Phoenix, Ariz.— At the Arizona Corporation Commission’s Regular Open Meeting on December 3, 2024, the Commission voted to adopt the ACC’s Policy Statement Regarding Formula Rates proposed by Chairman Jim O’Connor and Commissioner Nick Myers. The policy statement will allow regulated utilities to propose a formula rate plan in future rate cases for the Commission’s consideration.

Commissioner Myers opened this docket in January 2023 to explore alternative test year and ratemaking models and the Commission held two workshops on March 19, 2024, and October 3, 2024, to discuss various ratemaking approaches.

“After reviewing all the fillings in the docket as well as the comments and presentations made at the two workshops by Commissioners, ACC Staff, utilities, stakeholders, and the public, Chairman O’Connor and I brought forward this Formula Rate Plan proposal to advance multiple ratemaking objectives, including improving transparency, oversight and stakeholder engagement, a timelier cost recovery, reducing regulatory burden, and enhancing administrative efficiency,” stated Commissioner Myers.

“Arizona’s approach to setting utility rates made our State last in the nation for processing rate cases and ranked in bottom tier for investment climate.  We must adapt to the growing economy in Arizona, and the burgeoning growth in data centers and major industrial manufacturing, that demand significant investment in energy and water.  We must reduce regulatory lag, improve transparency, and deliver on our commitment to rate gradualism while maintaining affordable, reliable power and water,” said Chairman O’Connor.  “Formula Rates, which have been in use by the Federal Energy Regulatory Commission for over 60 years across the nation are a proven approach to accomplishing those objectives.  I applaud Commissioner Myers for initiating the investigation into alternatives to our draconian methods that have resulted in lumpy rate increases that customers cannot budget for easily, and that result in higher costs of debt and equity for our utilities.”

What Are Formula Rate Plans (FRPs)?

Formula Rate Plans (FRPs) are mechanisms that allow utilities to adjust their rates annually based on a pre-established formula, which accounts for specific cost inputs. Unlike traditional rate cases, which can be lengthy and expensive, FRPs provide a more streamlined and predictable method for setting rates. By using annual updates and true-ups, FRPs ensure that utilities can recover costs more promptly, while also passing any savings or benefits directly onto customers. The Federal Energy Regulatory Commission (FERC) has used FRPs for many years for transmission cost recovery in all fifty states.

The Benefits of FRPs

1. Promoting Gradualism
   With the use of annual updates, any increases or decreases are recognized more quickly and are reflected commensurately in the formula. This approach avoids rate shock for customers, which occurs in Arizona’s current approach to ratemaking that yields sudden large increase in rates.
2. Savings Passed on to Customers
   Changes such as favorable weather revenues, tax reductions, and customer growth are passed on to ratepayers through symmetrical formulas, ensuring that any financial benefits are passed on to customers.
3. Timely and Accurate Cost Recovery
   FRPs help utilities recover their costs more quickly, reducing the need for time-consuming rate cases. By enabling annual true-ups, utilities can adjust their rates to reflect actual costs, ensuring that both under- and over-recovery are minimized.
4. Lower Regulatory Burden
   With FRPs, utilities and regulators can avoid costly rate cases. This reduction in regulatory processes leads to savings in time, effort, and resources, which ultimately benefits customers through lower utility rates.
5. Improved Financial Efficiency for Utilities
   By reducing regulatory lag, FRPs lower financing costs for utilities, which in turn translates into lower rates for customers as there is less interest cost passed through to customers.
6. Facilitating Investment in Critical Infrastructure
   For electric, gas, water, and wastewater utilities, FRPs support investments in vital infrastructure, including generation, transmission, and water treatment facilities. These investments ensure the continued delivery of reliable and safe services to customers, including compliance with safety standards and environmental regulations.

Enhanced Customer Protections Adopted in the ACC FRP Policy Statement

1. Transparency and Accountability
   The FRP policy statement directs utilities proposing FRPs to include protocols modeled after FERC’s MISO protocols. These protocols include annual updates with data-populated formulas, public meetings for stakeholder discussions, and informal and formal challenge periods.
2. Use of Historical Test Year
   Proposed FRPs should use a historical test year as required by ACC rules. This means rates will be based on historical data not projected costs, which avoids the possibility of inflated projections. 
3. Annual True-up
   Proposed FRPs will include annual true-ups with an annual audit of underlying costs and inputs, preventing over recovery by a utility.
4. Earnings Test
   Proposed FRPs will include an earnings test to prevent overearning by utilities beyond the authorized return on equity.
5. Annual Updates Evaluated for Prudency
   Each annual update will include a prudency determination by the Commission to ensure capital expenditures are prudent and used and useful before the utility can recover the expenses.
6. Full Rate Case after Five Annual Updates
   Utilities using FRPs will file a full rate case application after five annual updates, though the Commission may direct the utility file a rate case earlier. The Commission adopted this provision from a stakeholder recommendation.   
7. Proposed FRPs Evaluated in Rate Case
   Any proposed FRP will be fully evaluated in a rate case by ACC Staff and all parties to the case and will ultimately be submitted for the Commission’s consideration.

The adoption of the FRP Policy Statement was opposed by the Attorney General of Arizona, Arizona Center for Law in the Public Interest, WRA, Sierra Club, SWEEP, Wildfire, Arizona PIRG Education Fund, Arizona Large Customer Group, and RUCO.  Stakeholders in support of the FRP Policy Statement included the Arizona Chamber of Commerce & Industry, Arizona Lodging & Tourism Association, Arizona Restaurant Association, Arizona Chapter of the Associated General Contractors, and the Arizona Farm & Ranch Group and Arizona Cattle Feeder’s Association.

“We’ve taken the first step in opening alternative approaches to utility rate setting based on tried-and-true methods.  I look forward to the Commission’s continued evaluation and adoption of other innovative measures to reduce regulatory lag, improve timeliness and lower embedded costs that customers pay for their utilities,” stated Chairman O’Connor.

“I am very pleased the Commission adopted the FRP Policy Statement, which I believe can help in ensuring our utilities will be able to meet the growing demand for service in our state,” commented Commission Myers, “that being said, I know that I and my fellow Commissioners will vigorously evaluate any proposed FRP to ensure it includes critical customer protections needed to keep rates just and reasonable.” 

For more information, please contact Chairman O’Connor at o’connor-web@azcc.gov or Commissioner Myers at myers-web@azcc.gov.