Ratemaking is the process of determining rates for LDC, pipeline, electric transmission, and electric distribution services. There are four common types of ratemaking:
- Cost-of-service ratemaking: The regulator sets a “reasonable” rate of return on the capital invested by shareholders of the utility and the utility can also recover “reasonable” expenses. Reviews may be done after the fact by the regulator during a reasonableness proceeding. The basis for this form of regulation is the regulatory compact, which ensures mutual benefits and obligations for utilities and customers.
- Performance-based ratemaking: The regulator sets incentives based on future performance or at a fixed rate set ahead of time. The energy company earns a return if they exceed the performance goals.
- Market-based ratemaking: The regulator determines if sufficient competition exists in a market and, if so, project owners are allowed to charge negotiated market-based rates. There is no additional review.
- Administrative ratemaking: A governmental agency or regulator sets rates in consultation with various stakeholders, or cost-of-service rates from a “model” utility are applied to all utilities.
Below is a representation of the steps that might be involved in cost-of-service ratemaking. The complexity and length of this process depends on the utility and the regulator. In certain cases, some of the parties may agree to a "settlement" at some point during this process, which would eliminate the need for some of these steps. The more parties to the settlement, the more likely that it will be expedited through the process.