Designing Utility Rates


In determining utility rates, regulators first allocate the utility’s total approved costs. They divide these costs among the customer classes: residential, commercial, and industrial. If costs are not appropriately assigned, at least one kind of customer will have to pay more than its fair share. Next, regulators develop a pricing structure to determine customers’ bills. Typically, rate design for residential customers results in a modest monthly fixed customer charge and a rate for each unit of usage. In a tiered or inclining block rate structure, the usage rate increases with greater consumption in each pre-determined tier or block, for example, 0-500 kWh is charged at one per kWh rate and 501-1000 kWh of usage is charged at a higher rate, and so on. In some states, utilities have proposed changes that will significantly increase fixed monthly charges while reducing usage-based fees.

Examples of these new rate designs include the following:    

  • high fixed charges—utilities increasingly are seeking to recover more of their costs through fixed customer charges that all users pay, while deemphasizing charges that vary based on usage (known as “volumetric charges”). To the extent that this occurs, it shifts the burden of paying for these costs away from customers who use more electricity or gas and toward those who use less. Straight fixed-variable rate design rates allow utilities to recover nearly all fixed costs through fixed monthly charges, having the effect of substantially increasing the monthly fixed fees while lowering usage charges.
  • demand charges—few utilities today impose demand charges on residential customers. But more and more are considering them. A demand charge is typically based on the highest average usage within a given month over a specified period. Using a lot of power over a short period results in a higher demand charge than steady usage does. The theory is demand charges create an incentive to reduce peak usage. However, it is difficult for residential consumers to both understand and control their peak usage. They cannot, for example, stop their refrigerator or air-conditioner from cycling on at the same time other appliances are in use. In addition, their peak usage period may not be the same as the utility’s peak.
  • trackers—another trend in rate design involves the use of new cost-recovery surcharges or trackers. Trackers adjust rates between rate cases based on actual increases or decreases in certain utility costs. The danger they pose for consumers is that such adjustments tend to limit regulators’ ability to scrutinize and evaluate costs. This design also may lessen the utility’s incentive to control its costs between rate cases.
  • decoupling (see also this chapter’s section Energy Efficiency Programs).
  • time-variant rates (see also this chapter’s section Time-Varying Rates and Demand Response).



Equitable allocation of costs

Regulators should assign system costs appropriately to customer classes. This should be consistent with universal service and affordability goals. Costs should not be unfairly shifted to residential customers.

Equitable rate structures

Regulators should ensure that residential rate design minimizes flat, fixed charges and fees.

They should not adopt high fixed charges, straight fixed-variable rate design, or demand charges for residential customers.