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Efforts to streamline the regulatory process for natural gas utilities are enabling those organizations to more efficiently address distribution system needs, along with a lowering of administrative costs due, in large part, to a less litigious and time-consuming regulatory and ratemaking process.

Together with the increased acceptance of revenue decoupling and other similar ratemaking mechanisms, such concepts have enabled some gas utilities to extend the time between rate cases, according to Black & Veatch’s 2014 Strategic Directions: U.S. Natural Gas Industry report. At the time of the survey, there had been a slight decline in the number of rate cases filed compared to previous years.

In the report, participants representing local distribution companies (LDCs) were asked to identify the top regulatory practices they believe would be most helpful in improving the efficiency of utility regulation. Formula rates were ranked highest by respondents because of the comprehensive nature of this regulatory practice. Respondents also said formula rates would best mitigate the continuing problem of regulatory lag – that is, the delay between the time a utility incurs costs and when it can recover those costs through rates.

Russell Feingold, head of the Financial and Regulatory Services practice in Black & Veatch’smanagement consulting business, said one regulatory practice that has gained widespread acceptance is the use of capital cost recovery trackers for LDCs. A cost tracker allows a utility to recover its actual investment costs from customers in the periods between rate cases. More than half of all state regulatory commissions in the U.S. have now approved capital cost recovery trackers for LDCs, up from the 21 states the previous year. In fact, slightly more than half of the survey respondents stated their organization has an approved capital tracker in place.

Source: Black & Veatch
Survey participants representing LDCs were asked if their organization has an approved capital cost recovery tracker or an accelerated infrastructure cost recovery mechanism to recover the cost of distribution pipeline replacements.

Feingold said capital trackers are beneficial because they address the cost elements associated with modernizing existing distribution infrastructure. These ratemaking mechanisms enable LDCs to recover their infrastructure costs on a full and timely basis while customers are provided with natural gas delivered on a safe and reliable basis.

“Utilities with cost recovery trackers are often required to file comprehensive plans that demonstrate the utility’s intended investments will deliver the most value for customers,” Feingold said. “These plans, which typically are updated and refiled every year, provide greater levels of detail and specificity into the utility’s investment decisions because of the reflected longer time horizons.”

Perceived Imbalance in the Regulatory Compact

The ability to recover costs and earn a reasonable rate of return on investment often pits the interests of utility shareholders directly against the interests of consumers who are impacted by increased rates. It is the responsibility of the state regulators to balance these competing needs.

“Many regulators continue to move cautiously on cost recovery and rate requests by utilities as a result of challenging economic conditions that still linger across much of the United States,” Feingold said. “The cautious approach by regulators often conflicts with an industry that is ready to build, invest and grow.”

Despite the wider acceptance of regulatory practices that streamline the ratemaking process – as evidenced by the increased use of capital trackers – respondents indicated that the utilities’ interests are favored much less by the regulator than those of the consumer.

“It is quite conceivable that such perceptions by LDC respondents are being influenced by various regulatory considerations,” Feingold said. “These could include the pressure to settle rate cases, the strong focus on demonstrating tangible customer benefits when proposing innovative ratemaking approaches and the increased desire by regulators to moderate increases in utility rates.”

While the number of participants believing that a “well balanced” result is being achieved by regulators has dropped 13 points from two years ago, Feingold said it was also worth noting that a large portion – 44 percent – of the LDC respondents indicated that they did not know the extent to which the regulatory compact is fairly balanced between utility stakeholders and customers.

“This suggests that LDCs are less able today to assess where regulators are coming out on this balancing of interests,” Feingold noted. “That large percentage may be due to the recent decline in the number of rate cases being litigated, or that a greater portion of them are being settled, which does not require the regulator to make the same types of definitive rulings as when a rate case is fully litigated.”

The Regulatory Environment for Pipelines

The recently announced joint pipeline project of Duke Energy, Piedmont Natural Gas and Dominion Resources reflects the desire of LDCs in the Southeast U.S. to benefit from the availability and security of Marcellus shale gas. However, the long-haul pipeline transportation services under long-term contracts signed by many LDCs in years past cannot simply be terminated.

“LDCs must carefully plan how their gas supply portfolios will accommodate these types of changes over time,” Feingold said. “Regulators want to be confident that the LDCs’ resulting gas supply portfolios can meet their projected gas demands, are flexible and diversified, and can minimize gas costs to customers without compromising reliability.”

Source: Black & Veatch
Survey participants representing LDCs were asked to select the top three regulatory practices they believe would be most helpful in improving the quality and efficiency of utility regulation and the ability to generate satisfactory earnings

He noted that LDCs located at the end of interstate pipelines have a particular incentive to secure local gas supply sources and offload some of their unused long-haul pipeline capacity. This has a ripple effect down the pipeline.

“For example, when the New England LDCs who pay the most for pipeline transportation service as the furthest customer reduce their gas volumes by acquiring additional gas volumes from new supply sources closer to the market, the question remains, which shippers will pick up the pipeline’s lost revenues?”

In its goal to treat revenue as a zero sum game, the costs not recovered by the pipeline from long-haul customers with reduced transportation requirements must be built into the rates of the short-haul customers. “As you can image, this often creates a contentious regulatory situation with elongated time frames to complete the necessary rate proceedings,” Feingold said.

A Look at the Future

With many of the ratemaking mechanisms now in place for a growing number of LDCs, the future focus will be on performance and whether these innovative ratemaking approaches have worked as intended.

“With the increased implementation of capital trackers, there may be fewer rate cases filed by LDCs in the next few years, with smaller rate increase requests,” Feingold said. “I think we’ll also see regulatory lag and earnings attrition addressed through greater adoption of regulatory practices such as a future test year concept, step rate adjustments and rate cases with multiyear test periods.

Overall, utility performance will take on an increasingly important role in rate cases and other regulatory proceedings.

“The focus on performance will be to achieve greater utility efficiencies in an effort to mitigate upward pressure on rates,” Feingold said. “Possibly in the future we’ll see moves by either regulators or utilities to Performance-Based Regulation (PBR) plans in some states.”

Published originally on Black & Veatch Solutions.