Cost Balance Sheet

Liese Dart

Electric supply cost is comprised of a number of factors: fuel costs, infrastructure costs, distribution costs, and maintenance to ensure reliable electric supply. The formula described below is called the "revenue requirement" and is the standard method of determining price per kwh for all types of electricity. Unfortunately for both utilities and regulatory commissions, it is a fairly complex calculation that requires a lot of time and number crunching.

The Revenue Requirement

The revenue requirement is a carefully calculated "best guess" at the per kwh rate that should be charged for electricity. When spread over the size of the customer base, the revenue requirement will ensure a utility recovers its necessary costs to provide reliable service and remain financially stable. The traditional revenue requirement model focuses on an individual company and seeks to determine what will be the cost of doing business for the reasonably efficient operation and management of the entire system in the forthcoming year(s). This equation is used by utilities and checked by each state public service commission to arrive at a "just price" for providing electricity. Because electricity is considered a public necessity, determining just and reasonable rates is paramount to the task of an electricity regulator.

What are the Components of the Revenue Requirement?

The revenue requirement is the sum of the utility's operating expenses, taxes paid, depreciation of assets, and the needed return on investments for investors. In addition to these traditional components of the revenue requirement equation, the formula can also be used to incorporate incentives to address environmental and equity problems. For example, a state legislature may pass legislation to require strict pollution controls on a fleet of plants- these costs can be added into the revenue requirement.

Set "operating expenses" account for a large portion of the revenue requirement and are comprised of wages and salaries, pollution permits, rentals, consultants, system maintenance, advertising, and necessary new infrastructure. Fuel is usually considered a "variable cost" which has two components, the price of the fuel (coal, uranium, natural gas) and the number of hours the plant will likely be used in a year. In addition to these expenses, the utility's "allowed return on investment," or profit, is subject to much discretion on the part of the utility and the regulator, and is based upon annual calculations of risk to the company, affected by the entire economy.

Approving the Revenue Requirement

There are several factors which impact how pubic service commissions approve a revenue requirement including; state and federal regulations (environmental and other), the amount of financial risk investors are asked to bear in a changing markets, and the cost of capital. Utilities are tasked with doing the initial cost calculations for providing service. The next step is for the utility to apply to the public service commission to be allowed to charge that rate. This process is commonly known as a utility "rate case." Public service commissions verify, modify or outright reject that calculation, using a test year to determine what will be the reasonable costs associated with providing electricity to the utility's customers for a full year of service.