Your electric utility board won’t increase rates, what are some options?
- May 14, 2021 1:26 pm GMT
Electric utilities of all types (electric cooperatives, investor-owned, and public power) have oversight boards or commissions at the state and local level responsible for approving electric rates. They base their decisions on rate studies prepared to estimate the amount of revenue provided from rates, comparing those revenues to expenses, debt service, capital improvements, and the expected return on ratebase.
There are times that these oversight bodies may not pass or may delay rate increases that are needed. Reasons vary, I.e., lack of convincing an increase is required, a compelling argument not presented by management, or politics and ratepayer pushback. A rate increase voted down opens the door for "Plan B", the fallback plan. But, what is the fallback plan? This article discusses some Plan B approaches.
The utility cost structure isn’t so flexible
The cost structure of a utility is a mixture of fixed and variable costs. The typical cost mix in a distribution utility's operating costs is shown in this chart:
As customer power usage increases or decreases, power expense (75% of total costs) moves in the same direction. So, the operating income of the utility remains relatively unchanged.
Labor expense (10% of total cost) is based on the utility's headcount. For construction crews, either fixed assets are being installed, or fixed asset maintenance is being performed, so the labor dollars remain the same unless the headcount is reduced.
Moving beyond the power cost and labor cost buckets leaves the final 15% cost bucket. What's in that bucket? Office costs, health costs, retirement costs, consulting, and maintenance inventory. Besides consulting fees, there isn't a lot of wiggle room for cost reductions, as many of these costs also operate as fixed in nature.
What to do to address this?
As shown in the previous section, it isn't easy to find cost areas for substantial reductions. Some best practices of cost control we have seen used include:
1. Reduction in headcount coupled with evaluating the cost-benefit of outsourcing some areas. Outsourcing areas could include:
- Tree trimming
- Customer service
- Meter operations
2. Use of technology to make operations more efficient.
Field tools with real-time access to systems streamline data flows. Engineering design tools (Building Information Modeling or BIM) make project design and management more efficient. Customer website access and chatbot assistance facilitate customer service. Artificial intelligence is moving into many finance areas. All of these can allow future workforce reductions through attrition and the movement of personnel into other areas.
3. Early retirement packages for employees to reduce headcount. The accounting for this approach allows deferral of buyout costs and recognizing these costs over an extended period.
Early retirement packages are used to urge employees in identified areas to take early retirement. That approach, along with normal attrition, can help for a speedier workforce reduction.
Early retirement packages do have a cost, but under the accounting rules, the buyout costs can be deferred and expensed over a more extended period. The longer expense period can help smooth the rate impacts and lead to longer team cash flow increases.
4. Delay of non-essential projects to reduce cash flow. Or issue debt to finance projects.
Project delay is the least popular but sometimes necessary option. Project managers will not be happy with these decisions, but delaying projects that do not impact system reliability can save short-term cash. Debt can be issued to finance projects to spread out payments over the useful life of the installed assets as an alternative to project delay.
5. Using surcharges in rates.
Depending on your definition, adding a temporary rate surcharge may or may not be a rate "increase". We have seen utilities add surcharges (an example would be an additional $0.03 per kWh) for:
- reduced hydro flow (which increases wholesale electric rates), future system capacity upgrades due to increased industrial loads, or building of cash reserves for future rate stabilization.
Your customers may think these are rate increases, so you will have to put a positive spin on the charges.
6. Using regulatory accounting to defer and spread out expenses.
Regulatory accounting under accounting standards can stretch out the recovery of large budget items or be used to build cash for items that may be several years in the future. This approach is often used as a “Plan B” to mitigate the impact on operating income and smooth related rate increases.
Your customers may not like rate increases, but they want reliable service
None of your customers look forward to rate increases, but meeting system reliability goals and utility growth drives customer rates. Your oversight board may get cold feet from time to time voting for increasing rates, so management should be prepared with good communication and messaging and also have a fallback plan if needed.
Russ Hissom is the owner of Utility Accounting Education Specialists (UAES), a company that offers online, on-demand, and custom utility accounting and finance business process courses; and thought leadership. You can reach him at email@example.com. The puaes.com website has a wealth of classes, articles and other online resources that will benefit your utility’s accounting and customer ratemaking strategies.
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