COSA FAQs

How a cost-of-service analysis provides a basis for equity between customer classes

PNGC Power provides member utilities with cost-of-service analysis (COSA) as part of their benefits. The high quality of PNGC Power’s COSA studies has been validated this past year by Cooperative Finance Corporation (CFC) and by a comparative evaluation with other commercial COSAs. Following is an interview with Mary Wiedl, PNGC Power’s Senior Engineering Analyst, on the value to utility cooperatives of the cost-of-service analysis.

Q: What is a cost-of-service analysis?

A: Wiedl: “It’s an analysis of existing data that answers questions for cooperative utilities that relate to ensuring equity between rate classes. Because I have been working on these exclusively for PNGC Power member-owner utilities for the past 10 years, when I’m working with a cooperative, it quickly becomes clear what’s routine – and what isn’t – in the end product of a cost-of-service analysis. A COSA tells about the relative equity of rate design among customer classes even if, overall, income and expenses seem to be in balance.”

Q: What cooperative utility data do you work with?

A: Wiedl: “A COSA uses a utility’s expenses (costs), kWh, demand and number of customers for each class of service (residential, commercial, industrial and irrigation). Then, plant expenses are assigned to functional categories, demand, energy and customer. Everything associated with investment in the facilities plus the cost of operations is considered, including: the headquarters building, line trucks, salaries and so on. These are then balanced against revenue generated by each class. More revenue has the potential to position a cooperative to reduce rates – and vice versa. It’s most effective to reevaluate this balance yearly.”

Q: So, why do a COSA?

A: Wiedl: “To determine – for a utility cooperative – that it has a positive rate of return. A utility cooperative needs to make a ‘margin’ to allow investment in new equipment. The existence of a margin helps avoid or reduce the need to take out loans to accomplish things like purchasing new equipment. A margin is equivalent to ‘profit.’ It’s valuable to look at the effect of changes in costs and rates especially if rates have not changed in a while. If there are significant changes in wholesale rate design, they need to be studied in the context of a COSA to understand how those changes will affect rate classes at the customer level. And, a COSA is a good basis for the distribution of capital credits back to customers. A customer class must have a positive margin in order to get a return. “The level of detail in a COSA makes it a ready tool for cooperative rate setting and for exploring rate design for each class of customer.”

Q: When is a cost-of-service analysis indicated?

A: Wiedl: “When you want to know what impact a retail rate change in one class will have on customers in other classes. When there are budget changes, when there are changes in wholesale rates, changes in board (leadership) philosophy regarding equity or financial management or when a large commercial or industrial customer is added or dropped. Cost-of-service, for cooperatives, is a ‘zero-sum game’ in that revenue plus margin must equal cost (or, expenses). Just like a co-op’s own budget is also a zero-sum game. A cost-of-service study is a good thing to do for a utility cooperative on a routine basis. For those utilities with COSAs done yearly, the analysis creates an opportunity to understand any unusual expenses or other anomalies. A COSA can be performed for all classes of service as long as data for the individual cooperative customer classes is made available.”

Q: So how, specifically, do COSA results interact with rates?

A: Wiedl: “A COSA is a preparatory step to rate design. For example, as a result of doing a cost-of-service, many PNGC Power members have unbundled their rates for large commercial customers. Basic cost of service is unhinged from the volume of use. Margin is collected on basic customer rate; not on kWh usage. The commercial and industrial customers like this approach. Among other things, it provides stability for both the customer and the utility. Another example would be seasonal residential usage. People expect to use a seasonal home just a few times each year and a cost-of-service establishes what an appropriate rate to them should be. A COSA underpins a minimum customer charge and is part of the connect or disconnect fee system to avoid one or the other being a financial advantage. All of this helps the year-round customer avoid shouldering any burden from the seasonal customer. Most member-owner utilities have made corrections in their rates and service policies to reflect this reality. Also, it’s always easier to aggregate classes back together as a result of a cost-of-service analysis for the purposes of rate design versus trying to divide up classes. The data is richer when it is collected separately for each class.”