The workings of the electricity sector are a far cry from the basic economic model of supply and demand and market competition. Understandably, most Americans are unfamiliar with the obscurities of electricity markets, planning processes, and ratemaking. With a widening recognition of the tremendous potential benefits of electric transmission infrastructure, decision-makers need a working grasp of key parts of this industry. This commentary illuminates one of those parts—transmission cost allocation—the ways we divide the costs of building power lines.
Cost allocation is a critical topic for transmission deployment because without a plan to pay for the infrastructure, it won’t get built. Indeed, cost allocation disagreements have undermined grid expansion in recent years, and we should expect this element of transmission deployment to continue to be a challenge. Fortunately, a long history and deep bench of practitioners in this area provide the toolbox and flexibility we need to collaborate across jurisdictions on cost sharing. With good-faith effort, we can overcome the challenges of transmission cost allocation, and succeed in building a 21st-century grid.
The vital role of state utility commissions
Electric utilities provide an essential product, yet as monopolies, they don’t have to compete in a marketplace as sellers. State public utility commissions (PUCs) are government regulators that serve a crucial gatekeeping function: they ensure that there’s enough private investment to fund electric infrastructure while preventing for-profit utilities from abusing their privileged position through price gouging or other means.
The state PUCs accomplish this in part through rate cases, which are public hearings similar to court cases. The PUC must approve any electric rate for it to go into effect and show up on customer bills. The parties participating in a rate case typically include the utility itself, a consumer advocate, and industrial energy users’ representatives, among others. Each party presents evidence and makes recommendations to the PUC. While the positions of the parties may align in some areas, they usually diverge on many points. The PUC uses the hearing record, weighs arguments from the parties, and makes difficult decisions to balance competing goals and set the electric rates.
How rate cases determine cost allocation
Cost allocation is a fundamental part of this ratemaking process. The PUC must decide both the total amount of money the utility can collect and how those collections are divided among different customers. A critical, long-standing concept in this space is the “cost causation” principle, which says that the parties responsible for an incurred cost should pay for that cost. In other words, electricity users should pay for electricity based on how they use the system. By segmenting customer types based on usage patterns (e.g. residential, commercial, industrial) and segmenting different components of electricity costs (power lines, customer meters, fuel), the PUC can design rates that fairly charge customers based on how they use the system.
In practice, data and analytics are crucial inputs to ratemaking decisions, but that’s not all the PUC must consider. Janice Beecher of Michigan State’s Institute of Public Utilities has described designing utility rates as a “mix of art, science, and politics.” Several parties present data and analyses to the PUC on how customers use the system. The PUC must weigh this evidence and the varying recommendations of the parties to set rates that fulfill its mission of enabling infrastructure investment and quality electric service at reasonable, fair prices. This usually involves trade-offs, difficult judgment calls, and a balancing of interests—often with imperfect information.
Strictly hewing to principles can also be impractical. For instance, technically the cost causation principle requires assigning each customer their own unique electric rate, but this is generally not done. PUCs typically approve lower rate increases than what the utility originally requested after considering the arguments of other parties. Sometimes, parties who disagree with the PUC’s order challenge it in court, but they’ll often avoid this additional litigation and even simplify the rate case itself by crafting a settlement agreement and jointly presenting it to the PUC for approval.
Despite these challenges, it’s worth highlighting some encouraging points:
1. The U.S. has successfully grappled with cost allocation for many decades. Although ratemaking can be contentious, electric rates do get updated regularly across the country, and large capital investments are constantly made to maintain electric service to customers. According to the Regulatory Assistance Project, the U.S. ratemaking process “oversaw and facilitated the development of the world’s most reliable and reasonably priced electric system” during the 20th century.
2. Every state has a PUC and employs professionals with backgrounds in engineering, accounting, economics, the law, and other disciplines, who also have specific training and experience in utility operations and ratemaking. The leadership of these offices typically has deep experience with this subject matter and its thorny debates, case decisions, legal settlements, and politics.
3. Historical ratemaking practice has yielded an extensive precedent of established methodology for cost allocation. This gives us both time-tested approaches and flexibility due to the variety and sophistication of the work that’s been done around the country.
Thus, institutionally, PUCs and the ecosystem of stakeholders who practice before them are well-suited to this task. While they could be better resourced, the challenging mix of “art, science, and politics” is a core competency of PUCs and the parties that participate in their proceedings.
How cost allocation applies to transmission infrastructure
The institutional experience and storehouse of methods for cost allocation are invaluable for current policymaking and implementation. However, we can also rely on many years of experience and methods specifically for cost allocation of transmission lines, including large interstate lines that tend to be the most valuable type of transmission.
A key established principle for transmission cost allocation is the “beneficiary pays” principle, which says that the customers who benefit from transmission infrastructure should pay for it. This is equivalent to the cost causation principle that applies in ratemaking more generally. Under beneficiary pays, data and analyses can guide cost allocation by providing information on the benefits of transmission infrastructure and their geographic distribution.
Just as general ratemaking and cost allocation use segmentation to differentiate electricity use by customer and equipment type, segmentation is also useful for transmission cost allocation. Grid operating regions are segmented geographically into smaller zones. The infrastructure itself can also be segmented, for example by voltage class (below 300 kV or above). Segmentation is evidence-based and serves to guide reasonable and fair cost allocation decisions.
Like general cost allocation, transmission cost allocation may rely on imperfect evidence, and different stakeholders may have imperfectly aligned interests or goals. However, the core competency of “art, science, and politics” means that state PUCs and their stakeholders are adept at navigating these waters. This competency is a powerful asset for cooperative analysis and negotiation among states and regions working together on cost allocation. With effort, openness, and trust among participants, states can overcome the difficulties, working together to identify portfolios of common transmission infrastructure along with mutually agreeable cost allocation plans. The rewards for doing so are rich, and collaborative work among states and regions can build on established approaches to help usher in an era of vigorous infrastructure growth in this sector.
Conclusion: addressing transmission cost allocation collaboratively
While electric sector pricing dances to the beat of a different drum, a deep history of theory and practice can serve us well as we attempt to modernize our transmission infrastructure. Despite the legitimate challenges inherent in transmission cost allocation, it can be done fairly and collaboratively. Regions, states, and localities can explore evidence together and devise customized approaches that make sense for their jurisdictions. Not only will mutually agreeable cost-sharing solutions allow transmission construction to proceed, they will also fortify relationships among stakeholders and drive additional success in future shared endeavors.