The volume of electric utility rate cases (the primary vehicle by which investor-owned utilities increase their rates) has risen dramatically in recent years and shows no sign of abating. This could spell rising rate pressure for electricity users and the need for creative solutions to fight back against rate inflation.
For some historical perspective, from 1997 to 2002, on average, approximately five rate cases were filed per quarter with state regulators. Since 2006 that figure has been roughly 13 per quarter1. The main reason for the dramatic increase in rate case filings is due in large part to an increased focus by many utility holding companies on regulated markets.
Ten years ago, many utility holding companies were heavily involved in unregulated enterprises. These efforts often emphasized the installation of merchant generators that were intended to take advantage of the perceived promise of unregulated power markets. However, after a period of over-building, and the Enron debacle, profitable opportunities for merchant generation declined sharply, and by 2003 many utilities had largely realized that unregulated businesses were not the primary avenue for earnings growth.
Investor-owned electric utility companies are increasingly focused on regulated markets to generate profits. However, in regulated markets, profitability is subject to the determinations of rate-setting commissions, which set the allowable rates of return for utilities. These allowable rates of return are determined by the utility’s asset base—and therefore, for a utility to generate higher profits, it needs to either increase the size of its asset base through capital investment, receive a higher allowed rate of return, or both.
Rate increases come from “rate cases,” in which a utility company presents an argument for a rate increase, and regulated earnings are a direct function of the utility’s assets and the rate of return allowed by the regulatory agency. Rate case arguments are often based on a need to recover costs incurred in capital expenditures made to upgrade aging transmission and distribution equipment, the addition of plants that operate on natural gas and renewable resources, plus the need to satisfy environmental compliance requirements. With the connection between capex and rate increases, industry capital spending exploded from $43 billion in 2003 to $74 billion in 2010, and was estimated to reach $102 billion in 20151.
What does this mean for corporate power consumers? Get ready for more electricity rate pressure—and find creative ways to fight back against rate inflation.
Utilities have had no shortage of areas in which to grow regulated assets. Investment areas include new generation capacity (primarily natural gas and renewables), investments to meet environmental requirements, upgrades to aging transmission and distribution equipment and smart grid investments. As their assets have grown, utilities have filed rate cases to incorporate these capital investments into the rates they receive, thereby boosting earnings.
Against this industry backdrop, it is therefore appropriate to anticipate that rate case volumes will continue to be robust. In addition, there are other factors that will support the filing of numerous electric rate cases.
During the past several years, the growth in the country’s power consumption has slowed markedly due to conservation efforts by customers. During 1975–2000, year-over-year consumption growth averaged 3.7 percent.
The corresponding figure for 2001–2006 was 1.6 percent. However, for the period from 2007 to 2014, actual energy consumption stayed roughly constant, showing no increase at all over that timeframe2. This trend makes it more difficult for the average electric utility to recover increases in fixed costs with existing rates, and raises the likelihood of rate case filings.
In addition, interest rates are at historically low levels, which has also reduced the returns on utility rate bases allowed by commissions. The allowed return on common equity is currently in the range of 9.7-10.4 percent, compared to approximately 12.5 percent in 1990. When interest rates rise, as they eventually will, utilities will have a powerful inducement to maintain, and possibly increase, the number of rate case filings.
Rate cases are also the vehicle for the introduction of new rates for utility business customers, and our team of energy experts continually studies rate case developments in order to identify potential new savings opportunities for clients.
Electricity prices are on the move, and the high frequency of rate case filings is here to stay. We advise clients to take a proactive approach to how they purchase, manage and use energy. This means getting good visibility to current consumption patterns and future demand across the organization, and analyzing the rate environment across all markets in order to better understand the impact prices may have on the organization’s production process, energy budgets and bottom line. Armed with precise data and analytics about current use, expected demand and the price environment, energy buyers are also in a better position to analyze the potential benefits of the many innovative alternatives to fixed rates that are available to help organizations manage energy price risk. It is also important for organizations to understand if, and to what extent, they should actively participate in rate case proceedings. This requires experience, knowledge and understanding of the legal, regulatory and environmental issues that affect your business and have helped shape the development of the power industry.
Sources and References:
1 - Edison Electric Institute Rate Case Summary, Q4 2015 Financial Update – Quarterly Report of the U.S. Shareholder-Owned Electric Utility Industry. Retrieved from: http://www.eei.org/resourcesandmedia/industrydataanalysis/industryfinancialanalysis/QtrlyFinancialUpdates/Pages/default.aspx
2 - U.S. Energy Information Administration, “Electricity Sales, Revenue, and Average Price (with data for 2014),” released October 21, 2015. Retrieved from: http://www.eia.gov/electricity/sales_revenue_price/