Classification and Allocation Methods for Generation and Transmission in Cost-of-Service Studies
7 May 2004
By Dr. Hethie Parmesano and Amparo Nieto with former NERA Senior Consultant Dr. William Rankin and former NERA Consultant Veronica Irastorza
An Embedded Cost of Service (COS) study begins with a utility's total costs (operating expenses, debt service, return on equity, taxes, depreciation, etc.) for a particular test year and uses a series of steps to identify each customer class' share of various cost components. Because most of a utility's total cost depends upon investment decisions made in the past, COS studies are typically designed to reflect the causes of those historical costs. COS studies are undertaken with the goal of creating an equitable allocation of historical total costs to various customer groups and individual customers without cross-subsidies.
There are many alternative methods for conducting the various steps of a COS study. While there is no engineering or economic theory that determines which method is appropriate, methods are usually chosen based upon the characteristics and objectives of the specific utility being studied.
In a February 2003 order, the Public Utilities Board of Manitoba (PUB) directed Manitoba Hydro to carry out a review of cost classification methodologies that would critically examine the impacts of the various methods and describe how such classification methods would impact the rate design process in terms of setting demand and energy charges. This report summarizes the results of the review.
The report suggests that, given the utility's active participation in the regional wholesale market, appropriate COS methods for Manitoba Hydro should:
- incorporate marginal or incremental cost elements;
- take competitive market conditions into account;
- treat large and variable export sales as a specific class; and
- allocate the above-cost revenues from export sales in a fair and minimally distorting way.
