Applying Ferc Fundamentals to Electric Cost of Service Studies

Electric Rates Are Electric Rates - The Method Doesn't Matter, Right?

Utility rates drive revenues and recover the full costs of operations, debt service, and capital additions. While most investor-owned utilities, electric cooperatives, and large municipal utilities use the "utility method" to develop electric rates, many small to mid-sized utilities base their rates on utility cash flows. What's the difference? Does it matter?

The basic approach is: Revenue requirement → Cost of service study → Develop electric rates

Developing the Revenue Requirement

Utility revenues should be sufficient to recover annual operating costs, debt service, and capital additions. The first step in the ratemaking process is to develop a "revenue requirement" that forecasts those three items for one year into the future.

The Cost of Service Analysis

Step 2 allocates the revenue requirement to the significant cost categories - electric demand (kW), energy (kWh), and customer costs in a cost of service study. Costs are allocated to these categories based on how the costs are classified in the general ledger.

Under the utility basis of ratemaking, the current FERC account balances of ALL current utility plant in service are allocated, not just current year plant additions.

Contrast this to the cash basis approach, where costs are generally allocated based on the makeup of the planned additions for the revenue requirement period (e.g., poles, overhead and underground lines, power production, general plant).

Can We Switch Methods?

Switching methods is not difficult since both methods' objective is to determine the revenue requirement for one year in the future. Changing from the cash method to the utility method involves plugging next year's budget into the utility method and adjusting the rate of return to yield the cash needs of the utility/coop.

Your call to action is to try the utility method with your next cost of service study. You may find that costs are being allocated differently than under the cash method. Still, the allocations will more accurately reflect general ledger costs and the overall makeup of your utility/coop electric system built to serve your customers.