Smart Rate Design

Rate design is the regulatory term used to describe the pricing structure reflected in customer bills and used by electric utilities in the United States. Rate design is not only the itemized prices set forth in tariffs; it is also the underlying theory and process used to derive those prices. Rate design is important because the structure of prices—that is, the form and periodicity of prices for the various services offered by a regulated company—has a profound impact on the choices made by customers, utilities, and other electric market participants.

The structure of rate designs and the prices set by these designs can either encourage or discourage usage at certain times of the day, for example, which in turn affects resource development and utilization choices. It can also affect the amount of electricity customers consume and their attention to conservation. These choices then have indirect consequences in terms of total costs and benefits to society, environmental and health impacts, and the overall economy.

Despite its critical importance, rate design is poorly understood by the general public and often lacks transparency. The difference between a progressive and regressive design can have a large effect—15 percent by one estimate, but it could be more—on customer usage. Traditional rate designs, which charge a single rate per unit of consumption (or worse, lower that rate as consumption increases) may not serve consumers or society best. As advancements in technology and customer preferences evolve, the industry must adapt to change or risk the fate of landline telephone companies, which have lost 60 percent of their access lines since the advent of telecommunications competition.

Rates can be designed to meet or, in the case of poor rate design, frustrate public policy objectives to use electricity more efficiently, meet environmental goals, and minimize adverse social impacts, including public health, among others. They are also pivotal in providing utilities the opportunity to recover their authorized revenue requirement. Revenue adequacy is a core objective of rate design, but the more constructive design ideal for rates is forward-looking, so that future investment decisions by the utility and by customers can be harmonized.

In Smart Rate Design for a Smart Future, RAP reviews and updates the rate design principles laid out in James Bonbright’s 1961 Principles of Public Utility Rates, and in Garfield and Lovejoy’s 1964 Public Utility Economics.

Based on these historical works, and looking forward to a world with high levels of energy efficiency, distributed generation, and customer options for onsite backup supply, the following three fundamental principles should be considered for modern rate design:

  • Principle 1:  A customer should be able to connect to the grid for no more than the cost of connecting to the grid.
  • Principle 2:  Customers should pay for grid services and power supply in proportion to how much they use these services and how much power they consume.
  • Principle 3:  Customers who supply power to the grid should be fairly compensated for the full value of the power they supply.

These principles and priorities should be reflected in smarter rates designed to maximize the value of technology innovations, open up new markets, and accommodate the distribution and diversification of customer-sited generation resources. This necessarily includes consideration of what those future technologies and policies could look like, with a focus on metering and billing, market structure, and pricing. In particular, rate design should provide a “price signal” to customers, utilities, and other market participants to inform their consumption and investment decisions regarding energy efficiency, demand response, and distribute generation, collectively referred to as distributed energy resources. Bidirectional, time-sensitive prices that more accurately reflect costs most closely align with the principles of modern rate design.

For additional information, see the following RAP publications: