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Arvid Kruze, B Eng, MBA
International Power Sector Consultant

Financial and Economic Analyses
Electricity Tariffs
Team Leader / Project Manager

Montreal, Quebec, Canada
+1 (514) 484-8050
info@arvidkruze.com

Electricity Cost of Service Studies

My site gets a fair amount of hits from people looking for cost of service studies. I feel I should oblige them with something useful, so here is my attempt at doing so. It would be interesting to get feedback.

Information on specific cost of service (COS) studies is generally available on the internet, as such studies are often filed with regulatory authorities and are then available for public scrutiny. The trouble with these actual studies is that they are very specific, too complex to follow and often deal with issues that may not be relevant to someone simply trying to understand the basic process in undertaking a COS analysis.

So, here is an Excel based simple COS model, broken down into 8 basic tables. The 8 tabs are followed by the design of illustrative cost-based tariffs using marginal cost pricing principles (however, the derivation of the marginal costs is not explained; I address that under another Topic). Also, here is a corresponding COS write-up that explains what is going on.

For more detailed information on cost of service studies, the Electric Utility Cost Allocation Manual, published by the National Association of Regulatory Utility Commissioners (USA), is quite good. This was first published in 1969. At one time, I had a copy of this famous Green Book, but lost it. The book was revamped in 1992 and is still available from NARUC. However, it is not as good as the 1969 version, mainly because it contains rather not-so-useful info on Marginal Cost Studies, which were not part of the 1969 version.

Just a few notes:

1.  The original study was undertaken for a Russian Energo , or electricity/ heat supply public utility, in the early 2000s as part of a pilot technical assistance project that was attempting to show certain Russian utilities and regulators how Energos can operate as commercially viable entities. That is why the analysis is carried out in Russian Rubles. Names and numbers have been changed to reflect the generic nature of this exercise. Sadly, the work was never adopted by anyone in Russia. In fact, it was probably all dismissed after only a passing glance. I have selected it only because of its simplicity.

2.  Such a simple analysis is possible only when data are not available and/or the regulatory system is not very well developed or oriented towards tariff development. On the other hand, this allows a novice to easier follow the steps of the analysis. With better information, there is added complexity and more issues to address regarding cost causality. As a consequence, COS studies typically comprise many, many, many more tables, sub-tables and qualifying notes. But that is the way these things work; i.e., start with a relatively simple analysis in order to get the basic concepts right, and then increase the complexity as better information becomes available.

3.  In the example, the profit or return to the Energo is allocated to customer categories in an unconventional manner, but which is consistent with the prevailing (2000) regulatory environment in Russia. The rationale is explained in text. I bring this up only because it is not the preferred allocation basis for profit, just in case anyone draws the conclusion that this is my view of how this particular allocation should be performed.

4.  The tariff design tables (i.e., following the first 8 tables) are not described in the accompanying text; however, the calculations are relatively easy to follow. This particular tariff design, which is a little simplistic, is based on the short-run marginal cost (SRMC) of energy, which itself requires a somewhat detailed analysis (but often not). Given the SRMC, the tariff design methodology is quite simple; i.e., set the energy rate at the SRMC, with the balance of the revenue requirement for the category collected from the fixed customer charge or the demand charge, as the case may be. Regarding the actual estimates of SRMC, these are a given in this exercise. I can provide a rather lengthy discourse on the value of employing long-run marginal cost (LRMC) and SRMC in electricity tariff design, but that is another topic.

Finally, I should note that the spreadsheet and write-up are mainly intended to explain certain major concepts in undertaking COS studies. The calculations are streamlined only because usable detailed data were simply not there at the time (which is typical of the former Soviet Union area). Happily, this has paved the way for some rather simplistic assumptions and allocations to be made, with the consequence that we have an 8-table cost of service study!