Hydro One Networks Stakeholder Session Principles for Defining and Allocating Cost to Density-Based...

Hydro One NetworksStakeholder Session

Principles for Definingand Allocating Cost to

Density-Based Sub-Classes

May 25, 2009

John Todd([email protected])

5/25/2009 Elenchus Research Associates 2

OutlineOutline

1.1. Principles and PrecedentsPrinciples and Precedents Examples of density-based classes Customer class definition principles General ratemaking principles

2.2. Defining Density-Based ClassesDefining Density-Based Classes Status Quo Alternative: “Granular” density-based classes Implications

3.3. Cost Allocation OptionsCost Allocation Options Status Quo Alternative: “Granular” density-based costs Implications

4.4. ConclusionsConclusions


Examples of Density-Based ClassesExamples of Density-Based ClassesCanada: CRTC, High Cost of Serving AreasCanada: CRTC, High Cost of Serving Areas Low-density, remote communities Competitive discipline ineffective Price regulation necessary, subsidization justified

Manitoba: Manitoba Hydro (1980’s)Manitoba: Manitoba Hydro (1980’s) Various usage and regional rates

California: CPUC, Urban/Rural Zones (1950’s)California: CPUC, Urban/Rural Zones (1950’s) “The Staff’s approach gives consideration to the

number of customers, the location of the customers, the number of customers per mile of distribution pole line, area growth pattern, and the history of rates.”

(San Diego Gas & Electric, Decision No. 57509, Oct 1958)


Customer Classification PrinciplesCustomer Classification Principles

Standard Ratemaking TextsStandard Ratemaking Texts Bonbright, Kahn, Phillips are silent on principles and

methods for identifying customer classes. Goodman: “As one commission has noted, ideally

each customer class … should be based on “distinct usage or cost patterns, not on type of building or nature of business.” (p. 1017)

Density as a Source of Economies of Scale:Density as a Source of Economies of Scale: The impact of the “level of traffic, i.e., density” on

capacity costs per unit of costs is recognized as a source of economies of scale. (Goodman, p. 417; Kahn, p. 125).


Relevant Bonbright PrinciplesRelevant Bonbright Principles

Bonbright et al (1988): 10 Attributes of a Sound Bonbright et al (1988): 10 Attributes of a Sound Rate Structure. Most relevant are:Rate Structure. Most relevant are:

4. Static efficiency of the rate classes and rate blocks .. 6. Fairness of the specific rates in the apportionment of

total costs of service … 7. Avoidance of undue discrimination …

OEB identified three rate design principle in OEB identified three rate design principle in Rate Design Review:Rate Design Review:

Full Cost Recovery Principle Fairness Principle Efficiency Principle


Conclusions on Principles (1)Conclusions on Principles (1)

The literature and precedents provide no The literature and precedents provide no guidance regarding the principles that guidance regarding the principles that should be used in addressing the issue of should be used in addressing the issue of establishing density-based rates.establishing density-based rates.

The central question appears to be: Are The central question appears to be: Are urban and rural customers “equals” or urban and rural customers “equals” or “unequals”?“unequals”?

Based on usage, they are equals Based on cost, they are unequals

Should cost differences due to density of customers (economies of scale/intensity of use) be reflected in rates?


Conclusions on Principles (2)Conclusions on Principles (2)

The rationales for density based rates include:The rationales for density based rates include: Competitive issues:

In telecom competitors can “cherry-pick” service areas Electricity customers served by LDCs with different mix of

urban/rural may have their own competitive concerns

Rate comparison issues: Benchmarking may need to consider cost drivers such as

density where LDCs have significantly different mix of customer densities

Neighbouring customers served by different LDCs compare rates which may reflect different customer mix (and intra-class cross-subsidies)

Fairness Principle: “Unequals treated unequally”


Defining Density-based Classes (1)Defining Density-based Classes (1)

Option #1: Areas based on average densityOption #1: Areas based on average density Historic HONI approach Urban Density Zone has 3,000 or more customers

Based on average LDC size at the time (with 312 LDCs) Should this be updated to new average size? Why?

Line density of 60 residential customers/km or more There is no apparent cost basis for this threshold Is there a more meaningful “break point”

“Urban areas” generally extended from a dense core to a “logical” boundary that met minimum threshold

Presumably some UR areas include a mix of urban and rural customers that is consistent with the urban definition


Defining Density-based Classes (2)Defining Density-based Classes (2)

Option #2: Classify customers based on Option #2: Classify customers based on “granular” density“granular” density

Principle: Ensure “equals treated equally” where equals are defined as customers requiring similar distribution infrastructure

Use small geographic areas as basis for determining density Classify areas/customers based on the “granular” density Result would be a more intuitive and consistent urban:rural split This approach would focus on small concentration of customers

(perhaps at the transformer level) This approach may ignore the distance to the backbone of grid

(which may be important to the cost of serving specific customers) Conceptually, an alternative “granular” approach would be to

define areas based on the network configuration (may be inconsistent with postage stamp principle)

Google Maps: Blind RiverGoogle Maps: Blind River



Implications of Redefining ClassesImplications of Redefining Classes

Rural or Remote Rate Protection (RRRP)Rural or Remote Rate Protection (RRRP) The customers benefiting and magnitude of subsidy may change Total value of the RRRP may change

Service Quality indicators (SQI)Service Quality indicators (SQI) Different SQIs apply in urban and rural areas SQI standards may have to be reviewed if composition of urban

and rural regions is changed (e.g., response time; reliability; SAIDI; SAIFI)

Significant effort (costs) will be required Significant effort (costs) will be required

5/25/2009 11Elenchus Research Associates


Cost Allocation OptionsCost Allocation Options

Option #1: Areas based on average densityOption #1: Areas based on average density Current CA Methodology using weighting factors

(presented at the previous stakeholder session)

Option #2: Classify customers based on Option #2: Classify customers based on granular densitygranular density

1. Use plant records for distribution plant serving groups of customers (directly allocate to the sub-classes)

2. Use regression analysis to estimate cost of wires/poles/ transformers to serve different customer classes

3. Sample actual capital and O&M costs incurred to serve customers in “typical” urban and rural areas

4. Use engineering analysis to determine cost differentials


The Significance of Cost FactorsThe Significance of Cost Factors

There are many factors that affect the cost of There are many factors that affect the cost of serving specific groups of customers:serving specific groups of customers:

Density of customers using a feeder Overhead vs. underground Rock/soil conditions Congestion in urban centres

Factors affecting the urban/rural differential:Factors affecting the urban/rural differential: Rural higher: Storm damage; brushing: travel

time; DS under-utilization; etc. Urban higher: Congestion; undergrounding;

SCADA; etc.


ConclusionsConclusions1. The current HONI approach to defining

density-based classes, allocating costs and setting rates is pragmatic rather than principled.

2. A more granular approach to identifying urban and rural customers would improve fairness, would have little impact on efficiency, and might compromise rate stability & simplicity.

3. Adopting a more rigorous cost-based approach to allocating density-based cost will be challenging.


DRAFT


QuestionsQuestions1. Are there any other principles that should

be addressed in the ERA Report?2. Are there other issues that are relevant to

the OEB’s consideration of the matter: Are density-based rates equitable? What is the appropriate way to define density-

based rate classes (e.g., UR; R1; R2)? What is the appropriate way to allocate costs to

density-based rate classes?

3. If the cost (rate) differential increases, should the urban-to-rural cross-subsidy (RRRP) be increased?


Hydro One Networks Stakeholder Session Principles for Defining and Allocating Cost to Density-Based...

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