Performance-Based Ratemaking (PBR) is a form of utility regulation that strengthens the financial incentives to lower rates, lower costs, or improve nonprice performance relative traditional regulation, which the authors call cost-of-service, rate-of-return (COS/ROR) regulation. Although the electric utility industry has considerable experience with incentive mechanisms that target specific areas of performance, implementation of mechanisms that cover a comprehensive set of utility costs or services is relatively rare. In recent years, interest in PBR has increased as a result of growing dissatisfaction with COS/ROR and as a result of economic and technological trends that are leading to more competition in certain segments of the electricity industry. In addition, incentive regulation has been used with some success in other public utility industries, most notably telecommunications in the US and telecommunications, energy, and water in the United Kingdom. In this report, the authors analyze comprehensive PBR mechanisms for electric utilities in four ways: (1) they describe different types of PBR mechanisms, (2) they review a sample of actual PBR plans, (3) they consider the interaction of PBR and utility-funded energy efficiency programs, and (4) they examine how PBR interacts with electric utility resource planning and industry restructuring. The report should be of interest to technical staff of utilities and regulatory commissions that are actively considering or designing PBR mechanisms. 16 figs., 17 tabs.

Learn from this collection of thought-provoking commentary on change and electric regulatory reform from executives, state regulators, and federal commissioners in the regulatory community. Plus, perspectives from other players -- the utilities governed by these regulators, the financial community (rating agencies), independent power producers, and public power.

Performance-Based Ratemaking (PBR) is receiving increasing attention by energy utilities and their regulators. PBR is the industry term for forms of regulation that increase financial incentive for performance relative to traditional cost-of-service/rate-of-return (COS/ROR) regulation. In this report, PBR plans filed by US gas local distribution companies (LDCs) are described and reviewed. The rationale behind energy utility PBR is presented and discussed. Using nine plans that have been proposed by eight LDCs as a basis, a framework (typology) to facilitate understanding of gas utility PBR is presented. Plans are categorized according to the range of services covered by the PBR mechanism and the scope of the mechanism's cost coverage within a service category. Pivotal design issues are identified and, based on the sample of plans, observations are made. Design issues covered include the length of time that the PBR is in effect (term); the relationship between PBR plans and status quo ratemaking; methods for formulating cost or rate indices, earnings sharing mechanisms, and service quality indices; and compatibility with gas utility DSM programs. The report summarizes observations that may be considered supportive of the rationale behind PBR. PBR is, however, not clearly superior to traditional regulation and few PBRs that are broad in scope have been adopted long enough to allow for a empirical analysis. Thus, the report concludes by identifying and describing commonly-cited pitfalls of PBR.

This report uses material from a recent Arizona Public Service Company rate case, and published literature, to address several issues generic to the electric utility industry: the effects on utility incentives and on rates to customers of including "construction work in progress" (CWIP) in the rate base; the use of prudence tests by regulators to determine what costs should, and which should not, be passed on to ratepayers; and the use of incentive programs, with explicit rewards and penalties, to reduce the construction costs of large power plants and to improve their operating performance after they go into service. It draws three major conclusions: (1) Economic principles do not support the notion that cost recovery from ratepayers should begin only after a plant is used and useful. (2) Traditional accounting practices produce rate shocks that force prices upward at the very time that the costs of using a plant are declining. Putting CWIP in the rate base is one of the ways rate shocks can be reduced. (3) Although including CWIP in the rate base may generate perverse incentives, the exclusion of CWIP from the rate base can also generate perverse incentives for utilities faced with severe cash flow problems.