Market-based rates refers to prices charged by regulated entities such as generators, electric transmission lines, gas pipelines, gas storage facilities, and gas or electric utilities that are set through negotiation or other market mechanisms rather than based on cost or other regulatory mechanisms. In cases where market forces are strong enough to prevent potential monopoly abuses, regulators have allowed regulated entities to charge market-based rates. This is common in the wholesale marketplace where generators and marketers that do not have a large enough market share to control markets can charge market-based rates. This type of regulation is the fundamental principle that underlies competitive electric markets created by market restructuring.
To charge market-based rates, generators or marketers selling power in the wholesale market must receive a certificate from FERC authorizing them to do so. But first they must demonstrate a lack of market power. FERC retains the right to implement rate caps and/or penalties at any point should these entities be observed exerting market power. FERC may also allow market-based rates for gas pipelines or gas storage facilities when sufficient competition exists.
Another example of a market-based rate is a negotiated rate between a utility and a large industrial customer. In some cases a state commission will allow a utility to negotiate such a rate to deter the customer from leaving the system. Keeping customers like these on a utility system benefits all ratepayers as fixed costs are spread over more customers, and rates are reduced for everyone.