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 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 data that answers questions for cooperative utilities that relate to ensuring equity between rate classes. The COSA results show the relative equity of rate design among customer classes even if, overall, income and expenses seem to be in balance. For example, the overall level for the utility may show that a 5 percent rate increase is necessary but the classes may vary from residential needing a 10 percent increase to lighting needing a 15 percent decrease. And that is what is meant by the equity between classes of service. The residential class is contributing too little while the lighting class is over contributing; this is not fair and equitable. A COSA will help show the relative inequities while also showing the inequities need to be corrected."

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, etc). 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 under the current rates. More revenue has the potential to position a cooperative to reduce rates - and vice versa. It’s most effective to reevaluate this balance yearly even if the cooperative chooses not to change rate levels or designs each year. Further an annual or biennial COSA would allow any significant rate design changes or extreme inequities to be corrected in a phased manner, lowering the impact on the customer."

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. Also if there are significant changes in wholesale rate design, those changes 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 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 larger customers. Basic cost of service is unhinged from the volume of use. Margin is collected in the basic customer or facilities charge, not on the 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/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-owned utilities have made corrections in their rates and service policies to reflect this reality. In general, the COSA results show how much revenue must be collected from each class. In the PNGC COSA model, there is enough detail in the results so that the cooperative could develop a number of types of rate designs from simple to complicated and evaluate the revenue impact. Further within the PNGC COSA model output there is some rate design examples included to help provide the underpinning for new and innovative rate designs."

Q. A COSA is an extensive and complex study; how does PNGC facilitate understanding the results?

A. Wiedl: "PNGC staff is always ready to go through the COSA results in as much detail as is necessary for the cooperative management/staff and Board of Directors to become comfortable with the results. This is with an appreciation for the brief shelf life of a COSA. Good for a budget year or a just-completed audited year, and is a guideline for both the overall level of revenue change (increase or decrease) as well as the level of change for each class of service. The combination of revenue level and rate design change must always be taken in context and local circumstances. Since all of the data is derived from the utility, the COSA results reflect the current financial situation at the utility and is an excellent tool for evaluating the cooperative’s ability to make overall financial goals."