Riders, Trackers, Surcharges, Pre-Approvals and Decoupling: How Do They Affect the Cost of Equity?

The cost of equity is affected by a number of factors, including shareholders’ risk of not recovering their money, of recovering it later than desired, and of receiving a return less than what they could earn elsewhere on investments of comparable risk.  These shareholder risks flow from traditional ratemaking's central principle:  that just and reasonable rates provide shareholders an opportunity, but not a promise, of earning the authorized return.

This gap between opportunity and guarantee has drawn the attention of legislatures and commissions.  A mix of devices now exists to reduce one or more of these shareholder risks, by allowing utilities to recover specified expenditures with more certainty.  These devices include riders, cost trackers, surcharges, pre-approvals and decoupling.  The first three authorize a utility to collect or refund specified costs (e.g., energy efficiency, renewable purchases, smart grid, nuclear power plants), as they increase or decrease, without filing a general rate case.  Pre-approval occurs when the commission commits, prior to a rate case, not to question the reasonableness of a particular utility action or cost.  Decoupling, in its most common form, insulates fixed cost recovery from sales volumes.  Each of these devices contrasts with traditional regulation, where (a) the commission addresses all expenditures (except perhaps fuel costs) in general rate cases only; and (b) capital expenditures receive approval for recovery only in rate cases filed after the associated asset entered commercial operation.

While these devices can reduce shareholder risk, and thus the cost of equity, the regulatory community is struggling with how to reflect that risk reduction in the authorized return of equity.  This paper sorts out the questions and offers answers.