Solving the rate puzzle: The future of electricity rate design, McKinsey's consultants Blake Houghton, Jackson Salovaara, and Humayun Tai

Last year my water rates doubled. I called my water provider and asked about the reason for the hike. Although my bi-monthly water bill still costs less that my monthly phone bill, the utility had not hiked rates to this extent since my service began. The water utility explained that their board had voted on a capital improvement charge. According to the McKinsey article, electric utilities should consider similar rate increases, given greater competition from distributed energy sources that generate less carbon.

Because of the federal regulation of electricity companies, unlike water utilities, electricity providers must obtain approval from federal regulators to increase rates. Regulators  and public utility commissions resist sudden spikes in rates. Having charged various customer classes according to the volume of energy used, residential, commercial, and industrial customers receive a volumetric rate, in addition to a flat rate, regardless of the time of use or other variables. Therefore, rates have remained consistent even when utilities face aging infrastructure and other capital costs, such as integrating renewable energy sources into the existing network. In addition to grid modernization, electric utilities face regulatory costs that they must absorb. With growing competition from low-carbon, distributed energy sources, electric utilities face a declining revenue stream and fewer customers.

The authors emphasize a change in the rate structure and urge companies to start planning for a more competitive future. The authors summarize the rate initiatives that utilities should take to generate sufficient revenue: "an updated rate design must align rates with system-wide costs, encourage flexibility, and address customer' differing needs." The authors suggest that utilities increase fixed charges and demand, volumetric, charges. Other recommendations include the adjustment of daily rates to reflect the costs of time of use (TOU)--cheaper at night and more costly during times of high demand. Additionally, the article adds that electric utilities should reward customers to control their home automation devices for cost effective use.  Partnering with customers, electric utilities can better manage the price of energy, its capacity, and the flexibility of use. Other variables that electric utilities can incorporate into the rate structure range from location, dynamic pricing based on market forces, reliability assurances, to energy source options--renewable versus other sources. Customers, residential, commercial, and industrial, would select which of the various offerings fit their needs. The utility would operate as a platform with a wide menu of options available to the customer. To realize these new rate goals and objectives company would assess their capability and support, customer acceptance, regulatory approval, and the alignment of a new rate structure with company sustainability policies.