Administrative ratemaking is an alternative to cost-of-service ratemaking in which a government agency determines rates rather than setting them in a regulatory proceeding like a rate case. In some cases of administrative ratemaking, rates are set by a government ministry in consultation with various stakeholders such as the utility, large industry users, and key government officials. This results in an untransparent process.
An alternate method with more transparency uses the “model utility” concept. In this case, rates are set based on a calculation of what rates would be for an efficient utility. This may be an actual utility that the regulators have chosen or a theoretical model utility. Here is an example used in Chile to set rates for electric distribution utilities:
Rate = Energy cost (pass-through) + Transmission fee (pass-through) + Distribution rate
The distribution rate is set based on a theoretical model utility:
- Distribution companies are grouped into "typical areas" based on service territory characteristics (density, geography, average demand, characteristics of distribution lines, etc.).
- The regulator builds a theorectical "model company" for each typical area based on information provided by distribution companies. A model company is the "ideal company" required to provide efficient service.
- The New Replacement Value of a distribution system (lines, transformers, substations, etc.) to provide model service is calculated.
- Reasonable administrative and O&M expenses are factored into the model.
- Acceptable energy losses are included in cost calculations.
- Distribution revenue is calculated to cover expenses, energy losses, and a reasonable return on the New Replacement Value.
- Total revenue required is divided by the prior year's actual usage to determine the distribution rate.
- Rates are adjusted monthly based on an inflation index.