Michigan Rate Case Primer

Do you ever wonder how your monthly energy bill is calculated? Or how to lower your bill? Do you ever wish you had a say in the process? Are you curious about the equity implications of how it’s structured? If you answered yes to any of these questions, keep reading for an introduction to rate cases. We’ll cover the way things are currently, but perhaps more importantly how the process can impact the outcome.

Michigan Utility 101

In Michigan, utilities like DTE and Consumers Energy are investor-owned and regulated by the Michigan Public Service Commission. That means a few things. For both utilities: 

1. They are allowed to make back the costs to provide service to their customers.
2. They are allowed to earn a “reasonable” profit for their investors.
3. The Commission approves, modifies, or denies specifically how much money the utilities get back and can profit, which then filters down to how much each customer must pay. They are the big decision makers. 

The fundamental reasons underlying and justifying this governmental oversight are that the utility supplies an essential service to its customers and the technological and economic features of the industry often mean that a single company can provide the overall need at a lower cost. Essentially, the utility accepts the responsibility to provide to its customers in return for the government setting rates that will pay them back for the costs to serve their customers. Notably, this means that the market is not exactly setting our price for energy in Michigan. Instead, the regulators set the price and they do that in a rate case. 

What is a Rate Case?

A rate case is a legal case conducted by the Commission to determine how much to charge customers through different rates. To figure this out, the rate case answers three questions:

• How big is the overall pie?
  • How much does it cost the utility to safely and reliably give its customers energy?
  • Referred to as “Revenue Requirement”
• How big is each slice of the pie?
  • How much money is needed from each customer group?
  • Referred to as “Cost Allocation”
• How is your individual utility bill determined?
  • How do we collect money from each individual customer?
  • Referred to as “Rate Design”

Three Step Process

We start by finding one number: the total amount of money the utility needs to get us energy plus their profit. This number is called the revenue requirement—which makes sense as it is the revenue required to provide service. The basic formula for the revenue requirement is:

Operating expenses are the costs related to operating and maintaining the utilities' plants and providing the utilities' services, things like fuel, supplies and work related to maintaining power plants, maintaining the poles and wires that distribute power to you, and employee costs. 

Capital investments represent the physical infrastructure costs related to working facilities like power plants, solar panels, and equipment needed to provide service. For those wanting to delve slightly deeper and more technical, capital investments are funded by both debt and equity, typically around 50 percent each, with interest on debt and a rate of return on equity. 

Rate of Return is a percentage that the Commission finds reasonable for the utility to earn a profit. For example, DTE has a 10 percent rate of return. So, if they spend 20 million dollars on capital investments and they make a 10 percent rate of return on the roughly half that is equity, they make one million dollars of profit. ($20 million/2 = $10 million of equity x .10 rate of return = $1 million profit).

Note that only the capital investment portion can earn the utility a profit. Meaning spending money on infrastructure and physical equipment like power plants provides the money-making opportunities. In most other areas of the economy, competition is expected to produce incentives for lowering costs by producers, leading to lower prices for customers. Without that, effectively, the utility business model can incentivize the utility to build and spend more money in order to make more money.  

It’s worth mentioning that energy efficiency programs, which lower energy use and energy bills, can help address affordability. Utilities in Michigan are paid for pursuing higher levels of energy efficiency which can partially, but only partially, counteract this problem.  

Once a utility’s revenue requirement is established, then the Commission determines how to divide the costs among all customers. 

Customers with similar characteristics of energy usage are grouped together and called “customer classes.” There are primarily three classes:

• Residential – You and your family home. 
• Commercial—The businesses big and small businesses that fuel the Michigan economy. 
• Industrial—The really big businesses and industries like Ford, Dow, and Hemlock semiconductor operations.

The general idea is that each class of customers pays the utility’s costs to serve their class. This is the intent. Big debates happen between participants in the case for who should pay more and based on what reasoning. There are many ways to spread the cost across customers that differently emphasize demand, energy, and peak (times when the most energy is needed and used). 

The top number in our equation is how much energy costs and the bottom is all customer energy usage. In theory, as customer usage goes down, so should the cost because you don’t need as much to provide energy. But as we saw above, utilities can be incentivized to spend more money in order to make more money. In any equation where they top number stays the same or increases and the bottom number goes down, we see a larger product. 

Less cost, more use = lower price;     More cost, less use = higher price

An oversimplified example: if last year we all used 50 units of energy and it cost $100 to get customers energy, then the customer cost is $2. If this year everyone reduces the amount of energy they use to only 10 units of energy, but the utility spends more money so they can make more money, say $200, then we’re now stuck paying more, a customer cost of $20. 

Now, the Commission and participants can make the case that the utility didn’t spend money wisely and therefore not allow them to make that money back, but it still begs the question: does this model punish reductions in usage? Alternative models like “performance-based ratemaking” aim to refocus the model to better align performance and profit.

Where the previous step determines how many dollars to collect from each customer class, this step establishes how to collect the dollars from each individual. 

The industry has widely recognized standards and principles for designing rates particularly in an increasingly modernized and dynamic grid. Smart Rate Design for a Smart Future suggests:

• A customer should be able to connect to the grid for no more than the cost of connecting to the grid. 
• Customers should pay for grid services and power supply in proportion to how much they use these services and how much power they consume. 
• Customers who supply power to the grid should be fairly compensated for the full value of the power they supply.

The last point being particularly important for customers with their own home solar installations. 

Michigan rate design is made up of two main pieces:

• A charge for how much energy you use. 
  • “Power Supply Charges” 
  • Goes up when you use more and down when you use less. 
• A charge for delivering that energy to you.
  • “Delivery Charges”
  • Includes a “service charge” which stays the same regardless of how much energy you use. This charge is meant to include things like the cost of the meter, overhead and underground wires services, customer accounting costs, and customer service expenses.
  • Also includes a “distribution charge” for things like maintaining the poles and wires that get the power to you.
  • This charge varies but much less than the supply charges.

Service charges are notable for being one of the few “fixed” pieces that do not change with more or less usage. Huge mansions with high energy usage are paying the same service charge as small apartment complexes. That means it’s incredibly important to only include what is appropriate in this charge: the costs to add a new customer regardless of usage. It also means there are situations particularly for low-income and low-usage customers where this charge makes up a larger percentage and burden that no level of efficiency or conservation can lower. Ensuring that inappropriate costs are not included in this charge is an important component of equity.

It’s also important to note that yes, we’re talking about mathematical equations, but the inputs for those equations are equal parts art to science. If your customer class does not have adequate representation with direct input from affected communities in these cases, you may be losing ground against those who do and see costs shift between classes.

How is a Rate Case Done?

Because a rate case is partially a legal proceeding, that means there are lawyers, expert witnesses, and (administrative law) judges. The utility files an application which is essentially a proposed plan with reasons and evidence for needing to adjust rates and then other parties can intervene into the case to review, evaluate, support, or critique the plan. It is the utility that has the burden to prove that the amounts it is seeking to recover in rates are needed, reasonable, and prudent. Each step is publicly documented on the MPSC website under the case number. 

In Michigan, a utility can file a rate case no more than once every 12 months and by statute they must be completed within ten months. Within those ten months, 

Again, if you do not have the resources and representation in these cases or if you haven’t been able to provide input in any manner, then you have no power in big decisions that impact how much money you are paying every month on energy. You can follow along with the cases online, watch Commissioner meetings on YouTube, or head over to the Commission office in Lansing, but it still begs the question how inclusive in the process? Some people don’t have internet access or the ability to travel to Lansing, and those may be the same people who will be most impacted by these decisions. 

Having a Voice in Rate Cases

The Commission needs to hear from you. We must gather more input in these cases--that's a collective we: the Commission, utilities, and participating organizations like NRDC. Part of that means bringing more information and transparency to the space, so that customers better understand the process. The other part is making sure there are plenty of ways to have meaningful dialogue and input into these important cases.  Here are some ways you can get involved: 

• Attend trainings about the MPSC and Michigan energy cases 
• Engage with Commission staff (one-on-one meetings/calls, there is also a low-income energy efficiency workgroup open to the public)
• Engagement with utilities directly (public hearings, meetings, calls, etc.)
• Help build public awareness via media (letters to editors, opinion pieces, press conferences), social media, blogs, etc. 
• Submit public comments supporting or opposing certain topics
• Share ideas and perspectives with groups that typically intervene 
• Direct legal intervention or co-intervention.

This is the second in a series of blogs aimed making the Michigan Public Service Commission and the decisions that take place there more accessible. In the Michigan Public Service Commission Primer blog, we learned about who the Michigan Public Service Commission is and what they do.