2. NARUC Energy Regulatory Partnership Program The Georgian National Energy Regulatory Commission and The Vermont Public Service Board by Andrea McHugh Vermont Public Service Board June 28, 2008 Principles of Rate Regulation

3. 2 Overview Part I:Economics of Regulation Part II:Sectors in Vermont Part III: Price Regulation Part IV:Rate Case Principles Part IV:Steps for a Vermont PSB Rate Case

4. 3 Objectives of Economic Regulation v Economic efficiency v Fair prices to consumers, producers and regulated entity v Reasonable service, with non- discriminatory access v Adequate quality and reliability v Other policy considerations (social objectives)

5. 4 Additional Goals of Economic Regulation v Attracting investment v Supporting privatization v Rights and obligations must be clear and enforceable v Transparent and predictable regulatory process and outcomes v Clear franchises v Enable fair competition where possible

6. 5 EFFICIENT MARKET v Number of players is large v Easy entry to and exit from the market ( contestable market ) v Fully informed market participants v Most of the players are private (seeking to maximize profits) DISTORTION v One or few players (monopoly, oligopoly) v Legal entry / exit barriers v Imperfectly informed players v Players do not have to pay for the full social cost of their activities (subsidies, externalities) v Most of the players are publicly owned (seeking to maximize growth and influence) Efficient and Distorted Markets

7. 6 PRICE DISTORTIONS v Above-efficient market prices Monopoly pricing Few players exercising their market power v Below-efficient market prices Subsidised industries v Non-internalised external costs (free pollution) GETTING THE PRICES RIGHT (MIMIC THE MARKET) v Monopoly price regulation v Market price caps v Merger control and antitrust v Removing direct and indirect price subsidies v Renewables pricing v Creation of emission rights / green certificates markets v Environmental taxation Distorted Prices – Regulatory Tasks

8. 7 Sectors Subject to Price Regulation in Vermont v Electricity –Transmission (federal regulation) –Distribution (state regulation) –Generation - not directly regulated (except through distribution company rates and siting) u Includes all in-state generators

9. 8 Sectors Subject to Price Regulation in Vermont (cont.) v Natural Gas –Transmission (interstate pipelines subject to federal jurisdiction) u Vermont pipeline is not connected to the interstate system u Canadian pipeline supplies Vermont –Distribution (state regulation) –Gas marketers (not in states that have deregulated)

10. 9 Sectors Subject to Price Regulation in Vermont (cont.) v Telecommunications –Landline phone companies v Water –Privately owned water systems

11. 10 Sectors Not Subject to Price Regulation in Vermont v Fuel Oil v Propane (except for safety and limited price regulation of propane systems) v Wood v Cell phone companies v Municipal water systems

12. 11 Intrastate Operations v In areas subject to price regulation, rate regulation includes all aspects of intrastate operations –Actual distribution plant –Generation facilities –Purchased power/purchased gas contracts

13. 12 Guideline for Price Regulation v The regulator should set regulated rates or tariffs for the regulated companies so that the regulated rates allow the companies to earn a revenue that covers the “justified costs” of their operation, that is the costs that are necessary and unavoidable to provide the regulated service at a predefined level of quality

14. 13 Price Regulation v Intended to address each of the economic objectives outlined above v Mechanism –rate levels (revenue requirement; cost-plus) –rate structure (rate design) v Prevent excessive prices or discrimination v Ensure adequate earnings and enable company to attract capital v Service v Safety v Management efficiency

15. 14 Elimination of Subsidies v Definition - prices below long run marginal costs (economic) v Problems - wrong price signals –Encourages consumption if prices too low –Discourages consumption if artificially high

16. 15 Discriminatory Pricing v Often occurs to meet social or economic goals v If not cost-based, who decides what goals should be supported? –Low income –Economic development –Environmental concerns v Solution - cost-based rates v Variations must be justified based upon actual cost differences

17. 16 Traditional Price Regulation v Revenue requirements supported by cost of service –“Cost-plus” ratemaking –Rate base –Expenses –Return on investment v Overall standard - Just and reasonable rates

18. 17 Annual Revenue Requirement (ARR) = Total Cost Price*electricity sold = FC + VC (justified) Price = (FC + VC) / electricity sold ($/kWh) Primary task is to understand costs Objective of Price Regulation

19. 18 Rate Case Objectives v Rates should reflect the cost of providing service v Costs should include all relevant costs, private and social v Costs should be reasonably and prudently incurred v Costs should be used & useful

20. 19 Revenue Requirement  “Cost-Plus” ratemaking  Determine OPERATING INCOME at current rates  Revenues, retail and other  Expenses, including taxes  Determine the RATE BASE  Estimate the required COST OF CAPITAL  Compute revenue deficiency or excess

21. 20 Accounting  Chart of Accounts- FERC requires use of Uniform System of Accounts (USofA) for accounting  Some state-specific forms  Vermont requires use of FERC system  Generally Accepted Accounting Principles (GAAP)  Use these standards and rules in preparation of financial statements for consistency

22. 21 From Costs to Rates  Step 1: Allocate costs between customer classes  Step 2: Design rates within customer classes  Step 3: Address tariff issues including credit, collection, service response, etc.

23. 22 Statutory Requirements in Rate Cases v Statute sets time limit for decision 7 months from suspension of tariff or start of investigation v Board must make decision based on record v Department of Public Service represents interests of the State

24. 23 Schedule v Basic steps are: –Tariff Filing, Petition for Investigation, or Board initiation –Prehearing Conference –Intervention by Parties –Public Hearing –Discovery –Filing of Testimony –Hearings (Can have separate hearings on direct and rebuttal cases or combined) –Briefs –Board Decision

25. 24 Schedule (cont.) v If the case is assigned to a Hearing Officer instead of the Board hearing it directly, there are a few more steps in the process after the parties file briefs: –Hearing Officer issues Proposal for Decision –Parties file comments, requests for Oral Argument –Oral Argument before the Board (if requested) –Board decision

26. 25 Notice v Board provides formal notice of all hearings, including status conference, prehearing conference v All Orders provided to parties and interested persons; in many cases, also to the press (depending on interest)

27. 26 Public Hearing v For a substantial number of Board cases, including most rate cases, Board holds public hearing v Advance notice to public, preferably in customers’ bills v Generally, entire hearing is devoted to hearing public concerns v Utility and/or public advocate may introduce issues v At times, will allow public to ask questions of company v Vermont Interactive Television can be used as tool

28. 27 Information Flow v Board receives the following information –Cost-of-Service Filing –Written Testimony (usually 2 sets from each party) –Discovery Responses (these are not part of the evidentiary record unless we or another party make them an exhibit) –Briefs (usually 2 sets from each party) –Also routine procedural filings (schedule, interventions, etc.) –Compliance filings (after final Order is issued) v Board can and will request parties to address specific issues in testimony (not in every case)

29. 28 Information Flow – Confidential Information v Companies regularly have information that they claim would cause competitive harm if disclosed v To allow exchange of information, parties generally execute protective agreements, which the Board then approves through a Protective Order –Unless asked, at this stage, Board generally does not review the merits of whether particular information should be kept confidential v If party wants to use confidential information at hearing, must make showing as to why it should be kept confidential

30. 29 Hearings v Held after all testimony is filed v Since parties file all testimony in writing in advance, hearings consist of cross- examination and Board questions v In typical rate case for large utility, hearings take about 1 week (on average) v Hearings are open to the public; occasionally it is necessary to briefly close the hearings to discuss confidential information

31. 30 Settlements v Utility and Public Advocate may reach settlement –Board may accept, reject, or condition –Intervenors may or may not support v Settlements reduce litigation and foster cooperative resolution, but, they may also provide less transparency

32. 31 Board Decisions v By law, Board must make decision based solely on evidence in the record v Board applies its expertise in reaching those decisions v Public input (from public hearings and comments) is not considered part of the evidentiary record. Instead, Board considers it in weighing testimony and raising issues v Ex parte communications are prohibited

33. 32 Board Decisions (cont.) v Staff will usually make recommendations –Board then accepts, modifies, rejects v Basic decision rules –Just and reasonable rates (fairness) –Consistency with past practice –Disallow imprudent or non-used-and- useful costs

34. 33 v Board decision-making and writing of decision often compressed v After briefs, usually have 4-6 weeks at most to issue decision v Rate case Orders are often substantial (100 pages) v Frequently issue press release to assist in public understanding Board Decisions (cont.)