Customers Ask: Cover lost profits?

The rates are designed to give the utility a reasonable opportunity to cover necessary costs of service including a level of “profit” referred to as the “authorized” return-on-equity (“ROE”).  There is no “guarantee” that profits will be earned at the PSC estimated level after rates go into effect.

Once new rates are approved, they go into effect. The utility can only charge the PSC approved rate and customers must pay their bills based on the PSC rate and their consumption levels.

At the end of the year the utility reports its sales, costs and net income based on audited figures.

• If the utility earns more than the authorized ROE used by the regulator in establishing the rates the additional amount goes to the shareholders.
• If the utility earns less than the authorized ROE (including if it shows a loss) the shareholders bear the burden.

There is no surcharge in future rates to make up for utility losses, nor is there any refund to customers of any previous year’s earnings above the originally authorized ROE. Such adjustments to rates based on past costs and financial experience would be considered “retroactive ratemaking” which is generally prohibited.

There are special instances where utility rates are put into effect subject to refund, particularly in cases of “emergencies” where regulators put temporary rates into effect prior to a full regulatory review. These are rare as investors don’t care for the uncertainty inherent in temporary rates.

Some critics assert that when utilities are losing money (or more frequently not earning a market derived and competitive ROE) the utility can appeal to the regulator for a rate increase to cover past “losses”. This is incorrect as the rate increase request cannot be made to recover “lost earnings” from the previous year. A rate change request can be made to set rates in the next period at a level, so the utility has a better chance to recover adequate earnings more fairly in future rate periods. The regulator would proceed with an investigation and hearings to determine whether the factors which led to low or no earnings in the previous period were “one time” events or such factors would persist into the future and thus justify a change in rates.

For example, when I was CEO of a natural gas distribution utility, we had an unusually warm winter leading to very lower earnings as gas heating in winter was the main source of revenue. However, both the PSC commission staff and my own experts concluded that the existing rates under normal weather conditions expected next year would provide adequate earnings. Hence, no rate change request was made.

Similarly, in the instance where the utility’s reported ROE is above the PSC’s estimates of a market required ROE, the PSC, customers or other parties can request a rate case review to determine whether the current rates need to be lowered to levels which will still provide an adequate ROE.  In some states the PSC initiated rate review is named a “show cause” order in which the utility is ordered to file a rate case with data demonstrating why rates should not be lowered.

What would cause a monopoly electric to not earn its PSC authorized ROE?

The annual revenue of a utility is
rates ($/KWh $/kW) x sales (kWh, kW) = $ revenue

Keeping mind that utility rates are calculated based on normal “test year” estimates of sales and costs lower earnings could be caused either by

1. lower than estimated sales volumes and/or
2. higher than estimated cost-of-service.

Variable cost factors include unanticipated weather-related labor overtime (storms), inflation, fuel and changes in other O&M expenses etc.