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Among the most central roles of the AUC's mandate in overseeing Alberta's utilities sector is setting rates for utility service. In carrying out this role the Commission seeks to balance ensuring consumers enjoy access to safe and reliable utility service at just and reasonable rates, with making sure that owners of utilities have an opportunity to earn a fair return on their investment. Utility consumers are expected to pay the fair costs of providing the service they receive. In a related exercise, rates are set by class (residential, farm, industrial, etc.) so that consumers pay the costs of servicing that class of consumer.

Rates differ from utility provider to provider, reflecting the different cost structures that underlie specific utilities. A rural utility, for example, may experience higher costs than an urban utility, as customers are spread out and network costs may be higher, and in turn, higher per consumer.

Historically, utility rates in Alberta and elsewhere were set using a cost-of-service model. Under this model, a utility's costs, including a reasonable profit on investment, are aggregated, attributed proportionately to rate classes, and then rates are set based on consumption levels. This approach has come under criticism, as it may not adequately encourage efficiency on the part of the utility.

In simple terms, under cost-of-service regulation, a utility's costs including profit are added up, that sum divided by the number of units of energy sold or distributed, and the result is the rate consumers pay. Rates are directly linked to utility expenditures and the utility earns a return on those expenditures.

The AUC established performance-based regulation, or PBR, for Alberta's regulated distribution utilities (EPCOR, ATCO Gas, ATCO Electric, AltaGas Utilities, FortisAlberta) in January 2013, following a decision issued in September 2012. This followed consultation with consumer and industry groups, and several years' work and an in-depth AUC proceeding and decision under the AUC's Rate Regulation Initiative to determine the most effective approach. ENMAX came under the same regime in 2015, after being subject to a pioneering form of performance-based regulation set by the AUC in 2009.

PBR is designed to mimic competition-like pressures in distribution rate-making, encourage efficiency and constrain distribution costs, while safeguarding reliability. In December 2016, the AUC released a decision that updates and enhances its approach to PBR to fine-tune the program's approach. It will take effect in January 2018.

PBR is an alternative form of rate regulation that is designed to incentivize utilities to be more efficient and in so doing to keep utility rates lower than they might otherwise be. Under PBR, a utility's rates are established using costs measured (actual and estimated) and tested in a reference, or going-in, year. Subsequent annual adjustments to rates are determined through a formula that limits rate increases to the rate of inflation less an industry productivity offset factor the utilities are expected to achieve, and a stretch factor. There is special treatment for certain capital expenditures and other costs that fall outside the control of the utility. The intent is to detach rates from costs, to encourage utilities to be efficient by allowing the utilities to retain the benefits from cost savings achieved for the duration of the PBR term. Benefits are shared with consumers through the productivity offset factor imposed during the PBR term and in the rate rebasing process at the end of the term, where productivity improvements made by the utilities are factored into rates going forward. Quality of service is safeguarded through separate, enforceable, AUC requirements.

PBR was originally instituted for a five-year term. As noted above, in 2016 the AUC and the regulated distribution utilities revisited the program through a detailed proceeding to update and refine the regulatory approach using the experience gained and the objective data gathered in the first generation.

In that December 2016 PBR decision, the AUC also required that the regulated utilities must regularly report on the state and upkeep of their capital assets and service quality. This is to ensure that cost containment does not come at the expense of service quality. As well, the approach to determining going-in rates for the new 2018-2022 term for PBR was improved to better eliminate the possibility of revenue requirements being overstated, and to streamline the rate-setting process.

While PBR is designed to constrain increases in distribution rates, costs for distribution in Alberta have still risen. These increases may stand out particularly when compared to energy commodity costs that are at or near historic lows.

Record economic and population growth prior to 2015 prompted an unprecedented level of necessary construction, expansion and reinforcement of Alberta's utility distribution infrastructure. These projects also experienced much higher input costs than what historically been the case. The costs for this utility expansion and reinforcement, the bulk of which are completed, could not be avoided. These types of costs are captured in the special treatment for certain types of capital that result in rate adjustments above and beyond the inflation adjustments provided by the performance-based regulation formula.