Step 4: Examine customer classes to determine whether tariffs reflect cost causation; redefine as needed
Cost causation is a key principle of rate design, whereby the rates that customers pay should reflect the costs that their usage imposes on the system. In a situation where cost causation can be perfectly identified, cross-subsidies (both within and between customer classes) can be avoided. Therefore, it is important, where possible, for the utility to examine its current definition of customer classes and determine whether existing tariffs reflect cost causation. If this principle is not upheld in the current rate design, the customer classes should be redefined, and cost recovery should be reallocated.
The entire power system (generating stations and transmission and distribution facilities) needs to be built so as to instantaneously meet potential peak demand, plus a reserve margin in case portions of the system are unavailable at peak times. Thus, in allocating costs to customer classes, the key issue relates to the relative contribution of each customer class to this peak load/demand. Based on cost causation, customers that contribute disproportionately to peak load are charged higher rates than those that do not. In this sense, load profile characteristics comprise the key factor that should drive the development of, and the relative prices imposed on, customer classes.
Utilities often segment their customers into industrial, commercial, and residential load, and charge different rates to each. Residential customers often pay the highest rate because they consume a higher proportion of their load at peak times. By contrast, industrial rates are often lowest because many industrial customers display more uniform consumption throughout the day, and some may not be connected at a distribution voltage, thus using less of the system.
