Guest essay: Why do we pay higher utility rates?

by Charlotte R. Lane

All sorts of things can trigger a rate increase request from a utility and approval of increased rates by the Public Service Commission of West Virginia.

The primary factors driving utility rate filings are the cost of operations and the cost to provide utility service. Key elements include maintenance of the utility’s lines, such as the transmission and distribution wires used by electric utilities and the pipelines used by gas, water and sewer utilities. The costs to produce or purchase what they sell are major components of their revenue requirements. For example, an electric utility must buy fuel to produce electricity. Water utilities must treat water to make it potable or buy it from a larger utility that meets those needs. Utilities also are required to expend considerable sums on environmental controls and meeting required environmental and safety regulations.

In addition, all utilities have large investments in plants and equipment. Cash is required to pay for the debt and equity capital used to finance those investments. Debt capital costs are directly related to the cost of borrowing money from banks, bondholders and other investors in utility debt. The cost of debt is set by the terms of utility borrowing agreements, which set repayment terms, interest rates and debt service reserve and coverage requirements.

Equity capital is different, since there are no guaranteed interest or repayment obligations. When an equity investment is made by stockholders or other owners of a private utility, those investors expect a return on their capital. Under generally accepted accounting principles, the return on investor capital is not recorded as an expense. Therefore, some level of reasonable net income after expenses and taxes must be available to provide a return on stockholder and owner investments in utility operations. This net income is commonly referred to, sometimes pejoratively, as “profit.”

 Profits are allowed to compensate investors of private utilities for money they have invested in the business, but only if that money was used prudently to finance assets that are necessary for the provision of utility service. Non-utility businesses can earn unlimited profits, but they also face greater risks than regulated utility companies.

While an interest in keeping utility rates low may seem to argue for the PSC to require very low or no profits, such regulation would be counterproductive if it limits a utility’s ability to attract the capital it needs to maintain high-quality utility services. It also would violate the law.

Courts repeatedly have ruled that utilities are entitled to earn a reasonable profit or rate of return from their operations. We call this the rate of return on equity investment. The PSC is legally bound to set that rate of return level at a figure that gives the company stockholders — which can be you, your retirement fund, your insurance fund or any other investor — a reasonable profit, which is really a return on their investment.

Companies generally file for two types of headline-grabbing rate cases. One deals with the overall financial condition and revenue requirements of the company. That is called a base rate case. A second type is one of several special cost recovery cases, which are limited to recovery of a set of specific costs that are excluded from base rate cases and considered on a stand-alone basis.

Base rate cases involve most elements of the company operations and maintenance costs; meeting whatever environmental controls it must; the day-to-day cost of the company operations; coverage of debt capital, including the interest payments; and return on equity invested in necessary property, plants and equipment.

These base rate cases are not filed on any regularly scheduled basis. The trigger for a base rate case involves many factors, including growth in plant investment, growth or loss of customer load, changes in environmental and safety regulations, tax law changes and changes in the cost of debt and equity capital. There were periods in the past when rate cases were filed almost every year, while during other periods there could be four or more years between base rate cases. Currently, we expect utilities will file base rate cases about every third year.

Each base rate case has its own particular set of circumstances driving the need for the filing, and I do not intend to defend or downplay the merits of the circumstances of individual utilities that may justify rate increases. However, we are well aware that recent inflation, changes in environmental and safety regulations and increased cost of borrowing money are all factors that are putting pressure on utility costs.  

Base rate cases involve an enormous amount of work, not only for the companies involved, but for the PSC, our staff and intervenors in the rate cases. Base rate cases generally involve a proposed major increase in rates. They take a long time to investigate, conduct hearings in which pubic protests and other public input can be received and all parties can provide expert testimony and evidence, and then for the PSC to reach a conclusion.

While we try to safeguard ratepayers from unreasonably higher utility prices, it is almost inevitable that rate increases are going to occur. Things just cost more, and requirements being placed on utilities plus inflation in costs, including payroll, are no exception to the rising expense.

In all of our rate cases, we allow representatives of all customer groups to participate. We also encourage negotiation meetings with the utilities and customer representatives to try to reach a compromise on rates and service that will be acceptable to everyone.

In many instances, after long negotiating sessions, a compromise is reached and given to the PSC. Usually, we give that compromise our blessing because, while it may require give and take where all parties give up something and gain something, it generally is endorsed and is satisfactory to all.

A second major type of rate case that involves only a subset of costs is one that allows recovery of the costs of the product utilities are selling to you. For electric utilities, these are called ENEC cases, which stands for “Expanded Net Energy Cost.”  The costs considered in these cases are limited to the cost of fuel used for producing power, purchased power from neighboring utilities and transporting power back and forth on the transmission lines of the utilities. ENEC cases are typically filed annually and are normally processed and finalized in six months or less.

Since the components of ENEC costs can fluctuate widely from year to year, and some of the costs are controlled by the Federal Energy Regulatory Commission, it is critical for most companies that we review these costs annually between base rate cases.

These cases also go through the process used in base rate cases, but because the issues are limited, they usually take less time to complete.

There are other limited issue rate cases allowed, some of which are required by law, and some of which have been approved by the PSC to extract specific issues out of the base rate group of costs so that they can be reviewed annually. These cases include:

  • Purchased water and sewerage treatment cost recovery cases. These cases are allowed for water and sewer utilities that purchase water or sewerage treatment from a neighboring utility. When the rates of the neighboring utility go up, the purchasing utility is allowed to file a limited and expedited rate request to recover the increased cost.
  • Natural gas pipeline replacement cost cases. The Legislature mandates these cases to allow natural gas utilities to recover costs related to specific pipeline upgrade and replacement programs. The pipeline programs are established as a five-year plan to improve utility pipeline systems. Each year the natural gas utility files an updated rate request to recover pipeline replacement and improvement costs that are projected to take place in a future 12-month period. In each case, the PSC reviews the future projects to determine that they are in compliance with the limitations of the five-year plan and also reviews the actual investments made in a prior 12-month period to determine whether the rates established resulted in an over-recovery or under-recovery of actual costs.

There are several other special cost recovery rate cases, some authorized and mandated by the Legislature and some established by the PSC to expedite and streamline the ratemaking process.

Rate regulation may not be a perfect system, but considering the necessity of reliable utility service to maintain a high quality of life and the nature of utility delivery systems that spread costs over the largest possible number of customers to produce the lowest reasonable rates, the rate and service regulatory system is the one we have and which we will strive to manage in the best interest of utility customers.

Charlotte R. Lane is chairman of the Public Service Commission of West Virginia.