How distribution rates are set

How distribution rates are set

The AUC has a responsibility to ensure that customers receive safe and reliable electric and gas utility service at just and reasonable rates. The AUC determines rates through its review process. In the review process, the Utilities Consumer Advocate represents residential, farm and small commercial customers to ensure rates are fair for Alberta customers.

In order to provide utility customers with safe, reliable service now and in the future, and to encourage continued investment in the utility industry, it is essential that distribution companies are provided with an opportunity to recover prudently incurred costs of providing service, which includes earning a fair return on investment.

Distribution companies own the systems that deliver electricity and natural gas directly to a customer’s home. Some of their responsibilities include connecting and disconnecting customers, building new services, operating, and maintaining the distribution infrastructure, replacing distribution infrastructure that is at the end of its service life, sending distribution charges to the retailer, providing meter reading services and implementing technology to maintain safe and reliable service. The costs incurred by the distribution company to provide these services are recovered through distribution charges on a customer’s utility bill that is provided to the customer by their retailer.

Distribution charges for investor-owned and certain municipally owned distribution companies are regulated by the AUC under performance-based regulation. Visit who we regulate for a list of regulated utilities in Alberta.

Distribution rate components

Distribution charges have both fixed and variable components. The fixed charge recovers those costs that do not vary with consumption of energy. Although distribution charges include a variable component, the majority of the utilities’ costs are fixed and do not change with energy consumption. The utility must build a system with enough capacity to deliver peak demand reliably at any and every point in time. Peak demand occurs whenever customers use the most amount of energy, for example on a cold winter day around dinner time or in the afternoon of a hot summer day when the need for air conditioning is high.

How much it costs a distribution company to build, operate and maintain its distribution system, and replace aging infrastructure depends on how big the system is and how new it is. A distribution system that serves rural areas will cost more than a system that serves urban areas because the distribution company has to build, operate and maintain more poles, wires, and facilities to serve each customer. The density of customers on a distribution system will also affect the cost per customer and therefore the rates. With more people splitting the costs, the rate may be less.

To ensure safe and reliable service, power lines and substations, natural gas pipelines and other utility infrastructure such as poles, transformers, overhead conductions and underground cables need to be upgraded and replaced. This concept is similar to apartment rental rates. An owner of an apartment building (similar to a utility) charges monthly rent to cover fixed and variable costs. Fixed costs may include things like property taxes, mortgage (which is similar to a loan or debt used by utility companies to help with financing), insurance and a property manager. Variable costs are similar to costs influenced by the number of tenants and how they use the property, including things like maintenance and repairs. The property owner has alternatives in how their money is invested, so they would need to receive a return on their investment as well.

In addition, the monthly rental rates will also need to cover the cost of eventually replacing the larger assets associated with the apartment complex as well, like fridges, stoves or the boiler. A relatively small amount is typically collected over a long period of time so when the actual cost to replace these assets is incurred rental rates do not spike, or the owner has to bear those costs on their own.

The parallel can be drawn further, in that larger apartment buildings typically have larger costs (both fixed and variable) than smaller buildings. However, for a given size of apartment building, the costs will depend on the number of tenants per square metre – a higher occupancy per square metre may mean the fixed costs are distributed among more tenants, but there might be higher variable costs.

Performance-based regulation

Rate regulation for electric and gas distribution utilities in Alberta is performed under a form of performance-based regulation, which was put in place by the AUC to replace the traditional cost-of-service rate regulation. Performance-based regulation is designed to mimic competition, encourage efficiency by providing incentives for the utility to reduce costs, while safeguarding reliability. In doing so, utility rates are kept lower than they might otherwise have been for customers.

Under performance-based regulation (PBR), rates are calculated by means of an incentive-based formula rather than by the traditional ratemaking method which sets rates based on the costs utility companies are expected to incur in a given year. The more efficient the utility operates, the more savings it realizes, which results in a greater rate-of-return, and since these benefits are then shared with customers, the lower the rates can be. Quality of service is safeguarded through separate, enforceable, AUC requirements. PBR also reduces the regulatory burden because once the formula is set, the utilities do not need to get their costs approved annually as they would under the traditional ratemaking method, until the PBR term has expired. Alberta has five-year PBR terms.