NRRI 00-08 COST ALLOCATION AND RATE DESIGN FOR UNBUNDLED GAS SERVICES


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By Mohammad Harunuzzaman, Ph. D.
Senior Research Specialist

And Sridarshan Koundinya, Ph. D.
Associate

May 2000

About half of the state public utility commissions (PUCs) in the United
States have introduced unbundling of gas services for residential and
commercial customers. Most of these states currently offer pilot choice
programs for a selected sample of small customers for a limited number of
services. A number of states have introduced state-wide unbundling and choice
for all customers, and for a relatively larger menu of services.
The success of the unbundling programs depends critically on the
accompanying regulatory policy choices. Among the policy choices, allocation of
costs for unbundled gas services and designing of end use tariffs have
significant impacts on whether and how much customers benefit from the
unbundling process. Regulators face the twin tasks of facilitating a market for
services that are beiieved to be competitive or potentially competitive, and
adjudicating fair and reasonable rates for the remaining services. To perform
these tasks, regulators are confronted with decisions about which services to
unbundle, how to allocate and separate costs of unbundled services, which
services to deregulate, and how to establish rates for regulated services.
To assist state regulators in developing rate-making policies for
unbundled gas services, this report provides a comprehensive study of these
issues. The report examines considerations that would dictate the identification
of services to be unbundled and identifies services that can be unbundled. It
provides overviews of cost allocation, cost separation, and rate design principles,
and discusses how these principles can be applied to the design of rates for
unbundled gas services. It also provides a comparative evaluation of alternative
cost separation and tariff design options, based on selected criteria of regulatory
objectives. Finally, the report offers recommendations on rate-making policy
options for unbundled gas services.
The study focuses on the application of the principles of cost allocation,
cost separation and end-user tariff design to unbundled gas services. It
discusses how the traditional rate design process needs to be changed to
address the rate design of unbundled services (see Figures ES-1 and ES-2).
The study concludes that no combination of cost separation and end-use
tariff design options can be unambiguously recommended to state regulators.
The reason for this is that no unique combination of options has all the desirable
properties to satisfy most of the regulatory objectives. For example, some
options may be economically efficient but inhibit competition. Also, the public
interest compulsions and preferences of each PUC may be different, and the
desirable set of options for one PUC may be an inferior choice for another. The
study proposes a strategic framework that can help the state regulator evaluate
alternative cost separation and end-use rate design options compatible with
actual conditions and the regulator's policy preferences.

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