1

Overview of Allocating Revenue

Requirements

Based on Shares of Marginal Costs

May, 2012

2

Review Panel and Marginal Cost Allocation Ordinance 123256 (March 2010)

Established Review Panel, defined role …assess City Light's implementation of marginal cost

allocation among customer classes to ensure that it provides a fair allocation of costs among customer classes and takes account of changes in costs and consumption.

Resolution 31351 (May 2012) Policy framework for City Light rate setting objectives,

rate design policies and marginal cost allocation among customer classes.

3

Why City Light Uses Marginal Costs/Prices

Economic theory = social welfare maximization (best way to allocate society’s resources) Customers will consume to the point where marginal value

to them = their marginal price If not worth the price to the consumer, society is better off

by not consuming

Encourages energy conservation Customers will not consume more that it is worth to them

on the margin (i.e., at the marginal price) Rates can be structured to reflect marginal cost (i.e., the

marginal price), but… Average rate paid by class = average cost for class

4

Marginal Cost at City Light

Revenue Requirement: total $ City Light needs from customers.

Marginal cost allocation is a method of assigning a portion of the revenue requirement to each customer class

The results of calculating marginal costs are percentages (“marginal cost shares”)

Example: Class x is responsible for 10% of the marginal energy cost. Class x will be assigned 10% of the revenue requirement related to energy.

Rates: • City Light does NOT charge customers the marginal costs.• Average rates by customer class come from the revenue requirement.• Price signals in rates can reflect marginal costs.

5

Categories of Marginal CostsCategory Sources of data

Marginal Energy Cost ($/MWh by time period)

Market price forecasts +Environmental externality cost +Transmission cost

Distribution ($/peak MW)

Current replacement costs per MW of capacity

Customer Service($/meter)

Accounting cost data for customer services divided by # of meters

6

More on Marginal Cost Data Sources:Marginal Cost of Energy ($/MWh)

3rd-party Mid-Columbia price forecasts by HLH and LLH: Ventyx, Kiodex prices (e.g., $31.01)

+ Cost of environmental externalities--CO2 emitted when energy is generated: IRP research (e.g., $5.07)(e.g., American Wind Energy Association, EPA, U.S. Forest Service, Dept of Energy, National Renewable Energy Lab)

+ Long-distance transmission cost: BPA transmission price (e.g., $4.42)

Total Marginal Cost of Energy: $40.50/MWh

7

Example: Forecasts of Market Prices, $ / MWh

HLH Prices CURRENT YEAR PRICES Based on monthly CPI estimates Annual

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Averge

2013 30.72 29.23 27.80 22.42 21.39 20.51 35.30 38.65 36.60 34.55 36.39 38.61 31.01

2014 37.24 35.00 32.91 27.12 26.37 25.78 35.82 38.05 34.38 34.76 34.90 36.58 33.24

2015 35.79 35.82 31.84 28.76 28.87 29.15 39.20 40.14 34.96 37.28 37.25 38.16 34.77

2016 37.81 37.45 35.23 31.81 31.91 32.21 43.29 44.32 38.59 41.13 41.08 42.07 38.07

2017 41.68 41.27 38.81 35.04 35.13 35.45 47.63 48.74 42.42 45.19 45.12 46.19 41.89

2018 45.74 45.27 42.56 38.40 38.49 38.83 52.15 53.34 46.41 49.43 49.34 50.49 45.87

LLH Prices CURRENT YEAR PRICES Based on monthly CPI estimates Annual

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Averge

2013 27.69 25.63 22.67 11.56 10.78 9.81 21.55 26.21 27.16 29.19 30.64 32.55 22.95

2014 34.23 31.18 26.96 17.18 15.05 14.80 24.99 29.68 27.88 31.55 30.95 33.38 26.49

2015 30.78 30.67 25.33 23.95 20.64 21.72 30.74 35.19 30.06 35.07 33.42 36.30 29.49

2016 33.78 34.06 28.03 26.49 22.81 24.00 33.95 38.85 33.17 38.69 36.86 40.02 32.56

2017 37.25 37.54 30.88 29.17 25.12 26.41 37.35 42.73 36.47 42.51 40.48 43.94 35.82

2018 40.87 41.17 33.86 31.98 27.52 28.93 40.90 46.76 39.90 46.50 44.26 48.03 39.22

8

Example: Annual Environmental Externality Costs

($/MWh in 2011$)

Year2012 $4.592013 $5.072014 $5.532015 $5.962016 $6.382017 $6.772018 $8.142019 $8.822020 $9.472021 $9.972022 $10.442023 $10.882024 $11.292025 $11.672026 $12.012027 $12.332028 $12.612029 $12.862030 $13.08

Environmental Externality Cost, 2011$/MWH

$0.00

$2.00

$4.00

$6.00

$8.00

$10.00

$12.00

$14.00

9

HLH Prices WITH Externalities, $ / MWH

15

20

25

30

35

40

45

50

1 2 3 4 5 6 7 8 9 10 11 12

2013

2014

Example: Market Price Forecast with Environmental Externality Price

10

More on Marginal Cost Data Sources:Marginal Cost of Distribution ($/MW) Capital:

In-service area transmission: SCL engineers-recent cost experience with line replacement (e.g., $80,000)

Substations: SCL engineers-recent cost experience (e.g., Denny substation estimate) (e.g., $110,000)

Distribution wires and related equipment: SCL engineers-recent cost experience (e.g., $200,000)

Meters: Recent SCL meter purchase costs-12 types (e.g., $100/meter but $10,000/MW)

O&M: recent costs from in FERC accounts (e.g., $18,000)

Total Marginal Cost of Distribution: $418,000/MW

11

More on Marginal Cost Data Sources:Marginal Cost of Customer Service ($/meter) O&M: recent costs recorded in FERC accounts

Meter reading costs (e.g., $20) Costs of uncollectibles (e.g., $2) Customer records and collections costs (e.g., $78)

Billing and account maintenance Credit and collections Customer engineering Account executives (large customers) Customer assistance (small customers)

Total Marginal Customer Cost: $100/meter

12

Marginal Costs

Residential Non-ResidentialEnergy $/MWH 40.50$ 37.60$ Distribution $/Pk MW 418,000$ 487,000$ Customer Svc $/Meter 100$ 150$

13

Simple Example of Allocating Revenue Requirements Using

Marginal Cost Shares

Step 1: Forecast consumption inputs by customer classStep 2: Multiply inputs by marginal costs by functionStep 3: Calculate marginal cost shares (percentages)Step 4: Separate Revenue Requirements into functionsStep 5: Allocate RR functions by marginal cost sharesStep 6: Calculate average rate by customer class

14

Step 1: Consumption Inputs--Forecasts of Load, Peak MW, & Meters

System Residential Non-Residential

Load, MWH 9,800,000 3,100,000 6,700,000 Peak MW 1,380 590 790 Meters 406,000 357,000 49,000

15

Step 2: Consumption Inputs x Marginal Costs

Slide 12 x Slide 14

Example: Residential

$40.50/MWh x 3.1 M MWh = $126 M (Energy)

$418,000 x 590 MW = $246 M (Distribution)

$100 x 357,000 meters = $36 M (Customer Svc)

Total = $408 M

(Million $) System Residential Non-ResidentialEnergy 378$ 126$ 252$ Distribution 631$ 246$ 385$ Customer Svc 43$ 36$ 7$ Total 1,052$ 408$ 644$

16

Step 3: Shares of Marginal Costs

From Slide 15

Example: Residential$126/$378 = 33% (Energy)$246/$631 = 39% (Distribution)$36/$43 = 84% (Customer Svc)$408/$1,052 = 39% (Total)

System Residential Non-ResidentialEnergy 100% 33% 67%Distribution 100% 39% 61%Customer Svc 100% 84% 16%Total 100% 39% 61%

17

Step 4 : Revenue Requirements

Million $

(1) Energy 460 (2) Distribution 280 (3) Customer Services 60 (4) Low Income Assistance 10

(5) Total Operating Costs 810

Less

(6) Net Wholesale Revenue (100)

(7) Net Revenue Requirements 710

18

Step 5: Allocation of Revenue Requirement

Slide 16 x Slide 17 (e.g., Residential Energy: 33% of $460 M = $153 M)

(Million $) System Residential Non-ResidentialEnergy 460$ 153$ 307$ Distribution 280$ 109$ 171$ Customer Svc 60$ 50$ 10$ Subtotal 800$ 312$ 488$ Share of Subtotal 100% 39% 61%

Low-Income 10$ 4$ 6$ Net Wholesale Rev (100)$ (39)$ (61)$ Total 710$ 277$ 433$

19

Step 6: Average RatesSlide 18 / Slide 14

System Residential Non-ResidentialTotal Rev Req ($M) 710$ 277$ 433$ Load (MWh) 9,800,000 3,100,000 6,700,000

Avg. Rate ¢/kWh 7.2 8.9 6.5

Example: Residential

$277,000,000 / 3,100,000,000 kWh = 8.9 ¢/kWh

20

Some cost allocation issues from customers

Low-Income Cost All customer classes (current policy) Residential only

Conservation Cost All customer classes (current policy) According to $ spent on specific classes

Net Wholesale Revenue Credit By shares of all other costs (current policy) By shares of energy costs