Future Test Years
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.
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 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.
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)
- Formula based rates
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