Rate Base: Understanding A Frequently Misunderstood Concept

The following post is an excerpt from a report by Regulatory Research Associates (RRA), a group within S&P Global Market Intelligence. To learn more about the full report, please request a call.

One of the most misunderstood, and underappreciated, concepts in the utility industry is rate base, a term that is entirely unique to the utility realm. A utility's rate base is essentially the company's "prudent" capital investment, as determined by the applicable regulatory authority’s net of accumulated depreciation. Stated differently, it is the net asset base from which the utility provides electric, gas or water service, and upon which the utility is allowed to earn a rate of return, usually the company's weighted average cost of capital. Thus, the rate base value is a key variable in the determination of a utility's revenue requirement.

For vertically integrated electric utilities, rate base generally includes generation, transmission and distribution infrastructure; in restructured jurisdictions, the generation component is not included in the rate base calculation, as that service is competitively procured. In these jurisdictions, legacy utility generation plants have either been divested altogether to a merchant generation company or transferred to an affiliate of the utility and the plants are no longer economically regulated. For a gas utility, rate base typically includes pipes and mains. For water utilities, rate base includes distribution pipes, water treatment plants, meters and hydrants. But when it comes to valuing rate base, there can be many other items that are included in, or used to offset, the net value of the utility's plant and equipment.

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