It’s easy to cut customer electric rates, right?
A common refrain from customers is that electric bills are "too high"; just cut electricity costs! With electricity costs increasing 15% annually in recent years and moves to phase out fossil fuel electric resources, the trend in electricity prices will continue to have upward pressures.
How easy is it to provide reliable electric service and stem the tide of increasing rates? Turns out, it's not easy at all. Given the current cost environment and the change to renewable power resources, electric power costs will not be below today's costs for the foreseeable future. The cost structure of electric utilities doesn't have much wiggle room for cost controls due to the fixed and variable components of costs that are incurred to generate and deliver electricity. In this article we discuss costs and possible solutions to mitigate cost impacts.
Key article takeaways
1. Electric costs continue to increase. That trend will continue as more baseload facilities face early retirement.
2. Only about 10% of the costs in an electric utility can be meaningfully affected through the budget process.
3. Increased fixed meter charges send price signals to customers. Cost of service study trends show fixed residential customer rate charges should be $50 - $100 per month. Most actual rates are $25/month or less.
Pole construction
Overall cost structure
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 approximately 75% power costs, 10% labor and 15% administrative.
These costs are a mixture of fixed and variable costs. Fixed costs are those that do not change with normal operations. The depreciation and debt service of the power plant built to generate electricity is a fixed cost - the cost is there whether or not the plant runs Variable costs vary with the level of unit sales. For example, as customer power usage increases or decreases, a portion of power expense moves in the same direction.
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There isn’t much room to move non-power costs
Labor expense 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 10% cost bucket. What's in that bucket? Office costs, health costs, retirement costs, consulting, and equipment maintenance. 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.
So, in reality, a utility has approximately 10% of what would be considered "controllable costs",
Why make these distinctions?
The distinction is essential when it comes to designing electric rates. It has been standard industry practice to set monthly customer charges at a rate lower than the actual fixed costs. This is a decision by oversight boards to under collect fixed power costs and recover the under collection in the customer energy charge per kWh. So, if kWh sales decrease, the collection of revenues for fixed cost payments also decreases. Other sources of funding or reserves must be used to make fixed payments.
Artificially keeping the customer charge lower than the cost of service is a policy decision many utilities follow.
A recent American Public Power Association study found that the average monthly residential customer meter charge was approximately $25 or less per month. This compares to a commonly calculated meter charge of $50 - $100.
Why not raise the fixed charge?
State and federal regulators set investor-owned utility rates. With decades of rate history built into a utility's rate structure, there is a reluctance to make significant, sudden course corrections, i.e., large jumps in the fixed meter charge and decreases in the volume charge. Some strides are being made, but the gap remains.
Pressure to keep rates lower for residential customers has eased in recent years, but it is rare to see a utility with true "cost of service" rates. The situation is even more pronounced in public power utilities and cooperatives. Regulators are publicly appointed or elected for public power utilities, while the member/customers of the cooperative also elect electric cooperative board members. So politics is a component of any rate decision.
About Russ Hissom - Article Author
Russ Hissom, CPA is a principal of Utility Accounting & Rates Specialists a firm that provides power and utilities rate, expert witness, and consulting services, and online/on-demand courses on accounting, rates, FERC/RUS construction accounting, financial analysis, and business process improvement services. Russ was a partner in a national accounting and consulting firm for 20 years. He works with electric investor-owned and public power utilities, electric cooperatives, broadband providers, and gas, water, and wastewater utilities. His goal is to share industry best practices to help your business perform effectively and efficiently and meet the challenges of the changing power and utilities industry.
Find out more about Utility Accounting & Rates Specialists here, or you can reach Russ at russ.hissom@utilityeducation.com.
The material in this article is for informational purposes only and should not be taken as legal or accounting advice provided by Utility Accounting & Rates Specialists. You should seek formal advice on this topic from your accounting or legal advisor.