FORMULA RATE PLANS: TWO TESTED APPLICATIONS. Ross C. Hemphill RCHemphill Solutions LLC

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Raymond Welch
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1 FORMULA RATE PLANS: TWO TESTED APPLICATIONS Ross C. Hemphill RCHemphill Solutions LLC Presented at National Regulatory Research Institute Webinar: Is It Time for State Utility Commissions to Embrace Multiyear and Formula Rate Plans? May 9,

2 Introduction Formula ratemaking is an approach to setting the appropriate level of revenue recovery on an annual basis through a streamlined regulatory process. This discussion will focus on two applications of this concept that are enduring the test of time. Alabama Rate Stabilization & Equalization Program for gas delivery Illinois formula ratemaking for electric delivery 2

3 Alabama Gas Corp Rate Stabilization and Equalization Program 3

4 Alagasco Rate Stabilization and Equalization Plan 30+ year history of a formula rate in Alabama Follows traditional ratemaking theory and practice with standard calculation of the cost based revenue requirement Objective is to keep the company s earned ROE within a band of 10.5% 10.95% with adjusting point of 10.8% if it falls outside Adjusting point can increase 5 bps if specified customer service incentives are met within rate year Evaluated quarterly with rate reductions if above range Annual evaluation can allow upward rate true up adjustment if below There is a ceiling on the equity component of the capital structure (currently 56.5%). 4

5 Alagasco Rate Stabilization and Equalization Plan Cost Control Measure Applies to non gas O&M expense Compared to inflation adjusted base year with a range of +/ 1.75% If rate year O&M is above this range, the company must return 75% of the excess If rate year O&M is below this range, the company may retain 50% of this difference 5

6 Alagasco Rate Stabilization and Equalization Plan Results Increase in amount of information made available to Commission and all other stakeholders Alagasco s average annual RSE increase is lower than CPI Favorable credit rating, which reduces costs of debt Lower regulatory costs for all parties Improved customer service 6

7 Illinois Formula Ratemaking for Electric Distribution 7

8 Legislation Passed in 2011 Energy Infrastructure Modernization Act (EIMA) In late 2011, Public Act was passed in Illinois, which established a new section of the Illinois Public Utilities Act, which included: 1. The establishment of an annual formula ratemaking process for setting distribution rates; 2. An authorized level of infrastructure investment including full deployment of smart meters; and 3. Accountability through performance metrics and other requirements to assure benefits are delivered by the utilities. 8

9 Illinois Formula Ratemaking for Electric Distribution It is streamlined due to three components of the process: 1. Allowed return on equity is a simple arithmetic calculation using known and transparent inputs; 2. Cost allocation and rate design are not part of the process; and, 3. Determination of a number of issues frequently litigated is settled by law. 9

10 Illinois Formula Ratemaking for Electric Distribution Process Utilities required to make filings each year by May 1 to set rates starting January 1 of following calendar year For example, filing May 1, 2017 will be for rate year starting Jan 1, 2018 Commission has 240 days to make decision All steps in a normal rate case take place prior to Commission decision Evidentiary hearings typically last less than 1 day Prior to the formula, rate case hearings would last 2 weeks 10

11 Illinois Formula Ratemaking for Electric Distribution Annual Filings Updated cost information Costs reported to FERC (Form 1) from Year t 1 used as proxy for rate year Plus capital additions projected for Year t Reconciliation of previously approved revenue requirement Actual costs are used to true up for the previously projected revenue requirement Any differential will result in a credit or charge, with interest, to be included in the delivery service charges applicable for Rate Year t+1 This formula is embodied in an approved tariff 11

12 Illinois Formula Ratemaking for Electric Distribution Statutory Protocols 1. Provide for recovery of utility s actual costs found prudent and reasonable by Commission. 2. Reflect the utility s actual capital structure for the applicable calendar year. 3. Includes a formula based cost of equity = average yields of 30 year U.S. T bonds basis points. 4. Sets forth protocols for inclusion in rates, if found just and reasonable by Commission 5. Utility is penalized up to 38 basis points off ROE if it does not meet targeted performance metrics 12

13 Illinois Formula Ratemaking for Electric Distribution Rate Design Cost of service allocation, interclass revenue allocation and rate design not part of annual formula process Separate case filed every three years to decide on these issues Annual formula cases use the allocations and rate structures from the most recent Commission decisions on these issues 13

14 Illinois Formula Ratemaking for Electric Distribution Results Annual performance based ratemaking is in its sixth year in Illinois Critical infrastructure investments are being made Reliability and customer service performance are at historical highs Customer satisfaction continues to climb Total (all in) electric rates remain below inflation rate for economy 14

A Continuum of Formula Rates

A Continuum of Formula Rates NARUC Staff Sub-Committee on Accounting and Finance Augusta GA Presented by Richard Sedano March 7, 2016 The Regulatory Assistance Project 50 State Street, Suite 3 Montpelier,