Multi-year rate plans are better than traditional ratemaking: Not so fast

Abstract

Utility regulators should ask themselves the basic question: What constitutes good public utility regulation? Regulatory experts generally agree that advancing the public interest is synonymous with high economic efficiency, fairness to all stakeholders, and reasonable regulatory costs. Ratemaking is the basic regulatory tool for achieving those outcomes.One rate mechanism, multiyear rate plans (MRPs), when well-structured and executed, has the ability to perform better than traditional (rate-of-return) ratemaking. Many economists and regulatory practitioners would agree with this assessment. On the other hand, poorly structured MRPs can perform worse. For example, structuring MRP to appease certain stakeholders or for political purposes can compromise its performance to serve the public interest. Regulators also face the inherent problem of having inadequate information to make good decisions, irrespective of the rate mechanism applied.Utilities hoping to get regulatory approval of a proposed MRP can improve their chances by demonstrating that it will enhance the well-being of their customers. The relevant question for regulators is whether an MRP would. The answer is not so apparent, as this essay argues.