Ratemaking is a two-step process.
The first step is to determine the utility's annual revenue requirement. Five factors are taken into consideration when determining the revenue requirement.
- The cost of capital invested in assets is called a rate of return that reflects the actual cost of debt and a reasonable return or profit the utility has an opportunity to earn on equity invested by shareholders.
- The total investment or "rate base" upon which a return will be earned.
- The accumulated and on-going depreciation of plant(s) and equipment.
- The company's reasonable and prudent operating expenses.
- Income taxes.
The second step is to design rates that will efficiently and equitably collect that revenue requirement from the utility's customers.
For more detailed information about revenue requirement calculations and rate design click here.
What Happens in a Rate Case?
- The Application
The utility files an application with the KCC to change its rates. The request includes the details of the proposal, prepared testimony and supporting data. In most cases, the KCC is allowed 240 days from the filing date to make its decision. However, the time limit can be waived under certain circumstances.
- The Review Process
In its review of the application, Commission staff - a group of accountants, economists, financial analysts, and engineers - reviews the utility's books and records. Commission staff has the ability to submit requests for additional data or information to the utility and the utility must respond to these requests. This review can take several months to complete. Staff then provides a non-binding recommendation to the three-member Commission. Intervenors, such as consumer groups or industrial customers, may also file recommendations in the case. The Citizens Utility Ratepayer Board (CURB) is the state-appointed representative of residential and small commercial ratepayers in rate cases before the Commission. Click here for more information about CURB. In some cases, agreements are reached that can settle all or some of the issues raised in the application. The Commission does not have to accept proposed settlement agreements. The Commission may accept, reject, or modify any settlement agreement.
- Public Hearing
A public hearing is not required by law, but is generally held in significant rate cases. The hearing provides an opportunity for the public to learn more about a utility company's proposal and speak before the Commission to express their views on the case. The public may also submit comments online via the Commission's website, in an email, or in a letter during the designated comment period. Statements made before the Commission at public hearings and public comments submitted during the comment period become part of the record for the case.
- Evidentiary Hearing
When held, the facts of a rate case are presented during a formal evidentiary hearing. Expert witnesses may testify and answer questions based on their written testimony submitted by the utility, KCC staff, CURB and other intervenor-parties to the case. The three members of the Commission read the written testimony, review the exhibits, hear the cross-examination, and may ask the witnesses questions as they weigh the evidence in the case.
- Reviewing the Record
Commissioners review the record, the facts of the case, and legal briefs to make their decision. The Commission will only authorize rate changes that are just and reasonable and in the public interest. By law, the company must be allowed the opportunity to make enough money to meet reasonable expenses, pay interest on debts, and provide a reasonable return to stockholders.
- The Decision
When a decision is made, the Commission announces it through a written order that is approved in an open business meeting. That order is subject to appellate court review which may be initiated by any party - except the KCC staff - who has filed a timely request for reconsideration with the Commission.
Understanding Rate Case Components
The Commission determines if a new plant has been put in service and is now "used and required to be used" in providing "efficient and sufficient" service. If a new plant has been shown to provide a benefit to consumers it is allowed in the rate base. Any plant that is not allowed in rate base does not factor in setting rates.
The Commission identifies any plant that has been removed from service or reached the end of its useful life and subtracts it from rate base.
The Commission identifies, generally based upon contested depreciation studies and depreciation schedules, how much a plant has been depreciated out of rate base since the company's last rate case and removes that amount from rate base. Depreciation is a decrease in value of plant investment based on normal use.
Rate of Return (ROR):
Utilities finance their investment in a new plant with bonds (debt) and stock (equity). Rate of Return is expressed as a percentage and is comprised of a weighted average of the cost of debt and a return on equity. The weighted average is based on the relative amount of debt and equity a utility uses to finance its investment in a plant. Utilities generally try to maintain a balance between debt and equity such that the weighting is approximately 50% debt and 50% equity.
Return on Equity (ROE):
Generally speaking, return on equity is shareholder profit on its investment in the company.
The Commission evaluates testimony from multiple witnesses. Based upon that analysis, the Commission determines the appropriate ROE for a given utility.
The Commission applies that ROE to the determined rate base to reach a dollar amount necessary for the utility to get the appropriate return on its investment. The utility is not guaranteed this return; it is simply allowed a reasonable opportunity to earn it.
Cost of Debt:
The cost of debt is simply the average interest rate a utility pays on its bonds. Because there are multiple issuances of bonds at different interest rates and maturity dates, the cost of debt is a weighted average of all the bonds outstanding.
A utility has many different types of expenses. The Commission determines what the appropriate amount of expense is for each expense type. Some expenses are disallowed in part or completely because they are deemed unnecessary for the provision of utility service. Included within the expense category is on-going depreciation of plant and equipment. After all disallowances are reflected, the Commission authorizes the total dollar amount of expenses necessary to provide electric service.
The Commission adds the dollar amount associated with earning the authorized ROR on the rate base to the expense total. That number gives the utility's revenue requirement.
The Commission Staff and other parties present a class cost of service (CCOS) study and propose a revenue requirement allocation based on the cost to serve each of the rate classes. Rate classes are generally made up of groups of similar customers such as residential, small business and commercial, and industrial. The CCOS is used to link the revenue recovered from each customer class to the costs caused by each customer class, respectively. The starting point for class allocation of the revenue requirement is the principle that the cost causer should be the cost payer, but other policy and equity factors may also be considered. Once the Commission determines how the revenue requirement will be divided among the customer classes (residential, commercial, etc.), it must determine how best to collect that revenue from the customers in each class. The collection of the revenue requires the development of a specific rate design for each customer class (in other words, the customer charge, the energy charge, and for some classes, the demand charge). Rate design is the final step in the revenue allocation process.