The basics · Rate design 101
How are electric rates set?
Your electricity price is not arbitrary. It comes from a structured, three-step process that utilities, regulators, and consultants have used for decades. Here is how it works — in plain English.
The short answer: electric rates are set in three steps. First a utility calculates its revenue requirement — the total dollars it needs to cover its costs. Then a cost-of-service study splits that requirement across customer classes based on what each one costs to serve. Finally, rate design turns each class's share into the actual charges on your bill. Regulators or a utility board review the result before it takes effect.
The revenue requirement: how much does the utility need?
Everything starts with a single question: how much revenue does the utility need to operate safely and stay financially healthy? That figure is the revenue requirement. It adds up operating expenses (labor, maintenance, wholesale power), depreciation on plant and equipment, taxes where they apply, and a return on the utility's investment.
For a not-for-profit cooperative or municipal utility, that "return" is not profit — it is the margin needed to fund system growth, retire debt, maintain equity, and satisfy lenders such as the USDA's Rural Utilities Service. For an investor-owned utility, a commission sets an allowed rate of return on the company's rate base. Either way, the goal is the same: recover the true cost of providing reliable service, and no more than that.
The cost-of-service study: who costs what to serve?
A single utility serves very different customers — a house, a hospital, a factory, a streetlight. They do not all cost the same to serve. A cost-of-service study (COSS) figures out each group's fair share of the revenue requirement through three moves that build on each other:
- Functionalize.Sort costs by the part of the system they belong to — power supply, transmission, and distribution.
- Classify.Sort those costs by what drives them: customer-related (the cost of connecting and billing an account, no matter its usage), demand-related (the cost of building capacity for peak load), and energy-related (fuel and energy costs that rise with each kilowatt-hour).
- Allocate.Spread each cost category across customer classes using factors that reflect how each class actually uses the system.
The payoff is a clear picture of cost responsibility: who is paying more than it costs to serve them, who is paying less, and where hidden cross-subsidies exist between classes. In the United States, this methodology follows long-established practice documented in the NARUC Cost Allocation Manual.
What each part of your bill actually pays for
Customer charge
A fixed monthly amount for the cost of your connection, meter, and billing — you pay it even at zero usage.
Demand charge
Common for larger customers. Recovers the cost of building enough capacity to meet your peak draw on the system.
Energy charge
Billed per kilowatt-hour. Recovers fuel and energy-related costs that rise the more you use.
Rate design: turning cost responsibility into real charges
Knowing what a class should pay is not the same as deciding how it pays. Rate design is the step that converts each class's cost responsibility into the specific customer, demand, and energy charges — plus any seasonal rates, time-of-use pricing, riders, or minimum bills — that appear on the tariff.
Good rate design balances cost alignment against real-world concerns: customer bill impact, rate stability from year to year, simplicity, conservation goals, and what a board or commission will accept. That is why the "indicated" result of a study is rarely implemented exactly as calculated — utilities often phase changes in to soften the impact on members.
Who reviews and approves the result?
The final check depends on the utility's structure. An investor-owned utility files a rate case at its state public utility commission, where the proposal is scrutinized in a public proceeding. An electric cooperative's member-elected board approves rates, frequently with lender oversight from RUS. A municipal utility answers to its city council or utility board. In each case, the transparency and defensibility of the underlying study is what makes the outcome credible to the people who must approve it — and to the members who pay it.
Frequently asked questions
Who decides how much I pay for electricity?
It depends on the utility. For an investor-owned utility, a state public utility commission reviews and approves rates in a formal rate case. For an electric cooperative, the member-elected board of directors sets rates, often with lender oversight from the USDA's Rural Utilities Service (RUS). For a municipal utility, the city council or a utility board decides. In every case, the rates are meant to recover the utility's cost of providing service — no more for a not-for-profit, and a regulated return for an investor-owned utility.
What is a cost-of-service study?
A cost-of-service study (COSS) determines how much it costs a utility to serve each class of customers — residential, commercial, industrial, and so on. It takes the utility's total revenue requirement and splits it across functions (generation, transmission, distribution), classifies those costs by what drives them (customer, demand, or energy), and allocates them to each class. The result shows who is paying more or less than the cost to serve them today.
Why does my bill have more than one charge?
Because a utility's costs are driven by different things. A fixed monthly customer charge recovers the cost of connecting and billing you regardless of how much you use. A demand charge (common for larger customers) recovers the cost of building enough capacity to meet peak load. An energy charge, billed per kilowatt-hour, recovers fuel and energy-related costs that rise with usage. Splitting the bill this way makes rates track the actual costs each customer imposes on the system.
How often do electric rates change?
There is no fixed schedule, but many utilities revisit rates every three to five years, or sooner when costs shift materially — for example, after a large capital investment, a jump in wholesale power costs, or significant load growth. A full cost-of-service study is often the trigger for a rate change.
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Our methodology
How Rate360 runs the revenue requirement, cost-of-service, and rate design stages.
Rate360 is the platform utilities and their advisors use to run these studies — from revenue requirement through cost allocation to rate design. See how it works