The way the electricity sector works is far removed from the basic economic model of supply and demand and market competition. Understandably, most Americans are unfamiliar with the ambiguities of electricity markets, planning processes, and rate setting. With increasing recognition of the enormous potential benefits of electricity transmission infrastructure, decision makers need to understand the most important aspects of this industry. This commentary highlights one of those aspects – the allocation of transmission costs – the way we allocate the costs of building power lines.

Cost allocation is a critical issue for transmission network development because without a plan to finance infrastructure, it will not be built. In fact, disagreements on cost allocation have hampered network development in recent years, and we can expect this aspect of transmission network development to continue to be a challenge. Fortunately, a long history and a large pool of practitioners in the field provide us with the tools and flexibility we need to collaborate on cost allocation across jurisdictions. With serious effort, we can overcome the challenges of transmission cost allocation and successfully build a 21st century network.

The crucial role of state supply commissions

Electric companies produce an important product, but as monopolies they do not have to compete as sellers in the market. State Public Utility Commissions (PUCs) are government regulators that serve an important gatekeeper function: They ensure that there is sufficient private investment to finance electric infrastructure while preventing for-profit utilities from abusing their privileged position through price gouging or other means.

State PUCs accomplish this in part through rate proceedings, which are public hearings similar to court proceedings. The PUC must approve each electric rate for it to go into effect and appear on customer bills. Parties involved in a rate proceeding typically include the utility itself, a consumer advocate, and representatives of industrial energy users, among others. Each party presents evidence and makes recommendations to the PUC. While the parties’ positions may agree on some areas, they typically diverge on many points. The PUC uses the hearing transcript, weighs the parties’ arguments, and makes difficult decisions to balance competing objectives and set the electric rates.

How tariff cases determine cost allocation

Cost allocation is a fundamental part of this rate-setting process. The PUC must determine both the total amount the utility can collect and how that revenue will be allocated among the various customers. An important, long-standing concept in this area is the “cost causation principle,” which states that parties responsible for costs incurred should also bear those costs. In other words, electricity consumers should pay for electricity based on their system usage. By segmenting customer types based on usage patterns (e.g., residential, commercial, industrial) and segmenting different components of electricity costs (power lines, customer meters, fuel), the PUC can set rates that fairly charge customers based on their system usage.

In practice, data and analytics are important inputs to rate decisions, but that’s not all the PUC must consider. Janice Beecher of Michigan State University’s Institute of Public Utilities has described utility rate design as a “mix of art, science, and politics.” Multiple parties present data and analytics to the PUC about how customers use the system. The PUC must weigh that evidence and the parties’ differing recommendations to set rates that meet its mission of enabling infrastructure investment and high-quality electricity at reasonable, fair prices. This typically involves trade-offs, difficult judgment calls, and balancing interests—often with incomplete information.

Even strict adherence to policies can be impractical. For example, the cost causation principle technically requires assigning each customer a separate electric rate, but this is generally not done. PUCs typically approve lower rate increases than originally requested by the utility after reviewing other parties’ arguments. Sometimes parties who disagree with the PUC’s order challenge it in court, but they often avoid this additional litigation and even simplify the rate case itself by working out a settlement agreement and jointly submitting it to the PUC for approval.

Despite these challenges, it is worth highlighting some encouraging points:

1. The United States has been successfully dealing with cost distribution for decades. Although rate setting can be controversial, electricity rates are updated regularly across the country and large investments are continually being made to keep customers supplied with electricity. According to the Regulatory Assistance Project, the U.S. rate setting process “oversaw and facilitated the development of the most reliable and lowest-priced electricity system in the world” during the 20th century.

2. Every state has a PUC and employs professionals with knowledge of engineering, accounting, economics, law and other disciplines who also have specialized training and experience in utility operations and tariff setting. The heads of these offices usually have extensive experience in this subject area and the sensitive debates, case decisions, legal settlements and politics associated with it.

3. Past tariff practice has produced numerous precedents for an established methodology for cost allocation. This gives us both proven approaches and flexibility given the diversity and complexity of the work carried out across the country.

Institutionally, PUCs and the ecosystem of stakeholders that practice before them are well suited to this task. While they could be better equipped, the sophisticated mix of “art, science, and politics” is a core competency of PUCs and the parties that participate in their proceedings.

Application of cost allocation to transmission infrastructure

The institutional experience and wealth of cost allocation methodologies are invaluable for current policy design and implementation. However, we can also rely on long-standing experience and methodologies specific to cost allocation for transmission lines, including large interstate lines, which tend to be the most expensive type of transmission.

An important established principle for the distribution of transmission costs is the ‘benefit payer principle’, which states that customers who benefit from transmission infrastructure should pay for it. This corresponds to the cost causation principle that applies more generally to tariff setting. Under the ‘benefit payer principle’, data and analytics can guide cost distribution by providing information on the benefits of transmission infrastructure and its geographical distribution.

Just as segmentation is used in general tariff setting and cost allocation to differentiate electricity consumption by customer and equipment type, segmentation is also useful for cost allocation in transmission. Network operating regions are divided geographically into smaller zones. The infrastructure itself can also be segmented, for example by voltage class (below 300 kV or above). Segmentation is evidence-based and is used to make sensible and fair cost allocation decisions.

Like overall cost allocation, transmission cost allocation may be based on incomplete evidence, and the interests or goals of different stakeholders may not be perfectly aligned. However, the core competency of “art, science, and politics” means that state PUCs and their stakeholders are well versed in these waters. This competency is an important asset for collaborative analysis and negotiation among states and regions working together on cost allocation. With effort, openness, and trust among participants, states can overcome the difficulties and jointly identify portfolios of shared transmission infrastructure and mutually acceptable cost allocation plans. The rewards are rich, and collaboration among states and regions can build on established approaches to usher in an era of strong infrastructure growth in the sector.

Conclusion: The distribution of transmission costs must be addressed jointly

While electricity pricing is a different story, a solid history of theory and practice can help us modernize our transmission infrastructure. Despite the legitimate challenges associated with allocating transmission costs, it can be done fairly and cooperatively. Regions, states, and municipalities can work together to examine evidence and develop tailored approaches that make sense for their jurisdictions. Mutually acceptable cost-sharing solutions not only enable transmission lines to be built, but also strengthen relationships between the parties involved and lead to further success in future joint ventures.