Don't Fear the Cost Study

By Clark Kaml

This book discusses the background and inputs that drive cost studies as used in utility rate making and why the results might not represent what an individual reviewing the results might think. 

• Language: English
• Publisher: Clark Kaml
• Release date: Dec 13, 2022
• ISBN: 9781958400227

Book preview

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Copyright © 2022

Clark Kaml

ISBN

All Rights Reserved. Any unauthorized reprint or use of this material is strictly prohibited. No part of this book may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system without express written permission from the author.

All reasonable attempts have been made to verify the accuracy of the information provided in this publication. Nevertheless, the author assumes no responsibility for any errors and/or omissions.

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This book is dedicated to the state utility regulatory analysts who deal with cost study issues on a regular basis.

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TABLE OF CONTENTS

Chapter I     Introduction

Chapter II     MONOPOLY MARKETS AND REGULATION

Chapter III     HISTORICAL, LEGAL, AND REGULATORY DIRECTION

Chapter IV     REVENUE REQUIREMENT vs COST

Chapter V     COST STUDIES AND REVENUE REQUIREMENT

Chapter VI     EMBEDDED COST STUDY AND RATE SETTING APPLICATION

Chapter VII     UNINTENDED CONSEQUENCES AND ALTERNATIVE THOUGHTS

Bibliography

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ACKNOWLEDGEMENTS

A frequent comment is that writing a book is a team project. There are individuals who were invaluable in the creation of this book.

Commissioner Ken Nickolai, who worked to understand cost studies. He sought more detailed information on cost studies in general and on specific cost studies. His inquiries often explored beyond current cases and to understand how a current proceeding was influenced by past decisions and how a current decision would influence future revenue requirements.  His questions, review, and input assisted in the direction and development of the book.

Commission Nelson Cox, who suggested that the book be written. In spite of his disregard for cost studies, he openly engaged in discussions regarding the fundamentals of costs studies. His questions and support for the writing were instrumental in its development.

Dave Dittemore, with whom I have engaged in rate regulation discussions for years. I am grateful for the time and comments provided on early drafts as well as his ongoing discussions and input throughout the process of developing this book. 

Lisa Taylor and the team at Gnome Writing, who worked to make the book more legible by removing discipline related terminology and industry jargon, and kept the discussion moving.

I would be remiss if I did not acknowledge work of those who have written about cost studies for the last several decades. The ideas presented in this book are not new but a distillation of the work of others.

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Chapter I

Introduction

The citizens of a country consume utilities that are provided by the state. This process of ‘providing’ or ‘provision’ can mean different things in different instances. Whether there is a private company selling a specific service (in the form of a utility) to consumers, or a state-owned company that performs the same service, there are going to be decision-makers involved behind-the-scenes in the process that translates into the provision of that utility for the public.

The utility industries are, in most cases, and have in most traditional cases been, regulated by the government. There are still not many countries around the globe where services like electric power, water and natural gas are open to market competition. For this reason there is a single company in most countries which is responsible for making one of these utilities available to the public.

Yet, no matter to what extent competition may or may not exist in these industries, the government always steps in to regulate the rates at which a particular company provides a utility. The raw material required by the company to make the service available always comes from assets that are owned by the state.

It would not be inaccurate to say that, along with other countries, we are all citizens of the free market. A common goal of the free market system is to signal the cost of providing a specific service.

Among the professional staff and decision-makers at the level of the state, developing rates for utilities is hardly a straightforward process.

There are different tools that these people at the decision-making level use to settle rates for the rate-regulated industries. And the decisions are not pushed without long sessions of hectically mulling over what to choose and what not to choose.

That is where the whole ball of wax of what we call ‘cost studies’ rolls in. The problem starts when a person charged with making an important decision about rates leafs through a stack of papers which carries the study of costs. What he or she sees is technical information that has been compiled after a service has been made possible. And you may guess that in many cases the individual charged with this decision lacks insight into what that stack of papers is saying.

The development of a cost study contains extensive details. The details usually hide important facts, and it doesn’t take too much for misinformation or misunderstanding to become the basis of decisions when either those facts cannot be communicated or cannot be detected.

The process of conducting cost studies has its own difficulties. But a bigger difficulty rises when we attempt to define it. It is easy to mix it up with things like ‘cash requirement.’

Ask anyone who speaks the English language to define the term ‘cost studies’ and they would be able to give you a meaning based on how the two common words are generally used in everyday patter. But is knowing that enough to be able to make a meaningful decision while dealing with controversial rate-setting issues?

In the rate-regulated utility industries, the definition becomes even narrower and tied up with accounting methods. That is another way of saying that instead of walking the road leading from the station, we stay glued at the station.

The exercise of cost studies should be the next step after the mechanism termed as accounting has been completed. The country of cost studies is the country of analytics and not the country of expended finances or past events.

But this is not where the trouble stops. There are decisions, laws and regulations that overshadow the process of conducting cost studies as there are matters of policy which automatically shape those decisions, laws and regulations.

This mix-up between what belongs to the sphere of ‘accounting for costs’ and an actual cost study makes it virtually impossible to appreciate what cost studies stand for, and what kind of message policy-makers could grasp from them. This easily leads policy-makers to ignore decisions which should be influenced