




                     R. W. Beck | Introduction to Cost of Service
Class Non-Coincident Peak Compared
to Contribution to System Coincident
Peak

                              Class Contribution to Peak Demand – Monthly

                                             Annual Coincident Peak                    Class B Peak
                1,200
                                                                                       Non-Coincident Peak
                1,000              Class C Peak
                                   Non-Coincident Peak
  Demand (MW)




                 800

                 600

                 400

                 200                                                                 Class A Peak
                                                                                     Non-Coincident Peak
                   0
                       Jan   Feb     Mar     Apr   May    Jun    Jul        Aug     Sep      Oct      Nov     Dec


                                   Class A                  Class B                         Class C




                                                                      R. W. Beck | Introduction to Cost of Service
Sum of Maximum Demands
Definition: Sum of demands
measured at the meter
   Load profile meter
   Billed Demand
         Beware of ratchets!
     Estimated Demands
         Load factors
         Load research study results



                             R. W. Beck | Introduction to Cost of Service
Concept of Coincidence and
Diversity

                Sum of Maximum Demands

                               Totalized Class Peak Demands (Class NCP)

                                                    System Coincident
   Industrial
                                                    (Class CP) Peak Demands




 Commercial




  Residential




                                   R. W. Beck | Introduction to Cost of Service
Demand Cost Allocation – Typical
Methods
    Coincident Peak (CP) Method
       Based on the theory that the demand
       costs are most strongly influenced by
       class demands imposed on the
       system at the time of the system
       peak




                         R. W. Beck | Introduction to Cost of Service
Variations of the Coincident Peak
(CP) Method
    1 CP – Based on class CP demands for the month in
     which the annual system peak occurs.
    2 CP, 3 CP, 4 CP, etc. – Based on class CP demands for
     each of the months of highest system demands.
    Examples:
      A summer peaking system might allocate demand costs on
       the basis of class CP demands in each of the 4 months
       June through September.
      A winter peaking system might allocate demand costs on
       the basis of class CP demands in each of the 3 or 4 winter
       months.
      A system with significant summer and winter peaks might
       allocate demand costs on the basis of class CP demands in
       each of 1 to 4 summer months and 1 to 4 winter months.
    12 CP – Based on class CP demands for each of the 12
     months of the year.



                                    R. W. Beck | Introduction to Cost of Service
Examples of Demand Cost Allocation
Methods Data Sheet
Monthly Coincidental Peaks    Class A     Class B          Class C            Total
(kW)
Jan                                300         250              280             830
Feb                                310         240              250             800
Mar                                320         200              250             770
Apr                                300         200              250             750
May                                300         220              250             770
Jun                                430         230              240             900
Jul                                460         240              240             940
Aug                                470         290              240           1,000
Sep                                430         240              250             920
Oct                                310         200              250             760
Nov                                310         200              250             760
Dec                                320         230              250             800
Total                            4,260       2,740            3,000          10,000

Annual Non-Coincidental           480         310               285           1,075
Peaks (kW)

Annual Energy (kWh)          1,270,000   1,051,000      1,752,000        4,073,000

Demand Costs ($)                                                          $100,000


                                              R. W. Beck | Introduction to Cost of Service
Examples of Demand Cost Allocation
Methods (1 CP Method)
   Monthly Coincidental        Class A     Class B       Class C        Total
   Peaks (kW)
   Jan                              300         250          280          830
   Feb                              310         240          250          800
   Mar                              320         200          250          770
   Apr                              300         200          250          750
   May                              300         220          250          770
   Jun                              430         230          240          900
   Jul                              460         240          240          940
   Aug                              470         290          240        1,000
   Sep                              430         240          250          920
   Oct                              310         200          250          760
   Nov                              310         200          250          760
   Dec                              320         230          250          800
   Total                          4,260       2,740        3,000       10,000
   Annual Non-                      480         310          285        1,075
   Coincidental Peaks (kW)

   Annual Energy (kWh)        1,270,000   1,051,000    1,752,000    4,073,000

   Demand Costs ($)                                                  $100,000


   Allocation Based on 1 CP
   Method
    Demand Used for Alloc.         470         290           240        1,000
    Allocation Percentage      47.00%      29.00%        24.00%      100.00%
    Allocated Demand Cost      $47,000     $29,000       $24,000     $100,000


                                                      R. W. Beck | Introduction to Cost of Service
Examples of Demand Cost Allocation
Methods (4 CP Method)
   Monthly Coincidental        Class A     Class B     Class C        Total
   Peaks (kW)
   Jan                             300         250         280          830
   Feb                             310         240         250          800
   Mar                             320         200         250          770
   Apr                             300         200         250          750
   May                             300         220         250          770
   Jun                             430         230         240          900
   Jul                             460         240         240          940
   Aug                             470         290         240        1,000
   Sep                             430         240         250          920
   Oct                             310         200         250          760
   Nov                             310         200         250          760
   Dec                             320         230         250          800
   Total                         4,260       2,740       3,000       10,000
   Annual Non-                     480         310         285        1,075
   Coincidental Peaks (kW)

   Annual Energy (kWh)        1,270,000   1,051,000   1,752,000   4,073,000

   Demand Costs ($)                                                $100,000


   Allocation Based on 4 CP
   Method
    Demand Used for Alloc.       1,790       1,000         970        3,760
    Allocation Percentage      47.60%      26.60%      25.80%      100.00%
    Allocated Demand Cost      $47,600     $26,600     $25,800     $100,000


                                                      R. W. Beck | Introduction to Cost of Service
Examples of Demand Cost Allocation
Methods (12 CP Method)
   Monthly Coincidental       Class A     Class B     Class C        Total
   Peaks (kW)
   Jan                             300         250         280         830
   Feb                             310         240         250         800
   Mar                             320         200         250         770
   Apr                             300         200         250         750
   May                             300         220         250         770
   Jun                             430         230         240         900
   Jul                             460         240         240         940
   Aug                             470         290         240       1,000
   Sep                             430         240         250         920
   Oct                             310         200         250         760
   Nov                             310         200         250         760
   Dec                             320         230         250         800
   Total                         4,260       2,740       3,000      10,000
   Annual Non-                    480         310         285         1,075
   Coincidental Peaks (kW)

   Annual Energy (kWh)       1,270,000   1,051,000   1,752,000    4,073,000

   Demand Costs ($)                                               $100,000


   Allocation Based on 12
   CP Method
    Demand Used for Alloc.      4,260       2,740       3,000       10,000
    Allocation Percentage     42.60%      27.40%      30.00%      100.00%
    Allocated Demand Cost     $42,600     $27,400     $30,000     $100,000


                                                     R. W. Beck | Introduction to Cost of Service
Demand Cost Allocation – Typical
Methods
    Non-Coincident Peak (NCP)
     Methods
        Based on the theory that demand
         costs are most strongly influenced by
         the highest demand of each class,
         whenever it occurs




                           R. W. Beck | Introduction to Cost of Service
Variations of the Non-Coincident
Peak (NCP) Method
    NCP – Based on the greatest
     demand of each customer class at
     any time during the year
    12 NCP – Based on the non-
     coincident peak demands of each
     customer class for each of the 12
     months of the year



                       R. W. Beck | Introduction to Cost of Service
NCP Method
Monthly Non-Coincident Peaks (kW)       Class A          Class B        Class C          Total
Jan                                            316              263            285             864
Feb                                            326              253            254             833
Mar                                            337              211            254             802
Apr                                            309              250            263             822
May                                            309              275            263             847
Jun                                            443              288            253             984
Jul                                            469              257            244             970
Aug                                            480              310            244           1,034
Sep                                            439              257            254             950
Oct                                            320              214            254             788
Nov                                            320              214            250             784
Dec                                            330              246            258             834
Total of 12 NCP                              4,398            3,038          3,076          10,512

Annual Non-Coincident Peaks (kW)              480              310             285           1,075

Annual Energy (kWh)                      1,270,000        1,051,000      1,752,000        4,073,000

Demand Costs ($)                                                                     $     100,000


Allocation Based on 1 NCP METHOD
Demand Used for Allocation                     480              310            285           1,075
Allocation Percentage                        44.6%            28.9%          26.5%          100.0%
Allocated Demand Cost               $       44,651   $       28,837 $       26,512 $       100,000

Allocation Based on 12 NCP METHOD
Demand Used for Allocation                   4,398            3,038          3,076          10,512
Allocation Percentage                       41.8%             28.9%          29.3%         100.0%
Allocated Demand Cost               $       41,838 $         28,900 $       29,262 $       100,000

                                                              R. W. Beck | Introduction to Cost of Service
Demand Cost Allocation – Typical
Methods
    Average and Excess Demand (AED)
     Method
        Based on the theory that demand
         costs are influenced both by the non-
         coincident peak of each customer
         class and by the energy usage - or
         average demand - of each customer
         class



                           R. W. Beck | Introduction to Cost of Service
Examples of Demand Cost Allocation
Methods (AED Method)
    Monthly Coincidental       Class A     Class B      Class C        Total
    Peaks (kW)
    Jan                            300         250           280         830
    Feb                            310         240           250         800
    Mar                            320         200           250         770
    Apr                            300         200           250         750
    May                            300         220           250         770
    Jun                            430         230           240         900
    Jul                            460         240           240         940
    Aug                            470         290           240       1,000
    Sep                            430         240           250         920
    Oct                            310         200           250         760
    Nov                            310         200           250         760
    Dec                            320         230           250         800
    Total                        4,260       2,740         3,000      10,000
    Annual Non-                    480         310          285        1,075
    Coincidental Peaks (kW)

    Annual Energy (kWh)       1,270,000   1,051,000    1,752,000   4,073,000

    Demand Costs ($)                                                $100,000


    Allocation Based on AED
    Method
     Demand Used for Alloc.      438.8       286.6        274.6        1,000
     Allocation Percentage     43.88%      28.66%       27.46%      100.00%
     Allocated Demand Cost     $43,880     $28,660      $27,460     $100,000


                                                      R. W. Beck | Introduction to Cost of Service
Examples of Demand Cost Allocation
Methods (AED Method cont’d)
   Average and Excess              Class A     Class B        Class C         Total         Calculation
   Demand Method
   Annual Energy (kWh)             1,270,000   1,051,000      1,752,000     4,073,000             A
   Hours in Year                    8,760       8,760           8,760         8,760               B
   Average Demand                    145         120             200           465            C = A /B
   Non-Coincident Peak Demand        480         310             285                             D
   (kW)
   Average Demand (kW)               145         120             200                              C
   Class Excess Demand (kW)          335         190             85            610            E=D-C
   System Coincidental Peak (kW)                                              1,000               F
   System Average Demand (kW)                                                  465                C
   System Excess Demand (kW)                                                   535            G=F-C
   Excess Allocation Factors       335/610     190/610         85/610                      H = E / E total
   Allocated Excess Demand (kW)     293.8       166.6           74.6          535.0           I=GXH
   Summary
   Average Demand (kW)               145         120             200           465                C
   Allocated Excess Demand (kW)     293.8       166.6           74.6           535                I
   Total (kW)                       438.8       286.6           274.6         1,000
   Allocation Percentage            43.88%      28.66%         27.46%        100.00%
   Allocated Demand Cost           $43.880     $28.660         $27.460       $100.000




                                                         R. W. Beck | Introduction to Cost of Service
Examples of Demand Cost Allocation
Methods (Summary of Results)

   Demand Cost
    Allocation
   Percentages    Class A   Class B             Class C              Total

   1 CP Method    47.00%    29.00%              24.00%              100.0%
   4 CP Method    47.60%    26.60%              25.80%              100.0%
   12 CP Method   42.60%    27.40%              30.00%              100.0%
   1 NCP Method   44.65%    28.84%              26.51%              100.0%
   12 NCP
                  41.80%    28.90%              29.30%              100.0%
   Method
   AED Method     43.88%    28.66%              27.46%              100.0%
                  41.80 –   26.60 –             24.00 –
   Range
                  47.60%    29.00%              30.00%
   Ratio,
                   1.14      1.09                 1.25
   High/Low




                               R. W. Beck | Introduction to Cost of Service
Energy-Related Allocation Factors
    Energy Allocation Factors
        kWh Sales adjusted for losses




                           R. W. Beck | Introduction to Cost of Service
Energy-Related Allocation Factors
  Annual Energy (kWh)
                                     Class A      Class B        Class C            Total
  Voltage Class Served at:          Secondary    Secondary       Primary
  At the Generator                   1,270,000    1,051,000       1,752,000        4,073,000
  Transmission Loss          1.5%      19,050       15,765          26,280           61,095
  Sales                              1,250,950    1,035,235       1,725,720        4,011,905
  Primary Loss               1.5%      18,764       15,529          25,886           60,179
  Sales                              1,232,186    1,019,706       1,699,834        3,951,726
  Distribution Loss          2.0%      24,644       20,394              NA           45,038
  Sales                              1,207,542     999,312              NA         2,206,854

  Allocation Percentage by Delivery Voltage
     At the Generator                   31.2%        25.8%           43.0%           100.0%
    Transmission                       31.2%         25.8%           43.0%           100.0%
    Distribution Primary               31.2%         25.8%           43.0%           100.0%
    Distribution Secondary             54.7%         45.3%            0.0%           100.0%




                                                 R. W. Beck | Introduction to Cost of Service
Customer-Related Allocation
Factors

   Customer Allocation Factors
     Weighting Factors
     Special Studies




                          R. W. Beck | Introduction to Cost of Service
Customer-Related Allocation
Factors


                                 Total System         Class A         Class B          Class C
No. of Customers                   90,000             72,000           12,000           6,000

Allocation %                                           80.0%           13.3%             6.7%
Billing & Collection Weighting
                                                         1.0             2.0             10.0
     Factors
Weighted Numbers of Customers      156,000            72,000           24,000          60,000

Allocation % after Weighting                           46.2%           15.4%            38.4%




                                                R. W. Beck | Introduction to Cost of Service
Other Methods to Allocate Costs
   Revenue Related Allocation Factors
   Direct Assignments
     Note: Some costs are specifically assigned to a
      particular customer or class of customers if it
      can be determined that those costs related
      only to that customer or customer class


   Primary/ Transmission level customers
    should not be allocated distribution level
    costs

                              R. W. Beck | Introduction to Cost of Service
Introduction to Cost of Service
Concepts and Techniques

Interpreting Cost
of Service Results
Subsidization
 The act of financially supporting
 service to one group of customers
 through excess collection of
 revenues from another group of
 customers.




                     R. W. Beck | Introduction to Cost of Service
Overview
   Subsidization
     Interclass
     Intraclass




                    R. W. Beck | Introduction to Cost of Service
Interclass Subsidization
 One class of customers subsidizing
 another class of customers.




                     R. W. Beck | Introduction to Cost of Service
Interclass Subsidization
         Revenues Collected
 Class              Revenues
 Residential               50%
 Small Commercial          20%
 Large Commercial          10%
 General Service           20%
                           100%



                    R. W. Beck | Introduction to Cost of Service
Interclass Subsidization
       Cost of Service Results
                        Revenue
 Class               Requirements
 Residential                       55%
 Small Commercial                  18%
 Large Commercial                   8%
 General Service                   19%
                                   100%


                    R. W. Beck | Introduction to Cost of Service
Interclass Subsidization
                   Revenues vs. Revenue Requirements

    60%


    50%


    40%


    30%


    20%


    10%


    0%
          Residential   Small Commercial       Large Commercial      General Service

                                 Customer Class

                        Revenue Requirements              Revenues



                                                 R. W. Beck | Introduction to Cost of Service
Intraclass Subsidization
 Customers within a specific class
 subsidizing other customers in the
 same class based on design of the
 rate and differing consumption.




                     R. W. Beck | Introduction to Cost of Service
Intraclass Subsidization Examples
 Assume for the following two
 examples that the Cost of Service
 study indicated that the respective
 classes (residential and general
 service) are contributing an
 adequate amount of total class
 revenues (no interclass subsidy
 exists).


                     R. W. Beck | Introduction to Cost of Service
Intraclass Subsidization
Residential Class


           Existing Rate                 COS Rate

Customer
Charge
           $5/mo.                       $12/mo.

Energy
Charge
            $0.07/kWh                $0.06/kWh




                      R. W. Beck | Introduction to Cost of Service
Intraclass Subsidization
Residential Class

                $80

                $70

                $60
 Monthly Bill




                $50

                $40

                $30

                $20

                $10

                $0
                      0   100   200   300   400   500   600   700      800     900     1000

                                                  kWh

                                  Existing Rate          COS Rate

                                                         R. W. Beck | Introduction to Cost of Service
Intraclass Subsidization
General Service Class


           Existing Rate                 COS Rate

Demand
Charge
           $6/kW-mo.               $10/kW-mo.

Energy
Charge
            $0.04/kWh            $0.03/kWh




                      R. W. Beck | Introduction to Cost of Service
Intraclass Subsidization
General Service Class

                             $1,800

                             $1,600
 Monthly Bill (10,000 kWh)




                             $1,400

                             $1,200

                             $1,000

                              $800

                              $600

                              $400

                              $200

                               $0
                                      10%   20%   30%      40%    50%   60%      70%       80%       90%      100%

                                                                   Load Factor

                                                        Existing Rate         COS Rate

                                                                         R. W. Beck | Introduction to Cost of Service
Introduction to Rate Design

General Ratemaking and
Regulatory Principles
Introduction
   Bonbright — Common Reference
   Industry Changes — Competition
   Social Pricing Objectives
   The Art of Balance




                      R. W. Beck | Introduction to Rate Design
Bonbright Principles
   Practical
   Uncontroversial as to
    interpretation
   Meet revenue requirements
   Revenue stability
   Rate stability
   Fairness among customer classes
   Avoidance of undue discrimination
   Economic efficiency
                       R. W. Beck | Introduction to Rate Design
Factors Affecting Electric Utilities
and Their Customers
   Inflation rates
   Fuel costs
   Uncertainty of fuel availability
   Uncertainty of the future of nuclear power
   Environmental concerns
   Uncertainty in predicting load growth
   Construction delays
   Increasing capital requirements
   Regulatory requirements
   Conservation of electricity and natural
    resources
   New technologies
                              R. W. Beck | Introduction to Rate Design
Objectives of Utility Ratemaking
 Cost of service
 What the public wants
 Fairness to all consumers
 Marginal costs
 Price as a resource-control measure
 Competition, market forces and elasticity
 Need for a cushion above costs
 Simplicity vs. complexity
 Price as a taxing measure
 Price as a welfare measure
 Quality of service
 Differences among communities' concerns


                            R. W. Beck | Introduction to Rate Design
Factors Which Can Influence the
Rate-Making Objectives of an
Electric Utility
   Overall cost of service
   Types of generation and fuel
   Self-generation vs. purchased power
   The size of the utility
   The age of its physical plant and rate of growth
    of the system
   Sources of capital or other funding arrangements
   Competition in the form of alternate fuels and/or the
    rates of neighboring utilities
   Customer mix
   Time-of-Use service
   Weather
   Legislation and regulation

                                    R. W. Beck | Introduction to Rate Design
Four Major Reasons for Rate
Adjustments
   Revenue adjustment
       Up or Down
   Cost of service realignment
   Competitive factors
   Legislative and regulatory mandate
       EPAct 2005




                       R. W. Beck | Introduction to Rate Design
Competing Objectives
    Meet revenue     Equity and fairness
     requirements     Behavior
    Low rates         modification



  Social issue        Simplicity and
   responsiveness       understandability
  Ability to compete  Unbundling
  Legislative         TOU and Real Time
   mandates            Rate Complexity


                            R. W. Beck | Introduction to Rate Design
Simplicity
   Time-of-Use and Real-Time rates
    frustrate simplicity
   Critical Peak Pricing and Load
    Curtailment add complexity
   Unbundled rates frustrate
    (but also enhance) understandability
   Adjustments for costs (e.g., ECAC)
    add to complexity

                       R. W. Beck | Introduction to Rate Design
Introduction to Rate Design

Electric Utility Pricing
Trends That Matter
               What are the Top Issues by Utilities?*
                                                            (2009)

           ISSUE (UNRANKED)                                                         COOPs         IOUs          MUNIs

           Renewables - requirements, power supply, pricing                             ■            ■           ■
           Energy Efficiency - program design, rates                                    ■            ■           ■
            Carbon - capture/sequestration/storage, pricing                             ■            ■           ■

           Emerging Technology - smart grid/metering, data centers,
                                                                                        ■            ■           ■
           broadband over power lines

           Electric vehicles - infrastructure, pricing, load impact                     ■            ■           ■
           Finance/credit issues - stimulus money, tight credit
                                                                                        ■            ■           ■
           markets
           Advanced Rates - TOU, net metering                                           ■            ■           ■
           Distributed Energy - feed-in tariffs, backup                                 ■                        ■
           Nuclear Power                                                                ■            ■           ■
           Transmission                                                                 ■



* Based on programs from 2009 NRECA, APPA and EEI conferences        R. W. Beck | Introduction to Rate Design
               What are the Top Issues by Utilities?*
                                                         (2006-07)

            ISSUE (UNRANKED)                                                      COOPs         IOUs          MUNIs
            Global Climate Change/Carbon Emissions                                    ■            ■           ■
            Challenges of Building New Generation                                     ■            ■           ■
            Finances/Credit Issues                                                    ■            ■           ■
            Developing the Workforce of the
            Future/Partnering/Recruiting/                                             ■            ■           ■
            Succession Planning
            Emergency Preparedness                                                                 ■           ■
            Efficiency of Customer Relationships Through Technology                   ■            ■           ■
            Industry Reliability                                                                   ■           ■
            Hurricane Damage Response                                                              ■           ■
            Rate Impact of Rising Costs                                               ■            ■           ■
            Transmission Expansion                                                    ■            ■
            Growth Strategies                                                         ■            ■           ■
            Renewables in the Generation Portfolio                                    ■            ■           ■


* Based on programs from 2006-07 NRECA, APPA and EEI conferences   R. W. Beck | Introduction to Rate Design
              Utility Costs Continue to Rise

                 Load growth (new supply)
                 Infrastructure catch-up
                 New infrastructure
                 Economic environment,
                  increased inflation, capital costs
                 Emissions
                 Security
                 Fuel

Source: Sieben Energy Associates, a Chicago-based energy consulting firm.   R. W. Beck | Introduction to Rate Design
Pricing: The Interface of Utility
Realities and Customer Expectations

Utility Realities                   Customer Expectations
     Demand                                    Low Cost
     Regulations




                       PRICING
                                                Choice
     Cost of Money
                                                Flexibility
     Technology
                                                Responsive
     Green Power
     Infrastructure                            Technologically
       Replacement/                              Savvy
       Renewal                                  Socially
     Workforce                                  Responsible




                                 R. W. Beck | Introduction to Rate Design
Rate Design Discussion

				
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