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Electricity - Evolution of Rate Making

( Originally Published Early 1900's )

FIFTY-YEARS AGO a discussion of rates for electric supply would have been impossible because there was no electric supply. It would not even have been academic, because the idea of a public supply had taken form only in the minds of the few men who in every generation are so far in advance of the times that their con-temporaries look upon them as dreamers or as prophets not deserving honor because of the futility of their prophecies. It is true that fifty years ago there were electric lights of a sort, electric arcs of a sort and platinum wires heated to luminosity, but these were all, or almost all, merely repetitions of laboratory experiments.

The development of a practical arc lamp and of a power generator of current for the series arc lamp, which were to change the public ideal of street lighting, and the development of the low resistance, constant potential generator, engine-driven, and the high resistance filament incandescent in a glass bulb, which were to revolutionize interior lighting, came in the decade which began fifty years ago. By the end of that decade the distribution of electricity from central stations, requiring the formulation of rates for electric supply, was an everyday fact.

Forty years ago found electric companies all over the civilized world furnishing street lighting service with reliable arc lamps at a contract price of so much per lamp per annum, and interior service with similar lamps more ornamentally incased, and even motor service by ingenious motors which were switched into and out of the series circuit which carried the arc lamps. The question of rates had arrived. Some of the factors applicable to rate making had been formulated. Even a meter had been invented which would record the number of hours during which a motor or an arc lamp was in service. It was a clock which ran when the current released its detent and stopped when the current stopped flowing, thereby recording the number of hours during which the connected device was in use.

A Beginning of Rate Making

There was even a beginning of theories of rate making. Dr. John Hopkinson's authoritative study "On the Cost of Electric Supply" was not presented to the world until 1892. But in 1883 he had introduced into drafts of provisional orders giving the parliamentary authority required in Great Britain for the introduction of electric supply,a provision for a method of charging which would recognize the variation of cost with load factor. In the second edition, published in 1884, of a book on electricity by John T. Sprague, an English telegraph engineer, I find the warning to those looking toward electricity as a competitor to gas that the interest and capital outlay in an electric plant, and often even the wages for attendants, will be the same for 500 hours' service annually as for 2,000 hours'—a warning which was sorely needed in many later years.

During the decade from 1884 to 1894 the making of electric rates was little influenced by theory. The service was sold on its merits, for what it would bring. The records of these years are of competition with gas lighting and with gas engine and steam motive power, and of strong competition between electric systems (so-called), and in either case the electric supply rate was of necessity the highest rate that would obtain the competitive business. My own memories and my old notes, when I resurrect these, show an endless procession of small central station enterprises, which, if they succeeded, did so almost in spite of their rate schedules; and if they failed, as was more often the case, did so because their managers could not see the difference between profitable and unprofitable service. An investment in an electric light company was a real "gamble." The action was not so quick as on the green cloth or on the stock exchange, but the result was just as unpredictable, and it was the occasional brilliant winning that kept the players in the game. The solitary and systematic attempt to learn what rates should be, was the study and comparison of earnings and costs in detail suggested by Mr. Edison early in the game and carried on by the Edison licensee companies.

In Great Britain, where many of the electric light enterprises were guided by consulting engineers, there was much study of rates after 1890. I have already mentioned Dr. Hopkinson's classic, in which he proved that the total cost of electricity supply could not be correctly stated as so much per unit unless the rate of supplying that unit be also stated—and that, with what we now call low load factor, the unit cost depends much more upon capital and standing charges than upon the running costs, which continue from hour to hour.

In 1896 Arthur Wright, the Engineer-Manager of the Brighton plant, presented another classical paper in which he showed from records of his plant that the additional kilowatt-hours delivered to customers during winter evenings were produced at a very slightly increased total cost beyond the costs which had to be incurred to deliver the much less number of kilowatt-hours supplied during summer evenings. He also offered a simple and sufficiently accurate device (since named the demand indicator) for measuring the maximum rate at which supply was called for by the individual customer. Upon this reasoning and this instrument, Mr. Wright built up a method of rate making which has flourished until this day.

Students on this side of the water were not lacking. In the Electrical World for February 29, 1896, there was printed a paper by W. J. Greene which is also a classic. Mr. Greene presented facts as to the elements of costs, which he had begun to study in 1889 by the analysis of plant records. His analysis of costs was complete. It recognized standing charges, running charges and those expenses affected by the number of consumers which we now call customer costs. He not only proposes but has put into operation a rate method which provides a minimum charge proportional to the investment necessarily made by the company for a customer's service and a sliding scale of discounts serving to reduce the average rate per kilowatt-hour rapidly as the monthly hours of use of demand are increased. Mr. Greene is, so far as I know, the first person to state concisely the basic truth that some such method is necessary to prevent the long-hour consumers being called on to pay the losses caused by the short-hour consumers.

A reading of these three papers will show that by 1896 the analysis of the cost of service was already almost complete. There was recognition of diversity factor and of load factor, for which latter useful expression the industry is indebted to Colonel Crompton. We had begun to speak of customer costs and of demand costs and of costs proportional to the energy metered. The defect of a rate method which encouraged the short-hour consumer by placing part of his costs upon the long-hour consumer had been clearly recognized. The sale of central electric power for continuous use in industries was still a small source of revenue compared with lighting, and the makers of rate schedules looked upon power business as the sale of a by-product. Service was still sold at flat rates—so much per connected lamp per month—or was sold by meter at so much per lamp-hour; but practical and accurate energy meters giving correct readings on dials were on the market, and the use of the kilowatt-hour as the measure of electric service was a matter of law in some localities and a rapidly spreading custom in all localities.

During that decade the fashion of selling service by the kilowatt-hour became almost universal. A special rate was made, of course, for power service, which entailed the use of separate meters for power and lighting on the same premises. The rate theory taking account of load factor was reduced to practice only by a few of the more progressive managements. While experience, costly in many cases, had taught that each and every kilowatt-hour could not be sold safely or competitively at the same rate, the adjustment of rates to costs, if made at all, was made by the establishment of numerous class rates, and by trial and error—instead of by analysis.

In my opinion, the causes which tended most to this delay of correct rate making were, first, the development of the alternating current watt-hour meter and the enterprise of the manufacturers who sold it to companies theretofore using flat rates, and sold with it the simplest kind of straight-line rate schedules, which, together with the salesman's type of meter, were guaranteed to work wonders toward the improvement of business. And, second, the continuation of the era of destructive competition between electric companies. It was not until the decade beginning in 1904 that the managers of electric light properties, the manufacturers of electrical machinery and the more intelligent leaders of public opinion recognized that our service to the public was hindered and not helped in its growth by local competition. Between 1904 and 1914 this economic truth found wide acceptance, and in the last decade of the fifty years' life of the Electrical World it has had no authoritative challenge.

When the electric supply managers found themselves—most of them—free from local competition they set themselves to consider ways and means to develop their business, and the effect of correct rate making on gross and net earnings received its long delayed recognition. Without looking at the files, I am sure that in the last twenty years the Electrical World has contained in every month at least one useful article dealing with rates. The proceedings of the trade associations both here and abroad have included many such papers. Even the mathematicians of the highly technical societies have exercised their talents on rate problems, so that there has at times been a plague of theory. Some of the most practical and useful studies of rate questions are to be found in the opinions and decisions of state and national public service commissions or courts.

No Complete Accepted Theory

We are far from the general acceptance of any complete theory of rates, but within the industry we are fairly agreed upon important principles. There is still much empirical rate making. I believe that empiricism persists because, after all, the ultimate test of a rate schedule is whether it serves to settle accounts to the satisfaction of both parties. There are lots of rate schedules in which adaptation has been sacrificed to superficial simplicity. Conversely, there are rate schedules which are injuriously complex.

I have wished more than once in the course of my years of service on the Rate Research Committee of the National Electric Light Association that my Committee had some such power as was attributed to it by malicious critics, to dictate the making of rates and rate schedules. I would willingly have used that power to prevent the making of cruel and unusual forms of electric rates and to abolish some that I found in existence, and I would with equal willingness have dealt harshly with the manager who was hurting his business by an arbitrary schedule which had no merit except brevity, and wrongfully laying a large share of service costs upon customers who had done little to incur those costs.

Thus far I have talked in terms of cost of service. But our studies of the last twenty years have recognized the element of value of service and the necessary apportionment of the burden of a reason-able profit to different classes of service according to the willingness and ability of each class to earn its share thereof. The immense increase in the use of our energy by industries which heretofore have produced their own electric power and could continue to do so has taught us the value of our service to these industrial consumers. They would not use it unless it paid them to use it. We have also learned the value of that industrial business to our nonindustrial customers, who have profited by the reduction of our costs through the increased output which the industrial sales have made possible. The extension of domestic electric service to the smallest households has put us in touch with the ultimate consumer, and in dealing with him we have learned and practiced the economic rule that service to the small consumer will become cheap to him and profitable to the company if every such consumer is served at a rate which encourages him to use our service liberally.

Finally, we have learned that theory is a necessary guide in rate making, but that because rates must be made for the future, the analysis of past costs cannot be any more than a guide and that rate making is an art. We have had it preached to us by disciples of John Hopkinson, who went much further than their teacher, that every kilowatt of reservation required by a customer should earn an identical annual return. We have had overzealous disciples of Arthur Wright preach to us that every kilowatt-hour sold should carry the same margin of profit. We know now that neither the equities nor the expediencies require us to be so meticulously exact. We have learned and lived by the rule that we shall serve every one at such a price that none shall be served at the cost of another and that no one shall be asked to pay us an excessive profit. We know that our own interests as well as public opinion require that we shall serve well the householder and the small merchant or manufacturer who is literally dependent upon us for service.

We have also learned that the large manufacturer and the mercantile magnate who buy our service by preference and not of necessity are alike able and willing to pay us a price which will be profitable both to the buyer and the seller. We have learned that other electric public services, such as street lighting and the supply of motive power to street railways and to railroads, can be and should be combined with our own work because the combination tends to lowest costs for all. The rate schedule which applies all these lessons is the ideal toward which we are progressing, and the progress of the last ten years has been very great.

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