How to Learn Cost of Service (If You Don’t Work at a Utility)

regulatorykitty_624_200

Read Bonbright; pet kitty; repeat.

There are about 8,300 public utility commission staff at 50 states plus D.C. There are around 400,000 jobs in electric generation, transmission, and distribution, according to the Bureau of Labor Statistics (NAICS 2211). But not everyone engaged in energy issues comes from those traditional avenues. Changing environmental and social forces are driving new players into energy, including nonprofits, large manufacturers and tech companies, and local governments. Unfortunately, there’s a fairly significant education gap for rising analysts in the energy and utilities field.

So how do you learn how to engage effectively in a regulated area if you’re on a nontraditional path?

In this post, I’ll focus on some practical tools for learning about cost of service studies. The basic concept is that services provided by regulated electric utilities should be provided for what they cost, to prevent discriminatory pricing to or between customers. The way you get there is to build a complex mathematical model that takes accounting and billing data and applies assumptions about how different types of customers contribute to the overall cost to provide electricity (or water, or natural gas, etc.). Utilities, commissions, and other parties then use the outcomes of this tool to varying degrees to propose what rates should be charged for different services.

I picked cost of service because it doesn’t seem like there are that many new people getting into it. This creates risks for a number of different players. Existing entities may lack people to whom they can pass on institutional knowledge. Newer entities that want to engage at commissions about utility rates and business practices may lack the tools. Moreover, the practice of ratemaking itself could stagnate as the same people say the same things for decades.

But it’s not an easy thing to learn. Implementing or dissecting a cost of service study involves knowing elements of law, economics, engineering, accounting, statistics, and maybe programming (depending on the tool being used). Your common avenues to learn this particular nexus of skills are: (1) work at a utility, (2) work at a commission, (3) work at a consumer advocate’s office, (4) attend a training by NARUC or similar, and (5) go back to school.

Maybe you can’t afford a week for an out-of-state training. Maybe you can’t or don’t want to go back to school for a new degree. (Hi, fellow law degree recipients!) I recommend three other tools:

  1. Read extensively.
  2. Talk to practitioners.
  3. Learn by doing.

Let’s focus on the first tool: building a library of resources that help you learn how to speak the language of cost of service and rate design. Unfortunately, cost can be a barrier, as many books have largely gone out of print, despite them being referenced in literally every utility rate case filing. However, there are free or cheap options for information, which I’ll highlight below where possible.

A comprehensive library covers at least these three areas:

  1. Law and Regulation. Legal precedent has put limits on regulatory decision-making, drawing from common carrier, police power, and contract theories. It considers economics, except when it doesn’t. But overall, the history is extremely important because of how much electric regulation is powered by concepts over a century old.
  2. Economics and Pricing. Economists talk about what electric rates are supposed to achieve. Cost of service doesn’t happen in a vacuum; it’s the midpoint between “deciding how much money a utility can collect” and “deciding how people should pay for that.”
  3. The Mechanics. I group accounting, engineering, statistics, and other “practical” aspects of how to build and use cost of service models in this category. They help put a concrete framework around the more esoteric aspects of legal theory and economics. Most of the materials I included below focus on accounting and the revenue requirement, which is important because it’s the starting place for developing all the costs that have to be broken down and assigned.

To give you a place to start, here are the books and papers I most frequently reference on cost of service and ratemaking issues.

Law & Regulation
 rap_sm This “101” guidebook by the Regulatory Assistance Project covers just about any issue you need to know to understand the universe of decisions regulators have to make and the factors that go into making them. It’s very accessible, and I tend to recommend it to people in part because it helps you understand the underlying factors for key concepts like the rate of return. The original was published in 2011, with a second edition in 2016 (embarrassing confession: I have not read the 2016 update yet). Both are available for free download here.
 nutshell_sm  Energy Law: In a Nutshell is more “okay” than “great,” but it is another level of detail up from the RAP guide, introducing more complex concepts related to the law and economics. It’s also got a pretty significant section on restructuring. It can be pricey because it’s tailored for law students, but it is probably one of only a couple of resources on here that are word-searchable, since there are eBook versions available.
 phillips_sm  The Regulation of Public Utilities (Charles F. Phillips, Jr., 1993 version) is one of my go-to texts for deciphering the historical, legal, and economic foundations of energy regulation. Very few people do a good job of organizing something that wide-ranging in a linear fashion, but I think he comes close. I tend to consult his descriptions of early 1900s caselaw, which continues to animate conceptions of the public interest in this area. Again, it’s available through PUF, or you can find used copies online for around $30-150.
Economics & Pricing
 bonbright_sm Bonbright’s “criteria for a sound rate structure” are cited in almost every rate design testimony filed at commissions, but his work comprehensively (and comprehensibly) describes a much richer economic history for regulated industries. He’s kind of a must-read. There are two versions, the original 1961 edition and the revised 1988 edition with coauthors — both seem to be products of their times. If you want a new copy, the 1988 version will cost you $139 through Public Utilities Fortnightly. Used editions run from $100-400 on Amazon, but I was lucky and found one on eBay for less than $30. If you don’t want to spend the money, there are two options: download the 1961 version for free through the Regulatory Assistance Project, or check university libraries.
 kahn_sm  KAAAAAAAAAAAHN. (Sorry.) Kahn’s The Economics of Regulation is best read in small doses, in my experience, but it covers a couple of pretty key concepts in modern regulation: in particular, it deals extensively with marginal-cost pricing and “cream-skimming” (when competitors steal “choice” customers, as utilities argue is happening with rooftop solar and community choice aggregation). This probably makes it more relevant to modern analysts than Bonbright, in many ways. Kahn also looks at some of the incentives that regulated entities, and regulators, operate under. I bought it online for about $10, and there are new and used copies from a number of booksellers — or this one is probably at your public or university library.
garfieldlovejoy_sm Garfield & Lovejoy’s Public Utility Economics (1963) has the distinguishing characteristic of looking like a paperback of Frank Herbert’s Dune. Fun fact: one of its authors is the father of the lead singer of Black Flag! He sounds less than pleasant. I have not spent as much time with this text as the other economics books, but one of the things I appreciated about it is that it looks at elements of distribution engineering as it works through economic concepts like cost of service. That gives it a useful practical dimension.
nudge_sm Nudge, by Thaler & Sunstein, is a great catalogue of behavioral economics concepts. Behavioral economics continues to influence commissions to varying degrees, although often more with regard to customer programs (like energy efficiency) than with rate design. You can find this online or probably at your public library.
The Mechanics: Accounting, Revenue Requirement, and Cost of Service
narucaudit_sm Let’s start with this rate case audit manual from NARUC. I’m a linear thinker, and what I appreciate about this guide is that it walks you through the common steps that commission staff person might take to review a utility’s rate case application and test it for errors, inconsistencies, omissions, and undesirable outcomes. It’s entirely focused on the revenue requirement, not much related to cost of service or rate design — but the revenue requirement is the necessary precedent to anything else. You can download this for free through the Body of Knowledge on Infrastructure Regulation, the precisely (if awkwardly) named educational site established by entities that include The World Bank and the University of Florida.
suelflow_sm This is my fairly grubby copy of Suelflow’s Public Utility Accounting: Theory and Application. The FERC uniform system of accounts has seen some updates since this was published in the 1970s, but this breaks down key concepts like which costs associated with marketing and advertising are below the line. Note that regulators can institute state-specific variations. For example, Illinois allows utilities to pass through to ratepayers the costs of charitable donations — which caused a kerfuffle when it was noticed that those charities sometimes testified on behalf of their donors.
deloitte_sm While Suelflow explains what goes in each account, this 2012 Deloitte white paper, posted on IPU’s website, is more about the mechanics of regulatory accounting, covering concepts like construction work in progress (CWIP). Sometimes reliable sources for regulatory terminology and alternative practices are difficult to obtain, which is why I like this as a supplement for the other resources in this section.
naruccoss_sm And now we come to the NARUC Electric Utility Cost Allocation Manual (1992). As Mr. Spock would say in Star Trek IV: The Voyage Home, “Ahhh . . . the giants.” They really know how to get to the point with their covers, don’t they? The NARUC Manual has some important context that sometimes gets missed when it’s being discussed in testimony. It was originally developed as a consensus project by commission staff across the country to identify and describe the most commonly used methodologies for electric utility cost of service studies. It presents the pros and cons of different methodologies, but rarely chooses one over the other. Some states have “adopted” the manual, but not every methodology that a commission has accepted is described within. This used to be $30 to download from NARUC, but now it seems to be available for free.

Outside of these resources, there are two others I think are particularly useful. Lawrence Berkeley National Laboratory has a “Future Electric Utility Regulation” series that has been putting out reports dealing with issues like performance-based ratemaking. LBNL is invaluable–I particularly enjoyed this recent analysis of electric utilities’ load forecasting practices. There’s also the National Regulatory Research Institute, NARUC’s research wing. I’m flagging these because they often include examples or surveys of multiple states, making them a handy reference for what policy tools are out there being considered.

These are the resources that will help you get started. If you really want to dig into cost of service, though, you’ll need to talk to experienced professionals and work through examples. I’ll talk about these other steps in a future post.

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