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In the world of public utilities, a rate base is the value of a utility’s assets on which it is allowed to earn a return. The term “return” refers to the amount of money, expressed as a percentage, the company is allowed to make in profit. A variety of assets and fixed costs can be taken into account when determining the rate base. Thus, this figure becomes vital in the overall financial picture of the company.
Public utilities are entities that provide essential services to the public. This includes such things as electrical power, natural gas, and telephone service. Even public transportation services, such as bus and railroad systems, are considered to be public utilities.
A rate base is considered to be important in order to guarantee a profitable return for a utility. Many people argue against such a guarantee, citing how it goes against the nature of a free market. Most, however, consider the services provided by utilities to be so essential that it is necessary to ensure the utility is making enough money to remain solvent. There has also been considerable debate as to what expenses and costs should be allowed to be included.
The rate base used to determine how much a company can charge for its commodity includes assets such as buildings, real estate, and equipment. In addition to a utility’s physical assets, some operating costs are allowed to be included. An example of an operating cost would be the expense of purchasing coal for an electrical utility operating its own power generating plant.
Each state has a regulatory agency that is responsible for governing its public utilities. The agency determines the rate base for the utilities operating in that state. Also, the fixed costs that are allowed to be included in figuring the rate base vary from state to state. As a result, the amount a utility can charge might differ even for the same company operating in more than one state.
In determining the rate base and the fair rate of return for a utility, the regulatory agency attempts to create a balance between profitability for the company and a fair price for the consumer. Adequate profits are necessary in order for the company to continue to operate and to be able to expand to meet growth in future demands. At the same time, the cost of the utility’s services has to affordable for its customers.