What is Cost of Capital (CoC)?

A utility’s Rate of Return (ROR), or Cost of Capital (CoC), is the weighted average cost of debt, preferred equity, and common equity a utility has issued to finance its investments.  Return on Equity (ROE) is the ratio of a utility’s net income over its rate base common equity.  The Commission attempts to set the authorized ROR at a level that is adequate to enable the utility to attract investors to finance the replacement and expansion of its facilities so it can fulfill its public utility service obligation.  In practice, this level is determined by comparing market returns on investments for other companies with similiar levels of risk.  
 

CoC is determined by the Commission for the major utilities in a single proceeding.  In 2008, Decision (D).08-05-035 established a multi-year Cost of Capital Mechanism (CCM) for PG&E, SCE, SDG&E, SoCalGas requiring each to file CoC applications every three years.  The CCM framework provides thorough review of utility risk and establishes a new "test year" CoC every three years.  The CCM also provides a mechanism which automatically adjusts utility CoC and associated revenue requirement based on utility bond rate changes in each year they are not required to file a CoC application.  The last time the utilities subject to the CCM received a thorough review was in 2012 in Decision (D.)12-12-034, after which the utilities have requested, the Commission has granted, a delay of the test year review.  Most recently, Decision (D.)17-07-005 adjusted the CCM formula and postponed the next test year filing to April 2019.

The cost of service regulation does not guarantee utilities will earn an authorized ROE.  A utility's actual or recorded ROR may be higher or lower than what the Commission has authorized, depending on how the utility manages its costs.  If the utility's actual costs end up lower than the authorized revenue requirement, then its recorded ROR could be higher than its authorized ROR.  When recorded ROE is higher than authorized ROE, shareholders will benefit.  This provides an incentive for utilities to reduce their operating costs below the authorized revenue requirement.

For current and historical CoC data, click here.

The Commission also establishes authorized Cost of Capital levels for small, multi-jurisdictional utilities.  Click here for more information about these proceedings.


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