Utility services, including electricity, natural gas, water, and sewer, are necessities for commerce and comfort. A community’s ability to meet utility service requirements can facilitate economic development—or its inability to meet those needs can frustrate the realization of those opportunities.
Electric service is provided to greater than 99 percent of American consumers, and other public utility services are also available to meet demands of the great majority of all urban and rural entities. In short, we take the availability of utility services for granted―at least until they become a constraint. Most often, the constraint arises in relation to the pricing of our utility services, but we always expect the lights to come on. The issue itself is simple. Understanding the cost equation is not. Still, with a little insight and some thoughtful planning, you may be able to reduce what your business pays for its utilities.
Facing Down Utility Business Decisions
The array of electric-service options available to commercial enterprises is growing at a dramatic rate. Some technologies are mature, others not. Short-term economics frequently obscure long-term solutions: Pricing can turn on regulatory winds that incorporate a host of social goals (such as renewable portfolio investments, energy-efficiency programs, etc.), but it’s generally based on a cost-recovery foundation. Proprietary and third-party options may trump regulated utility services, but at what price? And can the service risks be managed?
In fact, the issues surrounding your electric service decision form a rather straightforward business question. A determination of the most economic solution for your utility-service needs must address short- and long-term costs, risk assessments of the service alternatives available (that is, the technology that underlies them), and timing. It’s a simple question, but one whose answer requires a complex understanding of usage, utility service markets, and technology.
We’ll return to the basis for evaluating utility service business decisions, but first, a few thoughts on utility-rate regulation.
Utility Rate Regulation
Utility service rates provide the baseline for many economic decisions. Investor-owned utilities (IOUs) serve the great majority of consumers and account for approximately 75 percent of the electric service revenues collected by utilities. Electric cooperatives, which serve only 20 percent of electricity demand, are responsible for approximately half the industry’s transmission and distribution infrastructure. Both must recover the costs of serving customers, but the foundations for that cost recovery are dramatically different for the two utility service providers.
Typically, IOUs are regulated monopolies that are assigned service territories, and they provide services at a regulated cost that seeks to approximate a competitive market solution. To reach this solution, return-on-investment margins are regulated, and cost recovery is allowed only for “used and useful” resources. Utility managers seek to maximize profit for investor-owners, earning a regulated return on investment as well as recovering the costs of asset depreciation and amortization, and operating costs.
Alternatively, an electric cooperative serves its members, and profit (or margins) are returned to its member-owners. The member-owners establish business goals and manage their utility services to meet those goals—goals often related to reliability, cost minimization, economic development, and articulated social goals, such as energy-efficiency incentives, revenue stability, renewable-resource development, economic development, and other desirable infrastructure and service characteristics. The consequence is a utility resource dedicated to serving community desires, not generating a profit for cooperative owners.
Utility Service at What Price? Efficient Rates
Utility rate regulation starts with defining the revenue requirements, then allocating identified revenue requirements to customers. Disputes most commonly arise when revenue requirements are allocated to customer rate classes—and in the design of specific rate mechanisms to recover those costs.
There is no single correct way to allocate revenue responsibility or design specific rate structures to recover those revenues. Efficient rates are desirable; however, there are as many efficient rate designs as there are rate-design analysts asserting their views in a rate case. Effective advocacy in utility-rate proceedings is critical to achieving a favorable outcome for a client, the customers in a rate class, or any other party’s interests.
In the case of an IOU, rate design impacts the regulators’ ability to achieve the quasi-competitive outcome it seeks. As long as assets are allowed to earn a return through the rate base treatment and all relevant costs are recovered in rates, the IOUs profit-maximizing behavior is generally accepted as an effective incentive for utility management decisions.
To be clear, IOUs earn profit from investments in assets (such as utility-owned solar installations), and generally have no economic incentive for customers to develop distributed resources (for example, cogeneration or distributed solar resources) that don’t increase the earnings return on rate base.
However, in the case of an electric cooperative, the broader performance considerations modify the economic equation for achieving the stated goals and objectives of an efficient rate design. For example, a rural co-op that has a large resource extraction facility as a primary customer may legitimately choose to offer lower rates to its large commercial customers, and satisfy its otherwise underrecovered revenue requirement via increased charges to its other residential and small commercial customers. Such a rate design recognizes the social importance of maintaining a viable economic opportunity for the community and the resource extraction sector that fuels it. Similarly, private solar-resource investments by member-owners enhance the capabilities of the cooperative enterprise, although the management of those investments is placed in the hands of a private firm.
Silence is Not a Strategic Option
Advocating for your business with respect to rate design can dramatically impact economic outcomes. Still, it’s not uncommon to find a firm that spends millions (or tens of millions) of dollars on utility costs and has no formal strategy to manage those costs consistent with its short- or long-term business plan. How does such a firm engage an appropriate utility business strategy?
Most businesses simply remain price-takers, responding with a shrug and accepting higher rates as inevitable. An alternate but equally simplistic reaction is to challenge every proposed utility rate increase. But without a well-developed utility service business plan, how can the business know what it wants, when it is successful, or when its advocacy dollars can be better spent on engineering (that is, developing its own efficiency programs, self-generation options, etc.)?
Businesses should weigh the option of public-utility service against alternative costs for service from customer-owned or third-party resources. In many cases the ownership and control of resources provides a business with economic options, but these must be considered in the context of the response from an incumbent utility—which may choose to counter with more competitive offerings.
Developing a Utility Service Business Plan
Step 1: Understand Your Costs and Utility Use
The first hurdle is to understand the utility costs your business is paying, how those costs are impacted by discretionary operational decisions (such as time-of-use utility-service cost differentials, energy-related capital infrastructure, etc.), and potential operational or technological options available.
Step 2: Understand Your Options
Although the future costs of regulated utility service is fairly predictable (determined through formal resource planning submitted to regulators), most large energy users simply react to short-term issues (price increases) rather than formulating a long-term strategic response. The alternatives available to obtain the required utility services become more robust with each passing day. A well-informed, strategic response is becoming increasingly important, since myriad existing and emerging solutions are flooding the marketplace.
Step 3: Formulate a Business Plan
Engineering is important, but developing a business plan extends far beyond understanding your service alternatives. Indeed, your utility business plan should be informed by the engineering solutions you’ve analyzed, but this decision analysis isn’t necessarily performed in a design-build environment in which the planning recommendations lead directly to capital investment. Broad market trends (including technology or environmental policy issues), regulatory constraints, financing, and economic participation alternatives all shape the business decision.
Your business plan is an economic strategy, not a specific engineering solution. A utility business plan can define the analytical parameters to be considered and may be comprehensively scaled to facilitate financing for construction―but its goal, at the core, is to define the process by which alternative plans are evaluated.
Proactive Response: Formulate a Utility Strategy
The utility-related business planning process doesn’t need to be expensive, but the products of strategic planning can provide significant economic benefits—and few CFOs would challenge attempts to reduce operating costs.
Of course, the question becomes: As a consumer, is an investment in distributed resources likely to produce a net economic benefit over a relevant time period? A utility business plan must address this question. Although the analysis conjures up an image of decisions you may think are common only among major industrial consumers, the benefits of the planning process are equally applicable to an investor in commercial office building assets. Anywhere significant utility service cost management benefits are sought, a utility business plan can provide a strategic advantage.
In particular, a business informed by a strategic utility business plan is able to:
- Negotiate a rate design with a utility provider that best addresses the commercial goals of the business
- Participate in strategic utility services management discussions―working from an informed, analytic foundation―when considering partnering with a regulated utility provider or a private third-party resource or undertaking self-funded service alternatives
- Engage in discussion of innovative utility relationships, including those that may create partnerships leading to distributed resource investment and development
- Efficiently plan the development of facilities requiring utility services and anticipate when alternative solutions should be deployed
- Respond to solicitations and requests for participation in utility service–partnering opportunities with incumbent utilities, energy service companies, and independent third-party developers
- Understand the terms under which utility performance contracting can provide economic benefits to the business as well as the risk profile of alternative solutions
We're Here to Help
A utility business plan is a great tool to help answer whether a specific strategy makes economic sense, because it provides a thorough analysis of the opportunities and insights into potential roadblocks.
Because utility business plans require time and financial resources, affiliate your organization with carefully selected partners who will carry out the analysis in an efficient and effective manner. Contact a Moss Adams professional to learn more about what a utility business plan can do for your organization and how you can attain the greatest benefit from conducting one.