Efficiency Incentives and Cost Factors in Public Utility Automatic Revenue Adjustment Clauses

Abstract

Historically, productivity advances in the public utility sector have been high, substantially mitigating the impact of inflation on operating costs. However, today's high rates of inflation, coupled with regulatory lag, have resulted in profit erosion which impacts adversely on the utility's ability to attract new investor capital. One possible solution to this problem is the two-way automatic revenue adjustment clause, coupled with an incentive to higher efficiency. Several automatic revenue adjustment clauses, proposed or in operation, are reviewed by the author, with emphasis on the cost and efficiency adjustment clause. If a utility maintains its total productivity at the level of the prior period, this adjustment clause permits half the increase in unit costs to be recovered automatically; the other half may be passed on to the extent the company is able to increase its productivity. The author also suggests several alternative formulas incorporating efficiency incentives.