This June, the Maryland Public Service Commission denied Pepco’s application for a multiyear rate plan. What does this decision mean for Pepco and for the future of differentiated ratemaking in Maryland?
Ratemaking for utilities at a glance
Traditionally, regulated utilities have maintained a fair return on rate base through the filing of infrequent (typically spaced by several years) general rate cases designed to recover investments made on the system since the previous case. Commissions have generally established new rates by allowing a single increase to the utility’s cost of service – with rates remaining fixed until the utility deems it necessary to file a new case due to erosion in its realized return. However, this approach has come under increasing strain in recent years, as some utilities have been required to make sizable, frequent investments in system infrastructure (for instance, to integrate increasing levels of intermittent renewable generation) while potentially waiting several years to see an authorized return on these investments.
Multiyear rate plans (“MRPs”) are designed to address this issue by compensating a utility for changing business conditions without frequent, full true ups to its actual cost of service through traditional rate case proceedings. Some MRPs specify a specific dollar amount of allowed revenue change in each year covered by the plan, while others depend on an established formula or indices to determine allowable annual escalations. In addition to potentially reducing the regulatory lag time a utility sees between new system investments and an allowed return on those investments, MRPs may also lessen the need for cost trackers and surcharges given their automatic (usually annual) base-rate adjustments. Utilities regulated under MRPs are essentially given allowances for cost growth every year but are not reimbursed based on actual cost growth. This makes them distinct from formula rate plans, which “solve” for utility revenue by truing up rates to accommodate the preestablished earnings band for the utility. Some MRPs also incorporate features from other differentiated ratemaking mechanisms. These may include certain cost trackers, earnings-sharing mechanisms, and/or performance incentives amongst others – all of which are described in detail in FactSet’s Differentiated Ratemaking report.
Ratemaking in Maryland
Since the Maryland Public Service Commission (MPSC) began adopting MRPs in 2020 as part of its study of alternative forms of ratemaking, it has approved four MRPs for Exelon Corporation (NYSE: EXC) operating companies within the state: two for Baltimore Gas and Electric, one for Delmarva Power & Light, and one for Potomac Electric Power Company (Pepco). Given this string of approvals, Pepco management decided to request an MRP framework in its most recent rate case, docket No. 9702.
Pepco is a regulated electric utility subsidiary of Exelon Corporation that serves approximately 894,000 customers in Maryland and Washington, D.C. Pepco filed its second MRP in its Maryland jurisdiction on May 16, 2023, originally requesting revenue increases of $74.4MM in 2025 (Rate Year 1 or RY1), $59.4MM in 2026 (RY2), $59.4MM in 2027 (RY3), with an additional $20.4MM increase for the nine months ending December 31, 2027 (RY3E).
The problem for Pepco
After Pepco agreed to delay the case to allow the MPSC some time to clear up a busy calendar, the MPSC issued an order on June 10, 2024, that denied Pepco’s MRP, approving only a single increase of $44.63MM, or about 21% of the requested total. The $44.63MM was based upon a 9.5% ROE and 50.5% equity layer vs Pepco’s requested 10.5% and 50.5%, respectively, in the MRP for RY1. The 9.5% allowed ROE falls slightly below the average approved ROE of 9.67% for all electric cases decided in 2024 (YTD), as outlined in FactSet’s most recent quarterly Rate Case Update report.
Figure 1: Requested vs. Approved Terms of Commission Decision in Pepco Case No. 9702
Source: FactSet
What’s next
Most importantly, the Commission stated in their decision that while MRPs have been approved in the past, “all parties were on notice that any MRP proposal would be subject to the ‘lessons learned’ proceedings later this year for the pilot MRP, as specified by the Commission as part of its adoption of alternative forms of ratemaking in Case No. 9618.” The pilot utility is Baltimore Gas and Electric since it was the first utility to file under the MRP program in 2020.
The Commission has not made any final policy decisions around MRPs, as the “lessons learned” proceedings will take place later this year, but it has upended the ratemaking construct in the state with this MRP rejection. However, the Commission hasn’t shut the door on MRPs completely, as it stated that a final decision on the issue should be made in a separate docket – not this rate case. While we view this decision as unfavorable from an investor perspective, it doesn’t preclude Pepco from filling a new traditional rate case for what would have been RY2. It does, however, introduce uncertainty into the ratemaking construct in Maryland for all parties going forward.
This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.
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