Jun. 7--Customers of Tucson Electric Power Co. could be in for a sharp rate increase when a rate freeze expires at the end of 2008, the company has told regulators.

To avoid such rate shock, TEP has offered to extend the freeze imposed in a 1999 agreement if the company could recover higher costs for fuel and open-market power purchases through a new surcharge.

TEP also wants the Arizona Corporation Commission to let the utility sell more power on the competitive wholesale market, the company said in a filing with the commission.

"We don't want a big rate increase," said Jim Pignatelli, chairman and CEO of TEP parent UniSource Energy Corp. "We believe we can keep rates around where we have been, if we get some of what I'll call 'blowout' protection for runaway gas and purchased-power (costs)." The company's filing came as part of "rate check" proceedings mandated under TEP's 1999 rate settlement. A Corporation Commission administrative law judge will hear the issue today in Phoenix as part of a procedural hearing.

TEP sought clarification TEP asked the commission last month to clarify how it will treat TEP rates when the current rate deal expires at the end of 2008.

In follow-up filings, TEP contends that under the 1999 settlement, the company would be allowed to charge "market-based" rates for power generation after the rate freeze ends Dec. 31, 2008.

The anticipated payoff of deregulated power sales justified TEP's accepting the rate freeze, Pignatelli said.

Under the state's piecemeal electric competition rules and TEP's rate settlement, TEP's rates are based on a market price index minus a "competition transition charge." This charge was designed to protect ratepayers from high costs as a competitive retail market developed, but that market never developed.

If the transition charge -- which appears as a credit on customers' bills -- disappears as scheduled at the end of 2008, TEP ratepayers might be in for a "significant rate increase" when the freeze expires, the company said. Since the rate deal, TEP ratepayers have saved more than $1.3 billion through the competition transition charge, according to TEP.

But the Residential Utility Consumer Office, the state's utility ratepayer advocacy agency, contends there's nothing in the rate deal that continues market-based rates after the deal expires.

"Once the (competitive transition) charge goes away, there's nothing" that says the market rates continue, RUCO Director Stephen Ahearn said.

TEP said 16 percent increase justified Pignatelli said that under a series of cuts and a cap on rates imposed by the 1999 settlement, TEP's rates are roughly at 1994 levels. In its rate-review filings, TEP has said its higher costs could justify a 16 percent rate increase.

Other Arizona utilities have asked for rate increases to offset higher costs.

In March, the Corporation Commission granted Arizona Public Service Co. a rate increase of 4.2 percent for the typical residential customer.

The decision also allowed APS to begin collecting a "Power Supply Adjustor" to offset fuel and purchased-power costs higher than anticipated in the existing rate formula. The adjustor is largely meant to offset spiraling natural gas costs and thus is expected to result in a small surcharge, but it could also work in reverse if costs are below expectations.

RUCO's Ahearn said APS' fuel adjustor makes some sense because APS has invested heavily in gas-fired power plants in recent years, boosting gas from less than 10 percent of its power-generation portfolio to about 30 percent.

By comparison, gas is a relatively small part of TEP's power- generation base, which is dominated by coal, he said.

"Maybe they'll feel better about things if they get an adjustor," Ahearn said.

TEP may be making a good-faith effort to clarify the post-2008 rate approach, but it's premature to set rates for three years from now, he added.

"Part of the quid pro quo" Pignatelli said a move to market- based rates in 2009 was "part of the quid pro quo" for freezing TEP's rates.

"If that wasn't the intention, then we have to review a lot of things about what was included in that 1998 settlement, including the rate stability plan, because we are under-earning and we are rapidly writing down some of our assets so that we would be in the position to be competitive in 2008," he said.

A securities analyst said some Wall Street investors are drooling at the prospect of TEP being able to sell its relatively cheap coal- generated power on the open market, but Arizona seems to be leaning toward more, not less, regulation.

Analyst Maurice E. May of Westport, Mass.-based Power Insights noted that regulators rolled several of APS' new gas plants into the traditional rate base. TEP wants the opposite -- to have more of its power freed up for sale on the open market.

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