Future Test Years

The issue

The goal of rate-setting is to predict operating results during the period for which rates are being set – accurately estimating both expenses and revenues.

Electricity demand is projected to increase by 28% from 2011 to 2040 . New infrastructure will be needed to keep pace with this growing rate of demand. The use of future test years allows utilities to work with commissions on long range resource planning, while pre-approvals afford utilities the certainty to make large capital investments

Future Growth

State utility commissions typically use the concept of a “test year” – a consecutive 12-month period deemed to be a representative year for a utility in terms of costs and revenues relative to the year that rates will be in effect. A future test year uses projections and utility resource planning to derive forward-looking revenue requirements in rate setting.

How they work

A test year may be based on an historic test year, with adjustments made to account for changes in utility spending and load that are known and measurable and reflective of the rate year. Most jurisdictions with historic test years allow adjustments up to 12 months beyond the test year. Alternatively, a future test year may be entirely forecasted based on utility planning and budgeting.

Because historic test years may not accurately reflect future expenditures, utilizing future test years can capture planned expenditures, such as smart meter deployments or increased energy efficiency expenditures, reducing regulatory lag and the need for more frequent rate cases.

In some jurisdictions, the use of future test years involves longer range economic projections and utility planning. In Georgia, a three-year budget for operations and maintenance, capital investment, and energy is determined in a contested rate case. The state utility commission then approves a revenue requirement based on the three-year budget. Annual reports are filed after the first and second year of the three year plan to compare actual versus budgeted expenditure and ensure customers are not paying for expenditures that did not occur. A rider may be used in conjunction with this multi-year rate plan to track new capital investment.

AEP position

AEP supports the concept of future test years.

Past expenditures and historic financial trends are vastly different from those facing us in the future. To rely on historic expenditures in an era in need of large infrastructure investment simply slows the process of actual cost recovery.

Regulatory pre-approval

Having some type of regulatory pre-approval for cost recovery is becoming a necessity before many utilities will undertake new, capital intensive projects. When utilities request that a state commission determine prudency and commit to recovery principles prior to project construction, this reduces the uncertainty of cost recovery and often reduces cost for customers.

Pre-approval has increased in popularity among utilities for several reasons. Poor economic conditions, rising capital costs, and increased electricity demand have all but made certainty of recovery a necessity for utility companies.

There are many factors that must be considered before a commission grants pre-approval for a project. Chief among these considerations is that the project being pursued is needed and a prudent choice. Other issues include how costs will be recovered through rates and if this collection will occur contemporaneously with expenditures or once the project has been completed.

Examples of pre-approval mechanisms

  • Construction work in progress (CWIP)
  • Trackers/riders
  • Formula based rates
  • Securitization

Effect on Consumer Rates

When granting pre-approval, commissions often consider how customer rates will be affected. Among the things they may look at are:
  • Avoiding rate shock by gradually introducing rate increases
  • Ensuring consistency between the generation paying for the benefit and the generation receiving the benefit
  • Providing accurate pricing signals to promote efficiency

Issues In Electricity

Issues In Electricity

Future Test Years

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