Revenue requirements by Eric Eriksen

The electric utility rate making process consists of three parts:
1. Cost-of-Service Study
2. Revenue Requirement
3. Rate Design

In the Newsboy’s April edition, I reviewed the first step in the utility rate making process known as a Cost-of-Service Study. This is the process of allocating the cooperative’s costs based on member power usage patterns. In this edition, you’ll learn about the second step in the rate making process called Revenue Requirement. The cooperative’s revenue requirement consists of the total amount of revenue needed to pay for operating, maintenance, debt, depreciation and tax expenses.

RR=E+R+D+T
RR = Revenue Requirement
E = O&M Expense
R = Return on Investment (average cost of financing debt)
D = Depreciation
T = Taxes

SLVREC hires an independent third-party expert to perform the Revenue Requirement Study using an industry standard methodology provided by the federal rural utility services. Data is collected from a Board-approved audited financial statement “test year,” which includes 12-months of data ending Dec. 31. Since we performed the most recent study in 2024, then we used 2023 test year data. This is a very detailed process consisting of large quantities of data to analyze for every single transaction and penny through the test year.

An important takeaway from this formula is that there is zero profit added anywhere. This distinguishes a member-owned cooperative from an investor-owned utility. Another differentiator is our “R” (Return on Investment) expense. Utilities are financed with a combination of debt and member equity (cash). Debt is the result of borrowing money from a lending institution at a specific rate of interest.

To electrify rural America back in the 1930s, the federal government established low interest loans for not-for-profit electric cooperatives through the USDA. SLVREC was established in 1937 and able to take advantage of these savings for members then and today.

Two factors affecting the financing expense include how much debt we acquire and member equity cost. Since cooperative utilities are stable, long-term entities with very low financing costs, they can acquire more debt than other businesses. Targeting up to 60-percent debt and a 30-year rotation of member equity (capital credits). This results in the lowest rates for members.

The depreciation expense is describing how much members should reinvest into the replacement of electric distribution equipment to maintain its reliability. Items like poles may have useful life of 30 years, whereas metering equipment may only be 15 years. The average for electric distribution systems across America is 30 years, which is the same here.

We pay local, state, and federal taxes like all businesses. The local tax is an expense, but those monies stay within the San Luis Valley and fund our local public services. Operating and maintaining one of the largest service territories in Colorado is challenging. I am very proud that our employees care about you— working hard every day to achieve the most value in our operations and maintenance activities to deliver safe, reliable and affordable electricity. We care.

Once the study is completed, then the cooperative can see how the revenue requirements are changing over time. A change we all experience is due to the rising cost of goods and interest rates. The data is then used to update the rate making process. SLVREC’s practice has been to conduct these revenue requirement calculations about every three years to maximize cost efficiency.

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