Research note: the PSC’s role in ratemaking

Research note: the PSC’s role in ratemaking

Ratemaking is one of the oldest and most important responsibilities of many Public Service Commissions (PSCs) around the US. While the issue isn’t as important as other regulatory tools for the Nebraska Public Service Commission (NePSC) due to the state’s size and the commission’s limited jurisdiction, this research note will provide an overview of ratemaking and the NePSC’s role in it before examining the related topic of utility service restructuring in a planned subsequent research note.

What is ratemaking, and how does it work?

Ratemaking became used at the beginning of the 20th century to regulate public utilities (industries like electricity, natural gas, water, wastewater, telecommunications, and transportation), which are characterized by the public necessity and structure of their services. These industries’ services have essential value to public life and require large infrastructure investments in a localized area, creating the conditions for market monopoly power that could harm consumers. Ratemaking is meant to promote the public good in a limited market by controlling prices since competition can’t effectively control them.

It is important to note that public utility regulation by PSCs is an alternative to public ownership of the utilities. Publicly owned utilities (POUs) come in many forms, including municipal utilities, public utility districts, and utility cooperatives; in these bodies, operations have a local, not-for-profit focus and are usually governed by leaders elected by the community. PSCs mainly regulate investor-owned utilities (IOUs), which are privately held and have a for-profit focus; the PSC charge is to make rates reasonable for consumers while allowing IOUs to earn a fair return on investment.

The ratemaking process typically begins when an IOU files a rate case application with a PSC, proposing increased rates charged to customers. When this happens, the PSC will assign a docket number to the case and schedule town hall meetings and a hearing; expert staff in the commission will review the case. In Nebraska, the Public Advocate (PA) represents all Nebraska customers; he examines utility costs and rate issues and is advised by a team of consultants, allowing him to recommend rates to the NePSC. The PA and the opposing party have the authority to enter a joint “stipulation” after engaging in settlement negotiations, which provides the PSC with a recommendation for what rates to implement. The commission then holds a hearing to review the case and allow input from stakeholders before a final order is issued. In Nebraska, this entire process may take up to 8 months.

While there are many different methods used by PSCs to design rates, the most common method (and the one used by the NePSC) is cost-of-service ratemaking. This type of ratemaking first involves determining a total amount of revenue necessary for the utility to cover its costs, including operation and maintenance expenses, depreciation, taxes, and an authorized rate of return on the utility’s capital investment. Once total costs are figured out, they are allocated (or divided) among several broadly defined groups of ratepayers (often residential, commercial, and industrial) to determine which group of customers should pay which costs. Lastly, rates for each group are designed to reflect these costs. In other words, the revenue requirement determines the size of the pie, while rate design determines how much of the pie comes from each class of customer.

What is the Nebraska PSC’s Role in Ratemaking?

The NePSC has a much more limited role in ratemaking because of Nebraska’s relative lack of IOUs compared to other states. Iowa, for example, has 2 electric, 1 water, and 4 natural gas IOUs operating within the state and conducted 5 rate proceedings during 2023. Nebraska’s only IOUs are 2 natural gas utilities, Black Hills Energy and NorthWestern Energy; the NePSC’s most recent rate proceedings have been 2020 for the former and this year (2024)for the latter, making ratemaking a relatively infrequent task. The NePSC has no jurisdiction over electricity ratemaking, as all of Nebraska’s electric utilities are consumer-owned POUs (the only state in the country in which this is the case). While the Nebraska Revised Statutes provide for the NePSC to regulate the rates of private water companies, the NePSC doesn’t regulate any in the state.

Outside of the natural gas industry, the NePSC’s role with rates can be better described as regulating competitive environments. In the telecommunications sector, the commission provides oversight over incumbent local exchange carriers (ILECs), which are companies that are required to provide service in a certain area and have their rates regulated on the federal level. It authorizes competitive local exchange carriers (CLECs) to compete with ILECs for service in the state. The NePSC also offers grant programs to help expand universal service and broadband access in the state, and it establishes a safe harbor range of market rates for dark fiber leases or licenses. The NePSC’s approach to regulating motor carriers and grain storage can be described in a similar way.

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