Pricing the Components of Electric Service in Illinois Scott A. Struck, CPA Financial Analysis Division Public Utilities Bureau Illinois Commerce Commission

The Path to Customer Choice Vertically Integrate Monopolies ( ): Utilities provided generation, transmission, and distribution services to the end user. Bundled prices were set based on traditional cost of service ratemaking. The Transition ( ) Phase in of customer choice. Restructuring of electric companies. Transfer or sale of generating plants. Consolidate through mergers and acquisitions. 2

Customer Choice (2007 and Beyond) Customers may choose between the incumbent utility and other electricity suppliers. Customers still receive distribution service from the incumbent utility at prices set by the ICC. Transmission service is provided by a regional operator at prices set by the FERC. 3

What the Customers Can Choose Delivery Services Only Customers obtain electric supply from another provider at market prices. The local utility delivers electric power and energy to retail customers. Bundled Services All components of electric service, including electric supply, are provided by the local utility. The utility acquires electricity through a competitive procurement process. The utility sells the electricity to bundled services customers at cost, based on the competitive procurement process. Pricing for Both is Unbundled 4

Pricing Components Bundled Service Customer Charge Distribution Facilities Charge Standard Metering Charge Distribution Service Transmission Service Charges Transmission Service Purchased Electricity Charges Reconciliation Factor Electric Supply Delivery Only Customer Charge Distribution Facilities Charge Standard Metering Charge Transmission Service Charge Not Applicable

Pricing Distribution Service Based on a revenue requirement derived using the traditional test year cost of service model. Challenges that came with restructuring. Functionalization – The need to more clearly separating distribution and transmission. Common Costs Costs are incurred that benefit more than one function. Common costs must be assigned among the functions in an equitable manner. Related Party Transactions Electric supply is purchased from related entities for resale to customers. Administrative services companies provide services to the distribution utility as well as other affiliated companies. 6

Separating Distribution Operations from Transmission Operations When electric utilities were vertically integrated, the distinction between distribution and transmission facilities was based primarily on voltage level. Now that distribution and transmission services are provided separately and priced separately, a more meaningful way of separating them is needed. FERC identified seven factors and asked each state to apply them on a facility by facility basis to separate the distribution and transmission functions. When these factors were applied they produced a net shift of plant from the transmission function to the distribution function. 7

The Seven Factors Local distributions facilities are normally in close proximity to retail customers. Local distribution facilities are primarily radial in character. Power flows into local distribution systems; it rarely, if ever, flows out. When power enters a local distribution system, it is not reconsigned or transported on to some other market. Power entering a local distribution system is consumed in a comparatively restricted geographical area. Meters are based at the transmission/local distributions interface to measure flows into the local distribution system. Local distribution systems will be of reduced voltage. 8

Common Costs Common costs benefit all the functions rather than just one. Examples include general and administrative expenses as well as general and intangible plant. When electric utilities were vertically integrated, there was no need to assign common costs among the functions of generation, transmission, and distribution. Now that electric supply, transmission, and distribution services are provided separately and priced separately, common costs must be assigned among them and included in the prices in an equitable way. 9

Common Costs Issues – An Example The utility transferred its generating plants to an affiliated company. In rate cases subsequent to the transfer, there was concern that the utility’s Administrative and General Expenses (A&G) had not declined commensurate with the plant transfer. The utility failed to show to the Commission’s satisfaction that it had not retained some of the A&G that still supported the generation function. As time has passed, the utility has done a better job of showing that it’s A&G support only the distribution function. This issue also arose regarding General and Intangible plant. 10

Related Party Transactions and Relationships The utilities no longer own generating plant, but much of the generating plant is owned by the utilities’ affiliates. The holding companies that own the utility operating companies have also formed separate centralized services companies that provide administrative services to the electric distribution companies as well as to the related generating companies and other related companies. We need to ensure that the rate-regulated operations do not subsidize the competitive operations. We need to ensure that the related companies do not pass to the regulated companies costs beyond what is reasonable. We need to ensure the regulated utilities do not discriminate in favor of their related supplies that are in competition with alternative suppliers. 11

Pricing Transmission Service Based on a revenue requirement derived using an annual formula approach. Challenges that came with restructuring. FERC’s assertion of jurisdiction. The ICC is now an intervenor rather than the regulator. The rates set by the ICC essentially pass through to customers the pricing that is set by the FERC. 12

Pricing Supply Service Customers may choose among alternative suppliers. When a customer chooses a Retail Energy Supplier other than the incumbent utility, those prices are set by the market. When a customer chooses the incumbent utility as its supplier, the prices the utility charges are set by the ICC. Retail Energy Suppliers Electricity is sold at a market price based on agreement between the seller and buyer. Bundled Service from the Incumbent Utility The incumbent utility procures electric supply through a competitive process. The incumbents utility then resells that electric supply to customers at its cost. Tariffs are necessary to translate the utility's purchase price and administrative costs into customer charges for electric supply. 13

Competitive Procurement Process Auction Multiple round, descending clock auction. Full requirements – Supplier agrees to supply a set portion of the utility’s full requirements throughout the term of the agreement, even though the amount of energy at some times will be greater and more costly than at other times. Tranche size of 50 MW of each customer segment’s peak demand. Post 2007 – Illinois Power Authority (IPA) The Illinois Legislature established the IPA to procure power and energy through a competitive solicitation process and to generate its own power and energy. The IPA submits a procurement plan which the ICC approves if the ICC determines that the plan “will ensure adequate, reliable, affordable, efficient, and environmentally sustainable electric service at the lowest total cost over time, taking into account any benefits of price stability.” The IPA procures electricity under a competitive RFP process, the results of which must be approved by the ICC. Utilities recover cost of electricity procured under this process. 14

Purchased Energy Charge Formula PEC g = Purchased Electricity Charge PEP = Peak Energy Purchased Electricity Price EPE g = Expected Peak Energy OPEP = Off Peak Energy Purchased Electricity Price EOPC g = Expected Off Peak Energy E g = Expected Energy Exp g = Expansion Factor

Summary Customers Can Choose: Purchase electric supply from the incumbent utility under bundled services. Purchase electric supply from a retail electric supplier and take only delivery services from the incumbent utility. All Prices are Unbundled. Services are priced the same for all customers who take those services. 16