Cost allocation is one of the major steps in the traditional regulatory process for setting utility rates. In this step, the regulators are primarily determining how to equitably divide a set amount of costs, typically referred to as the revenue requirement, among several broadly defined classes of ratepayers. The data and analytical methods used to inform cost allocation are often relevant to the final step of the traditional regulatory process, known as rate design.
Cost allocation has been addressed in several important books and manuals on utility regulation over the past 60 years, and these works and historic best practices are foundational. But the legacy methods from the 20th century are no more suited to the new realities of the 21st century than the engineering of internal combustion engines is to the design of new electric motors. Charting a new path on cost allocation is an important part of creating the fair, efficient and clean electric system of the future.
The manual is divided into five parts:
- Part 1: Chapters 1 through 4 lay out principles of economic regulation of electric utilities, background on the rate-making process, and definitions and descriptions of the electric system in the United States. Readers who are new to rate-making and utility regulation should start here for the basics.2 Much of this material likely will be familiar to an experienced practitioner but emphasizes key issues relevant to the remainder of the manual.
- Part II: Chapters 5 through 8 cover the important definitions, basic techniques and overarching issues in cost allocation. Some of this material may be familiar to an experienced practitioner but also lays out the issues facing cost allocation.
- Part III: Chapters 9 through 17 delve deeply into the subject of embedded cost of service studies, including discussion of historic techniques, current best practices and key reforms.
- Part IV: Chapters 18 through 26 cover the field of marginal cost of service studies, including historical development, current best practices and key needed reforms.
- Part V: Chapters 27 and 28 cover what happens after the completion of the quantitative studies, including presentation of study results and adjustments, and the relationship between cost allocation and rate design.
This manual focuses on cost allocation practices for electric utilities in the United States and their implications. Our goal is to serve as both a practical and theoretical guide to the analytical techniques involved in the equitable distribution of electricity costs. This includes background on regulatory processes, purposes of regulation, the development of the electricity system in the United States, current best practices for cost allocation and the direction that cost allocation processes should move. Most of the elements of this manual will be applicable elsewhere in the Americas, as well as in Europe, Asia and other regions.