Incentive Regulation For Gas Utilities

February 21, 2008

Enbridge Gas Distribution and Union Gas are on the verge of implementing a new approach to setting distribution rates for their customers, for the period 2008 to 2012. The new approach is known as "incentive rate-making." Industry experts believe incentive rate-making will encourage new levels of efficiency by the utilities, lowering costs for customers and potentially reducing the administrative cost of regulating the utilities during the five years of the plan. The new approach also brings a level of improved predictability to rates.

Incentive rate-making differs from the "cost of service" approach to setting rates that has been used to date. Under cost of service regulation, the regulator sets rates to recover the costs the utility is forecast to incur for a period of time, usually a year. In contrast, incentive rate-making adjusts rates for each year of a longer period according to a formula that incorporates inflation and productivity factors. The utility must manage its costs within the revenue generated by these rates without compromising quality of service to customers.

In 2007, the gas utilities each filed applications with the Ontario Energy Board (OEB) in which they proposed their incentive rate-making plans for their respective companies. Typically with any rate application to the regulator, not all interested parties agree with all aspects of a utility's rate proposals. As a result, the OEB requires that the utilities and stakeholders (including ratepayer representatives) hold discussions to attempt to reach an agreement on the details of the utility's rate proposals.

In the current cases, these discussions have been completed with agreements having been reached on most aspects of the incentive rate-making plans. The agreements have been presented to and approved by the OEB.

The details of each plan differ between the utilities, but the basic concepts are the same. The Union Gas plan is called a "price cap", and the Enbridge plan is a "revenue per customer cap".

The main idea behind these incentive mechanisms is that a specified base revenue component used to determine rates is increased (or decreased) each year by a percentage that reflects a predetermined measure of inflation less a factor for productivity gains the utility is expected to achieve. The component subject to adjustment is tied to the portion of distribution rates that covers costs which the utility can control.

This result is then further adjusted for routine elements of the utility's rates that are beyond the utility's control, such as the commodity cost of gas or the rates charged by pipelines for getting gas to the utility's franchise area.  There are also adjustments for any non-routine items beyond the utility's control. Once all of these adjustments have been made, distribution rates for each rate group for the year in question are developed. All steps in the process and the resulting rates are subject to review by stakeholders and the regulator, and must be approved by the OEB.

Aegent will provide updates on the implementation of the new approach to distribution rates.