The Regulatory Assistance Project

50 State Street, Suite 3Montpelier, VT 05602

Phone: 802-223-8199web: www.raponline.org

Breaking Down Barriers to Energy

Efficiency Utility Revenue Decouplingand other

Revenue Stabilization Tools

Jim Lazar, RAP Senior AdvisorPresented to: Keystone Energy Efficiency Alliance

September 20, 2011

2

Energy Efficiency Is BY FAR the Cheapest Resource Available

• Energy efficiency costs much less than existing or new generation, and avoids transmission, distribution, line losses, and environmental impacts.

• Because it’s cheaper than supply-side options, it effectively achieves carbon reductions at a negative cost compared with a conventional resource strategy.

$0.00

$0.04

$0.08

$0.12

$0.16

$0.20

$0.24

Efficiency New Power

Efficiency

Customer Service

Distribution

Transmission

Generation Plant

Emissions

Fuel

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BUT: Energy Efficiency Will Not Happen Without Support

• Many barriers to efficiency:– Access to capital– Time horizon– Renters will not invest their own money, and landlords

don’t pay the bill– Lack of adequate information

• Utility Programs Are A Proven Tool To Achieve High Levels of Efficiency.– Utilities have long time horizons– Utilities have access to capital

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Tactics for OvercomingBarriers to Efficiency

• Energy Efficiency Performance Standard– Mandate to distribution utility

– Funded by system benefit charge

– Penalties for Underperformance

• Supplier Obligation (Europe)– All retail energy providers required to provide

• Third Party Administrator (Vermont)

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Energy Efficiency Can Impair Utility Net Income

• Higher costs and lower sales mean less revenue to cover costs fixed in short run.

• With efficient rate design – pricing incremental usage at long-run incremental cost, lost revenue greatly exceeds short-run avoidable expense.

• SO: a means to make the utility whole is needed.

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How Changes in Sales Affect EarningsOne Example Utility

12.31%11.88%$11,076,180$1,176,180$1,809,5081.00%

13.61%23.76%$12,252,360$2,352,360$3,619,0152.00%

14.92%35.64%$13,428,540$3,528,540$5,428,5233.00%

16.23%47.52%$14,604,720$4,704,720$7,238,0314.00%

17.53%59.40%$15,780,900$5,880,900$9,047,5385.00%

11.00%0.00%$9,900,000$0$00.00%

4.47%-59.40%$4,019,100-$5,880,900-$9,047,538-5.00%

5.77%-47.52%$5,195,280-$4,704,720-$7,238,031-4.00%

7.08%-35.64%$6,371,460-$3,528,540-$5,428,523-3.00%

8.39%-23.76%$7,547,640-$2,352,360-$3,619,015-2.00%

9.69%-11.88%$8,723,820-$1,176,180-$1,809,508-1.00%

Actual ROE% ChangeNet EarningsAfter-taxPre-tax% Change

in Sales

Impact on EarningsRevenue Change 

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Methods For Recovery of Lost Utility Margin

• Lost Revenue Accounting Mechanism (LRAM)

• Straight Fixed / Variable Rate Design• Shared Savings Mechanisms• Bonus Rate of Return• Annual rate cases• Decoupling

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The Essential Characteristic of Decoupling

Traditional Regulation:Constant Price =

Fluctuating Revenues

Decoupling:Precise Revenue Recovery =

Fluctuating Prices

Revenues = Price * Sales Price = Target Revenues ÷ Sales

$0.1147

$0.1152

$0.1157

$0.1162

$0.1167

$114,800,000

$115,000,000

$115,200,000

$115,400,000

$115,600,000

$115,800,000

$116,000,000

1 2 3 4

Adjusted Revenues Adjusted Price Rate Case Price

$0.1147

$0.1152

$0.1157

$0.1162

$0.1167

$114,800,000

$115,000,000

$115,200,000

$115,400,000

$115,600,000

$115,800,000

$116,000,000

1 2 3 4

Actual Revenues Rate Case Rev. Req. Rate Case Price

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Revenue Decoupling:The Basic Concept

• Basic Revenue-Earnings Decoupling has two primary components:1. Determine a “target revenue” to be collected in a

given period• In the simplest form of revenue decoupling

(sometimes called “revenue cap” regulation), Target Revenues are always equal to Test Year Revenue Requirements

• Other approaches have formulas to adjust Target Revenue over time

2. Set a price which will collect that target revenue• This is the same as the last step in a traditional rate

case – i.e. Price = Target Revenues ÷ Sales

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The Decoupling Calculation

• Utility Target Revenue Requirement determined with traditional rate case

– By class & by month (or other period coinciding with how often decoupling adjustment is made)

• Each future period will have different actual unit sales than Test Year

• The difference (positive or negative) is flowed through to customers by adjusting Price for that period (see Post Rate Case Calculation)

Target Revenues $10,000,000

Test Year Unit Sales 100,000,000

Price $ 0.10000

Actual Unit Sales 99,500,000

Required Total Price $ 0.1005025

Decoupling Price “Adjustment”

$ 0.0005025

Periodic Decoupling Calculation

From the Rate Case

Post Rate Case Calculation

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Decoupling is Not Really “New”

• Fuel adjustment clauses decouple utility earnings from fuel and purchased power costs.

• Conservation cost recovery clauses decouple utility earnings from expenditures for Energy Efficiency implementation.

• Other adjustment clauses include nuclear decommissioning, infrastructure replacement, renewable energy costs, renewable energy production tax credits, pollution control costs.

• Decoupling is dramatically simpler than implementing a fuel adjustment mechanism.

Lower utility costs become lower customer costs

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Risks and Other Issues Affected By Decoupling

• Weather• Economic Cycle• Regulatory Lag• Financial & business risk of utility

– Cost of capital implications

– Focus of utility management on controllable costs, not sales growth

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How Big are the Price Adjustments?

Northwest Natural Power

YearPGA

% ChangeDecoupling% Change

PCA% Change

(Res)Decoupling% Change

1995 (6.2)1996 (4.8)1997 10.51998 9.21999 7.22000 21.42001 20.82002 (12.7) 7.52003 4.9 0.6 (18.9)2004 20.1 0.36 02005 16.6 0.77 02006 3.8 (0.27) (14.0)2007 (8.7) (0.1) 11.02008 15.6 <(1.0) 8.45 (0.8)2009 10.2 0.8

Source: Lesh, Rate Impacts And Key Design Elements Of Gas And Electric Utility Decoupling: A Comprehensive Review, The Electricity Journal (June 2009)

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Do Prices Always Go Up?

21

2

13

23

7

5

12

0

3

1

67

4

2

0

0

5

10

15

20

25

> 3% ≤ 3% ≤ 2% ≤ 1% ≤ 1% ≤ 2% ≤ 3% > 3%

Decoupling rate adjustment

Nu

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er o

f an

nu

al r

ate

adju

stm

ents

Gas

Electric

Refund Surcharge

Source: Lesh, Rate Impacts And Key Design Elements Of Gas And Electric Utility Decoupling: A Comprehensive Review, The Electricity Journal (June 2009)

No!

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Comparison of Traditional Regulation and DecouplingIssue/Topic Traditional Regulation Decoupling

Revenue Requirement Cost of service Same, but may allow a “revenue path” between rate cases

Likelihood allowed revenue requirement will be over- or under-collected

High Low – revenue collected equals “target” revenue

Weather risk Customers and company bear weather risk with opposite “signs”; Results in wealth transfers based on weather

Customers and company shielded from weather risk; Earnings stability means lower equity ratio required

Economic cycle risk Company primarily bears economic cycle risk

Company shielded from risk; results in lower cost of capital

Need for rate cases Likely need more often when growth or other factors are changing

Reduced to 3-5 year periodicity at commission’s discretion

Rate Design See company’s current rate design

No change required, but income stability concerns addressed.

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How States Have Approached Decoupling?

Feature Gas Decoupling Electric Decoupling Revenue change between rate cases

Revenue-per-customer 23 4 Attrition adjustment 3 4 No change 3 1

No separate tariff 3 3 Timing of Rate True-ups

Annual 19 8 Semi-annual/quarterly 2 1 Monthly 4 3

Weather Not weather-adjusted 20 10 Weather-adjusted 8 2

Limit on adjustments and/or dead-band 9 6 Per class calculation and adjustments 25 7 Earnings Test 4 Pilot/known expiration date 11 4 Surcharges only 3 Total Utilities Analyzed 28 12 Source: Lesh, Rate Impacts And Key Design Elements Of Gas And Electric Utility Decoupling: A Comprehensive Review, The Electricity Journal (June 2009)

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One Innovative ProposalTucson Electric - Arizona

• Annual decoupling adjustment• Inverted seasonal residential rate design• Any surcredits applied to initial block• Any surcharges applied to end blocks

Summer WinterCustomer Charge 7.00$ 7.00$ First 500 kWh 0.080$ 0.073$ Minus any decoupling creditNext 2,500 kWh 0.102$ 0.093$ Plus any decoupling surchargeOver 3,000 kWh 0.120$ 0.113$ Plus any decoupling surcharge

About RAP

The Regulatory Assistance Project (RAP) is a global, non-profit team of experts that focuses on the long-term economic and environmental sustainability of the power and natural gas sectors. RAP has deep expertise in regulatory and market policies that:

Promote economic efficiency Protect the environment Ensure system reliability Allocate system benefits fairly among all consumers

Learn more about RAP at www.raponline.org

Jim Lazar: jlazar@raponline.org