182 Utility Costs

Utilities perform their activities in a manner similar to that of any other privately-owned company. The utility obtains a large portion of its capital in the competitive money market to build its system. It sells a service to the public. It must generate enough revenues to cover its operating expenses and some profit to stay in business and to attract capital for future expansions of its system.

In general there are two broad types of costs incurred by a utility in providing its service. First, there are the fixed capital costs associated with the investment in the facilities needed to produce (or purchase) and deliver the service. Some of the expenses associated with fixed capital costs include interest on debts, depreciation, insurance, and taxes. Second, there are the expenses associated with the operation and maintenance of those same facilities. These expenses include such things as salaries and benefits, spare parts, and the purchasing, handling, preparing, and transporting of energy resources. The rates paid by utility customers are designed to generate the necessary revenues to recover both types of costs. Both capital and operation and maintenance costs are allocated between the major cost elements incurred by a utility.

18.2.1 Cost Components

The major costs to a utility can be separated into three components. These include customer costs, energy/ commodity costs, and demand costs. These cost components are briefly described below.

Customer Costs

Customer costs are those costs incurred in the connection between customer and utility. They vary with the number of customers, not with the amount of use by the customer. These costs include the operating and capital costs associated with metering (original cost and on-going meter-reading costs), billing, and maintenance of service connections.

Energy/Commodity Costs

Energy and commodity costs consist of costs that vary with changes in consumption of kilowatt-hours (kWh) of electricity or of cubic feet of gas. These are the capital and operating costs that change only with the consumption of energy, such as fuel costs and production supplies. They are not affected by the number of customers or overall system demand.

Demand Costs

Electric utilities must be able to meet the peak demand—the period when the greatest number of customers are simultaneously using service. Gas utilities must be responsive to daily or hourly peak use of gas. In either case, the utility will need to generate or purchase enough power to cover its firm customers' needs at all times. Demand-related costs are dependent upon overall system requirements. Demand costs can be allocated in many different ways, but utilities tend to allocate on-peak load. Included in these costs are the capital and operating costs for production, transmission, and storage (in the case of gas utilities) that vary with demand requirements.

18.2.2 Allocation of Costs

Once all costs are identified, the utility must decide how to allocate these costs to its various customer classes. How much of each cost component is directly attributable to serving a residential, a lighting, or a manufacturing customer? In answer to this question, each utility performs a cost-of-service study to devise a set of allocation factors that will allow them to equitably divide these costs to the various users. After the costs are allocated, the utility devises a rate structure designed to collect sufficient revenue to cover all its costs, plus a fair rate of return (currently, this is running between 10 and 14% of the owners' equity.)

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