When considering a rate application, the Board must weigh all the available evidence. As such, the PUB operates on the basis of sound, established regulatory principles in order to come to decisions. There is no single authority that sets regulatory principles, and these principles may conflict or overlap, but it is the goal of the PUB to effectively balance the following principles and consistently take them into consideration when setting utility rates.
Cost of service standard
This principle is at the heart of rate regulation. Under this principle, a utility is permitted to set rates that allow it to recover its costs for regulated operations, including a fair rate of return on its investment devoted to those regulated operations—no more and no less. In most cases, rates are set in anticipation of future costs. If the regulated entity over-recovers those costs, it keeps the excess. If it under-recovers, it bears the cost of the deficiency of its projections.
Under this principle, customers in a given period should only pay the costs that are necessary to provide them with services in that period. They should not have to pay any costs incurred to provide services to customers in any other period. This principle is consistent with setting rates that are just and reasonable. For example, a regulated entity is usually not allowed to earn a return on projects under construction because any costs incurred are incurred in order to provide services to future customers. Instead, the costs are capitalized and recovered through depreciation over the period that the assets are used to provide the service.
This principle requires that a regulated entity’s costs be matched to the period that benefits from the costs being incurred, and should be recovered from customers in that period. In other words, the customers in each period should pay for the costs of providing them with service in that period. The matching principle follows from the cost of service standard and the principle of intergenerational equity. Consistent with the cost of service standard, all of a regulated entity’s costs should be recovered from customers. Consistent with the principle of inter-generational equity, only customers in the period that benefit from the cost being incurred should pay for the cost.
Rate stability and predictability
This principle requires rates to remain stable and predictable, at least to the extent practical. Therefore, the principle may justify smoothing out increases to avoid any sharp rate climbs.
The principle of rate stability and predictability may require costs to be collected from customers in periods other than those for which the costs were incurred. Therefore, the principle is inconsistent with the principle of inter-generational equity. Despite that, it is justified because it recognizes the problems customers can face in adjusting to significant short-term rate fluctuations.
Used or required to be used
Under this principle, customers should only pay for the cost of those assets that are either used or required to be used to provide them with the service. An application of this principle is in the case of a diversified company with both regulated and non-regulated operations. The customers of the regulated operations should not be required to pay for assets used to supply non-regulated services.
Under this principle, customers should be charged only for prudently incurred costs. This recognizes the fact that regulated entities have a responsibility to manage themselves in a prudent manner. This principle is central to the PUB hearing process and the wealth of evidence collected and examined by the Board in its proceedings.
Why we do it
Due to the capital intensive nature of the business, and the inherent difficulty of competition in such a closed market, utilities naturally tend toward monopoly formation, meaning the complete absence of market competition. The PUB regulates public utilities precisely because they constitute a so-called natural monopoly in the marketplace.
The industry demonstrates so-called “economies of scale,” meaning that the costs for the utility in distribution and production decrease as demand increases. In short, the more customers, the cheaper it becomes to serve them. This means that one large firm can provide utility service at a lower cost than two or more firms.
In the absence of a competitive market, prices are not set based on supply and demand pressures but rather on a self-determined reasonable rate of return for the utility, coupled with some outside evidence of what consumers will reasonably pay. Without market competition there is a risk that consumers will pay exorbitant prices for utility service.
In Manitoba, these natural utility monopolies are largely controlled by the government, or the Crown, as state-owned enterprises or Crown Corporations Manitoba Hydro (which includes natural gas subsidiary Centra Gas) and Manitoba Public Insurance. These state-owned enterprises seek only to break-even in their operations.
But while state-owned monopolies do not seek to generate a profit, they may charge unfair or unjust rates in the absence of oversight. Regulation and rate setting is intended to ensure that rates are prudent, just and reasonable, that utility service is reliable and safe, and that a balance is achieved between customer needs and the revenue requirements of the utility and its creditors.