Formula Based Rates

Formula-based rates have long been used for wholesale generation contracts under Federal Energy Regulatory Commission (FERC) jurisdiction. More recently, FERC has approved formula-based rates for Open Access Transmission Tariffs (OATTs) at the request of the transmission owner. This issue briefly focuses on the relatively new use of formula-based rates in retail ratemaking. Formula-based rates set the upcoming year’s rates based on the previous year’s expenses, a predetermined formula derived from the utility company’s costs and a reasonable rate of return. In retail rate setting, two distinct mechanisms have been approved – performance-based formula rates that use a formula to keep a utility’s rate of return within a set performance band and formula-based rates that tie rate increases to an economic index.

How they work

Performance-based formula rates allow a utility to earn a rate of return that falls within a percentage band above or below its approved rate of return, with a sharing mechanism at the top and bottom ends of the band that splits revenue variations outside the band between the shareholders and ratepayers. That band usually is divided in such a manner as to incent the utility to increase efficiencies.

For example, if a utility has been authorized for a 12% return, with a 1% band, then that utility could earn between an 11 and 13% return without adjustment. A sliding scale sharing mechanism would split revenue variations above 13% or below 11% between ratepayers and shareholders.

Example: Formula Based Rates

Example: Formula Based Rates

AEP position

AEP considers formula-based rates based on appropriate mechanisms to be desirable and advocates for them. Currently, we have formula based retail rates in Louisiana and formula based transmission and wholesale generation rates in the PJM and SPP transmission regions.

Issues In Electricity

Issues In Electricity

Formula Based Retail Rates

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