Risks in Utility Ratemaking
Throughout their lifetimes, a vital activity for utilities is the periodic filing of rate cases. The key word here is “periodic,” as utilities may go several years or even a decade between rate cases. That can make it a major ordeal when the time does arrive for the utility to approach the state utility regulatory commission or municipal board and plead its case. In short, it can be a very intense and nerve-racking process.
But it doesn’t have to be.
According to Russell Feingold, Vice President of Black & Veatch’s management consulting division and head of its Rates & Regulatory Advisory Group, the ratemaking and regulatory risks utilities face can be mitigated with the right approach to ratemaking and the ongoing interactions with its regulator. Key drivers that prompt rate cases include the need to invest in new assets due to aging infrastructure; an increase in operating costs; an insufficient return on assets; unstable/declining margins; or a decrease in usage causing a reduction in revenue (see table below for effective ratemaking solutions to various business challenges faced by a utility).
“Understandably, there is a large amount of uncertainty for a utility when filing a rate case before its regulator because the decisions impact the future financial conditions and operational performance of the utility,” Feingold said. “We help our clients mitigate regulatory uncertainty through proper preparation of their rate case filings and by fostering a trusting, open relationship between the utility and regulator.”
According to Feingold, the risks in utility ratemaking are caused by a number of factors, including:
- Not knowing the long-term direction and progression of regulatory decisions;
- The potential for cost disallowances in “after-the-fact” prudent reviews of utility decisions by regulators;
- Not being able to secure from regulators pre-approval of major infrastructure investments;
- Changing perspectives of regulators over time in addressing the proper balance between customer and shareholder interests; and
- The periodic change in the leadership of regulatory bodies.
“One of the most important components of a rate case filing is for the utility to create in advance a trusting relationship with the regulatory commissioners and their staff,” Feingold said. “The trust issue affects virtually all of the roles, responsibilities and best-practice principles of regulators, and it greatly influences their interactions with the utilities they regulate.”
One way for utility management to create trust is to commit to ongoing discussions with the regulator on the utility’s current and future business initiatives – and to highlight both its successes and challenges. “There should be no surprises to the regulator when a utility files a rate case if the utility has done its job right,” Feingold said.
RATE CASE PREPARATION
When preparing a rate case, there are several factors that must be considered before filing, according to Feingold. Subject matter experts, like Black & Veatch, can help a utility prepare and support the underlying analyses and evidence, often utilizing computer models and extensive analytical capabilities.
“A utility faces a potential risk as it structures its evidentiary support,” Feingold said. “Not only does the utility have the ‘burden of proof,’ it also must remain credible in the overall structure and specific evidence of the rate case.” A key component is consistency. The same message, or story line, must be woven throughout the utility’s rate case evidence. “The story lines the utilities create are vital, because these represent the overarching and unifying message for the entire rate case,” Feingold said. “So in addition to all rate case requests being supported through detailed evidence, a utility must also ensure its rate case witnesses are on the same page throughout the process.”
Feingold also states a utility must understand regulatory precedents and stakeholder perceptions. “They must anticipate and address trouble spots before they occur,” Feingold said. “We always recommend that a utility meet with its stakeholders – including the regulator, consumer advocate or attorney general, and other special interest groups – in advance of the filing in order to preview the case. This gives the utility an opportunity to highlight key issues and get stakeholder reactions to the utility’s proposals.”
In addition to perhaps gaining buy-in, Feingold also says it offers the utility the opportunity to “fine-tune” its proposals for the rate case if it senses initial concerns from one or more parties. “This preview will also help prepare the utility for the cross-examination of its witnesses as well as the cross-examination of the stakeholders’ witnesses,” Feingold said.
Once the rate case is filed and the case is litigated before the regulatory body, Feingold says it becomes a waiting game for the utility until a final decision is issued. Once that occurs, the utility will assess the outcome of its case to determine where it was successful and where it may have fallen short of expectations.
“A realistic self-assessment can be a valuable exercise for utility management to determine how to improve the process to secure a rate case outcome that best aligns the interests of both the consumer and the utility’s shareholders,” Feingold said.
Story by Jessica Woolery, Black & Veatch