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Principles of Public Utility Rates

Principles of Public Utility Rates

James C. Bonbright
1961
T2 433 pages · about 7h 13m to read OL4654372Wgoodreads

The rate-making reference: how an allowed return is actually set.

Summary

James Bonbright wrote the standard treatment of how regulated utility rates should be set, and it remains cited in rate cases six decades later. Its subject is the economic and practical criteria that a rate structure must satisfy and the unavoidable conflicts among them.

Bonbright's contribution is his list of criteria, which he states as attributes of a sound rate structure: the revenue requirement must be met; rates must be simple, understandable and free from controversy; they must avoid undue discrimination; they must promote efficient use; they must be stable for both the utility and the customer; they must be fair in apportioning cost among customers; and they must yield revenue that is stable and predictable. He is explicit that these conflict, that no rate structure satisfies all of them, and that ratemaking is therefore a matter of judgement rather than of calculation.

The analytical chapters address the underlying economics: the difference between marginal cost pricing, which is efficient, and embedded cost pricing, which is what regulators generally use because it recovers the actual revenue requirement; the treatment of joint and common costs in a multi-service utility, where allocation is inherently arbitrary; the demand and energy components of electricity cost and the tariff structures that reflect them; and the rate base and rate of return determination. The book predates deregulation, competitive generation markets, distributed generation and time-varying pricing technology, so the institutional context is dated. The criteria and the treatment of cost allocation remain the framework used in the field.

Key takeaways 7

  1. A sound rate structure must satisfy criteria that conflict with each other, so ratemaking requires judgement rather than calculation.
  2. Efficient pricing follows marginal cost while revenue recovery requires embedded cost, and regulators must compromise between them.
  3. Joint and common costs in a multi-service utility cannot be allocated non-arbitrarily, so any allocation is a policy choice presented as accounting.
  4. Electricity costs have distinct demand and energy components, and tariffs that ignore the distinction misprice both.
  5. Rate stability for customers and revenue stability for the utility are separate requirements that a single tariff must serve simultaneously.
  6. The rate base and allowed return determine the utility's incentive to invest, which makes the return decision an investment policy decision.
  7. Bonbright argues that undue discrimination is a matter of degree, since all rate structures discriminate among customer classes by design.

Who should read it

Investors in regulated utilities and anyone working on rate cases who needs the framework that regulators and intervenors still argue within.

Where it sits in the reference 2

Business models
Philosophy

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