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Case Study - Electric Utility Moves Towards Cost of Service Rates for Each Customer Class and Develops New Rates for Emerging Technologies

Russ Hissom's picture
Owner, Utility Accounting Education Specialists -

Russ is the owner of Utility Accounting Education Specialists a firm that provides power utilities consulting services and online/on-demand courses on accounting, finance, FERC best-practices,...

  • Member since 2021
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  • Jun 15, 2022

Electric cost of service studies allocate the costs of electric service to each customer class. But, the actual rates charged to each customer class may over or under collect their cost of service. Why is that? 

The cost of service is the science, and the rate design is the art. The electric rate structure of any utility has decades of embedded history and political decisions. Until the 1980s, it was common for industrial rate classes to subsidize the rates of the residential classes to “keep residential rates low and reasonable.” As the political climate turned more towards economic development, the pendulum swung in the other direction, increasing residential rates faster than industrial rates to “catch up.” 

The approach now is more towards basing rates on the cost of service. There are still inter-class subsidies in rate design, but more focus has been on closing those gaps.

A recent study shows a case study of one electric utility’s approach to cost of service and ratemaking.

The Situation

An electric utility recognized that it needed to increase electric rates after developing its budget for the coming year (also known as a revenue requirement). The utility had not increased rates in 5 years and wanted to take the opportunity to move customer rates towards their cost of service and to incorporate distributed energy resources (DER) and electric vehicle charging into their rate structure.

The Approach to a Solution

The utility obtained a portion of its power supply from a joint action electric agency and the remainder from the day-ahead power market in its region. The utility had a high level of electric heating and wished to drive down its peak to smooth power costs. The utility had just undergone an extensive smart meter installment for all customers and had detailed load data for all customer classes.

We worked with the utility to develop a cost of service study with the refined metering data. Deep analysis of customer load curves was done to set the groundwork for a rate design more closely matching each customer’s service cost. There was also a more significant effort to incorporate a DER generation forecast into the utility’s power supply mix. This was not spurred on by FERC Order 2222, but by recognizing that DER load was becoming a more significant portion of the overall utility load and was impacting their load curve and open market purchases.

The goal was also to provide customers with pricing signals and incentives to change their consumption patterns if they wished, with the benefit of an overall reduction in their power cost.

The Outcome

We worked with the utility to design rates to reflect the costs to serve each customer class. We assisted the utility in developing rate structures to provide incentives for customers, including:

1. Residential time-of-use opt OUT rate
2. DER rate with a system connection charge

The Residential time-of-use opt-out rate had a phase-in period of three years to deliver a customer information campaign designed to encourage sign-ups beyond the early adopting customers. At the end of three years, all customers were automatically included in the rate. The alternative opt-out rate option had a fixed monthly customer charge and flat kWh energy rate designed at a 5% higher rate than the opt-out time-of-use rate.

The DER rate paid DER customers for their energy production at the avoided cost of the utility’s purchases in the day-ahead power market. The DER system connection charge recognizes that the cost to connect to the utility’s infrastructure should be paid by the benefiting customer and not subsidized by non-DER customers.

We also designed an electric vehicle off-peak charging rate and is experimenting with a subscription charging rate (i.e., the EV customer can charge all they need for one monthly rate). As the use of EVs in the utility’s service territory is still minimal, it will continue to monitor the rate as EV usage grows to determine changes that might be needed.

Giving customers choices incentivizes them to monitor their power usage and shift how they use electricity to lower their power bills. The percentage of customers that take an interest in doing so is not high. Still, with opt-out rates carrying a 5% premium, the utility is hopeful that the lower rate structure of the time-of-use rate will spur more customers to stay in the rate vs. opting out.


About Russ Hissom - Article Author

Russ is the owner of Utility Accounting Education Specialists a firm that provides power utilities consulting services and online/on-demand courses on accounting, finance, FERC best-practices, improving business processes, and implementing strategy. Russ is passionate about the Power and Utilities Industry and his goal is to share industry best practices to help better your business and enhance your career knowledge. He has over 35 years serving electric investor-owned and public power utilities, electric cooperatives, broadband providers, and water, wastewater, and gas utilities as a past partner in a national public accounting and consulting firm's power and utilities practice. Russ was named one of the 2021 Top Voices in the Energy Central Community by EnergyBiz Network.

Find out more about Utility Accounting Education Specialists here or you can reach Russ at

The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by UAES. You should seek formal advice on this topic from your accounting advisor.

Michael Keller's picture
Michael Keller on Jun 20, 2022

Looks to me your plan simply disincentives utilities (which are natural monopolies) to keep their costs reasonable and simply dumps that burden on the ratepayer. Further, looks to me like the plan incentives commodity traders to game a system that is not really a free-market. That is precisely what has occurred in California.

Need to recognize that energy production and distribution needs to be properly regulated  to insure reasonably priced and reasonably reliable power. Your time-of-use plan does exactly the opposite, as amply demonstrated in California where rates are easily double that in the rest of the US while blackouts and brownout are commonplace.

Russ Hissom's picture
Russ Hissom on Jun 21, 2022

Thank you for your comment, Mr. Keller!


Every utility is regulated to some degree, be it by FERC, state commissions, or at the local level. Those at the local level are probably the most regulated, as city councils and utility boards answer to the city where they live. The rates are developed based on a revenue requirement approved by an oversight board and the opt-out TOU rate is designed to encourage load shifting by customers to both lower their bills while the overall class' cost of service is met. TOU doesn't raise rates, it allows for customer choice.


Your comment on California rate merits a much longer article and response, but at its core is a state energy policy that relies more on higher priced produced electricity and a move towards renewables, where the storage issue has not caught up to where it needs to be to be a viable option.

Richard McCann's picture
Richard McCann on Jun 20, 2022

Cost of service allocation is far from being a settled "science." One of the open questions is what set of metrics to use as alternative cost benchmarks. Another is how are rates to be set to incentivize customer investments into measures, including DERs, that save other customers money over the long run. Using short-run day ahead prices for DER compensation fails to recognize the value of deferred PPAs and distribution investment. For example in California, distributed solar appears to have reduced the CAISO peak by 15% since 2006, yet that resource is villianized as supposedly imposing costs on other customers. Another issue is how are costs to be allocated between existing customers who have investments in infrastructure and new customers who create added nodal costs far away from those existing ones? An accurate cost of service study looks at the dynamics of system costs and does not take the current status quo as given going forward.

Russ Hissom's picture
Russ Hissom on Jun 21, 2022

Thanks for reading the article and for your insights!

Russ Hissom's picture
Thank Russ for the Post!
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