Public Utility Rate Case: Cost-of-Service - ABA YLD 101 Practice Series

By Jaime Ott

An investor owned public utility company initiates a rate increase case by filing proposed tariff sheets that reflect an increase in chargeable customer rates. The "cost-of-service" component of a rate case is the amount of money it cost public utility company to operate its business. The regulatory body for investor owned utilities should balance the rate structure to provide just enough money for the public utility company to serve the present and future interest of the its customers and not a penny more.

Regulatory bodies set customer rates for investor owned utilities, generally based upon a "just and reasonable" standard. "Just and reasonable" is one that is fair to both the utility and its customers; allowing the utility to provide safe and adequate service while giving the investors an opportunity to receive a return on their investment. The regulatory body should establish a rate that is sufficient to cover the Company's prudent operating and maintenance expenses, enable it to undertake necessary improvements, be able to attract capital, to maintain its creditworthiness, and to access the financial markets at a reasonable cost.

In establishing "just and reasonable" rate, the ratemaking process is two-fold. There is the "revenue requirement" component and then there is the "rate design" component. "Revenue requirement" is the amount of revenue an investor owned utility company must recover to pay the cost of producing the utility service while yielding a reasonable rate of return to the shareholders. "Rate design" is the equitable construction of tariffs that formulates the utility's approach to collecting the necessary revenue requirement from its customers (ratepayer).

Revenue requirement is typically established by using a "test-year." A test-year is an agree upon year time frame between the regulatory body, utility and any other party, to review the utilities accounting books and use the numbers to establish the cost-of-service. When assessing a utility company books and records there is a general focus on the following: (1) the rate of return the utility has an opportunity to earn; (2) the rate base upon which a return may be earned; (3) the depreciation costs of plant and equipment; and (4) allowable operating expenses.

The longstanding traditional ratemaking formula focuses on four factors; cost of service, value of utility plant that is used and useful, deprecation cost, and return on capital investments. The calculation of revenue requirement from these four factors is expressed in the following formula:

RR = C + (V - D) R

where:    RR = Revenue requirement;
                   C = Cost of service including depreciation expense and taxes;
                   V = Gross value of utility plant in service;
                   D = Accumulated depreciation; and
                   R = Overall rate of return or weighted cost of capital.

This formula establishes the utility company's cost-of-service and used during the traditional ratemaking process.


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About the Author

Ms. Ott is an assistant general counsel with the Missouri Public Service Commission. She is a member of the American Bar Association Young Lawyers Division, the Missouri Bar Association, and the Illinois Bar Association. She has served as the Chair for the American Bar Association Young Lawyers Division, Public Utility, Transportation, and Communication Committee.

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