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June 27, 2013
Article Authored by Brattle Consultants on Alternatives to Original Cost Rate Regulation Published in Public Utilities Fortnightly

Brattle principals A. Lawrence Kolbe, Phil Hanser, and Bin Zhou have authored an article that explores alternatives to traditional original cost regulation that will mitigate rate shocks to the utility industry. The article, “Reducing Rate Shocks,” has been published in the June 2013 issue of Public Utilities Fortnightly.

Over the next several years, electric, gas, and water utilities will need to invest heavily in environmental, efficiency, or asset replacement measures that will increase overall costs, yet leave demand unchanged or even reduced. Under the traditional original cost (OC) ratemaking, these investments will result in rate shocks that will lead to problems for utilities, customers, as well as regulators. OC rates, either directly or via fair-value rate base procedures that replicate the original cost outcome, are not well suited for competitive industries, since competitive prices are based on current values, not historical book values.

The authors propose that alternatives to traditional OC ratemaking for major capital investments should be considered, which will mitigate rate shocks while keeping utility investors whole. These alternatives, trended original costs (TOC), level nominal rates, and level real rates, have gradually gained wide acceptance for FERC-regulated natural gas pipelines and electric transmission. These alternatives have also been employed successfully by independent power producers, renewable energy producers, as well as utility planners.

According to the authors, by adopting an alternative ratemaking approach now, utilities can gain confidence to take advantage of current low interest rates, which could spur construction and bolster economic growth. The authors note, however, that as with all changes in ratemaking approach, it is important to minimize risks due to the transition itself. These risks can be lessened though legislation, project financing, or other mechanisms to reassure investors, therefore minimizing transition costs for customers.