Phrase of the Day: Rate Base

Sept. 16, 2015 by Alexandra Aznar, Joyce McClaren

Rate of return regulation is a type of regulation that allows utilities to cover their operating expenses (i.e., variable costs) and ensure a fair rate of return on capital investments. The public utility commission determines the allowable rate of return for each utility. The utility’s rate base is the total value of a utility’s assets (e.g., plant, equipment, working capital, and deductions for accumulated depreciation). Both the rate of return and the rate base are components of the utility’s revenue requirement, which the utility collects from customers in the form of electricity rates.

The formula for calculating the revenue requirement is:

R = V + s(B)

where R = revenue requirement, V = operating expenses, s = allowed rate of return, and B = rate base.

There is increasing discussion about how customer adoption of distributed energy systems impacts utility economics under rate-of-return regulation. Items included in a utility’s rate base affect the total revenue requirement, hence, electricity rates. Electric utilities are required to purchase generation from their customers' distributed solar systems. However, because these systems typically are not owned by the utility, they are not included in the utility's rate base; instead, they're included in the utility's operating costs. Utilities increasingly are interested in the economic benefits of owning customer-sited solar capacity.

In August 2014, Arizona Public Service (APS), an investor-owned utility in Arizona, submitted a proposal to its public utility commission to install and own rooftop solar PV systems on their customers’ roofs. The proposal called for passing the solar PV system costs to customers, which means this type of investment would go in the rate base. In December 2014, Arizona’s public utility commission (the Arizona Corporation Commission) did not object to the proposal; therefore, APS will move forward with the project, arguing that the investment is prudent in its next rate case.