• The Electric Utilities' Pricing of Electricity and the Role of the Public
  • September 27, 2013 | Author: Woo S. Jun
  • Law Firm: Weltman, Weinberg & Reis Co., L.P.A. - Brooklyn Heights Office
  • In the United States, electricity is available to consumers essentially at the mere flick of a switch.  It's a commodity that is readily available to everyone; however, most people have little or no understanding of how the price of electricity is determined. Generally speaking, electric utilities must set electricity prices to recoup the cost of producing or purchasing electricity for customers and the cost of delivering electricity to customers' homes and businesses, along with a desired rate of return on their infrastructure investments.  As electric utilities are natural monopolies, the prices that it may charge its customers are largely regulated and determined by each state public utility commissions, weighing the publics' interests.

    The following are some key factors that an electric utility must account for in their pricing of electricity:

    • Cost for construction and maintenance of power plants: cost can vary depending on the type of the power plant, i.e. nuclear power plant vs. coal power plant
    • Cost for transmission and distribution lines: transmission and distribution of electricity to its customer base are approximately 42% of the total cost in electricity
    • Type of fuel consumed to generate electricity in the power plants: coal is relatively inexpensive while natural gas tends to be more costly
    • Weather conditions: extreme heat can increase the demand for electricity to run air condition units
    • Type of customers-residential vs. commercial vs. industrial: prices are highest for residential and commercial consumers because it costs more to distribute electricity to them.  Industrial consumers use more and can take their electricity at higher voltage, thus their prices are the lowest
    • Type of electric utility company: investor owned utilities (IOU) look to earn a profit while publicly owned electric utilities or cooperatives look to provide electricity at costs1

    The electric utilities' determination of electricity prices or rates is very complicated as many factors impact pricing.  The collection of rates is called a tariff, which is designed to supply electric utility companies with enough income to earn their desired rate of return after operating and maintenance costs.  The type of electric utility company factors into the desired rate of return and the electricity tariff it charges.2

    Each state's public utility commission is principally involved in regulating the electricity tariff an electric utility may charge its customer base.  Public utility commissions regulate investor owned utilities (IOU), which is 75% of all electric utilities, as they require a rate of return on its infrastructure investments.3  Most state public utility commissions comprise of three to five appointed or elected commissioners and its staff to carry out some or all of the following functions:

    • Determine the revenue requirement;
    • Allocate costs among the different customer classes;
    • Design price structures and price levels that will collect the allowed revenues;
    • Set service quality standards and consumer protection requirements;
    • Oversee the financial responsibilities of the electric utility; and
    • Serve as the arbiter of disputes between consumers and the electric utility.4

    Generally speaking, an electric utility may recover from its customer base its operating expenses, plus a reasonable return on its infrastructure investments.  When an electric utility company requests an increase in its electricity tariff from its customer base, it must submit that request to its state public utility commission for approval.  Then, the state public utility commission reviews the request in conjunction with its finances to ensure that the company is fulfilling its responsibilities.5 

    More specifically, when an electric utility company requests a rate increase, the public utility commission looks at whether the proposed increase in the electricity tariff would provide the electric utility with adequate operating revenue.6  There are many factors that determine a company's revenue requirement, i.e. the cost of providing service to customers, maintenance of infrastructure and equipment expenses, depreciation expense, taxes, and a return on the company's infrastructure investments.  The revenue requirement is the amount of money a company is allowed to collect from its customers during a given year based on the electricity tariff.7  After reviewing the proposed rate increase in the electricity tariff and its revenue requirement, the staff at the public utility commission prepares a report and makes recommendations to the commissioners on its findings.  The commissioners may adopt those findings to make a determination on the proposed increase in the electricity tariff, or at times, the commissioners may conduct public hearings to carefully weigh the public's interests in the proposed increase in the electricity tariff.8

    Electric utilities are regulated by the public utility commission in each state to carefully weigh the interests of the utilities and the general public in determining the electricity tariff.  When an electric utility company requests an increase in the tariff, the public utility commission must review its revenue requirement versus the public's interest.  The electricity prices that electric utilities may charge its customer base is complicated as many factors determine the price of electricity.

    [1] US Energy Information Administration, Electricity Explained: Factors Affecting Electricity Prices, http://www.eia.gov/energyexplained/print.cfm?page=electricity&under;factors&under;affecting&under;prices (last visited on Aug. 13, 2013).
    [2] The Electricity Forum, Electricity Prices Explained, http://www.electricityforum.com/electricity-prices.html (last visited on Aug. 13, 2013).
    [3] The Regulatory Assistance Project, Electricity Regulation in the US: A Guide, http://www.raponline.org/document/download/id/645 (last visited on Aug. 9, 2013).
    [4] Id.
    [5] The Public Utilities Commission of Ohio, AEP's Distribution Rate Case, http:// http://www.puco.ohio.gov/puco/index.cfm/consumer-information/consumer-topics/aeps-distribution-rate-case/ (last visited on August 16, 2013).
    [6] Id.
    [7] Id.
    [8] The Public Utilities Commission of Oregon, How Utility Rates are Determined, http://www.puc.state.or.us/Pages/consumer/rates.aspx (last visited on August 16, 2013).