An Overview of Revenue An Overview of Revenue Decoupling MechanismsDecoupling Mechanisms

Dan HansenChristensen Associates Energy

ConsultingAugust 2012

August 2012 2

Purpose of Revenue DecouplingPurpose of Revenue Decoupling

Traditional regulated rates recover fixed costs through volumetric rates

Provides utility with: An incentive to increase usage A disincentive to promote conservation and

energy efficiency

Problem: revenues and sales are directly related

Solution? “Decouple” revenues from sales

August 2012 3

Purpose of Revenue Decoupling (2)Purpose of Revenue Decoupling (2)

Revenue decoupling removes the link between sales and revenues, thus making the utility indifferent to the effects of conservation

Decoupling does not provide an incentive for the utility to promote conservation

Utility revenues are typically “recoupled” to some other factor(s), such as the number of customers

August 2012 4

Illustrating the IssueIllustrating the Issue

Rates are set by dividing the revenue requirement by the expected number of billing units The utility is allowed to recover $1 million It expects to sell 20 million kWh per year Therefore, the rate is:

$0.05 per kWh = $1 million / 20 million kWh

(The rate includes only fixed costs, not variable energy costs.)

August 2012 5

Illustrating the Issue (2)Illustrating the Issue (2)

Suppose customers conserve energy, reducing usage by 10 percent If the utility sells 18 million kWh instead of

20 million kWh, the utility only recovers 18 million kWh x $0.05 per kWh = $900,000

Lower sales lead to lower utility revenues without a commensurate reduction in utility costs

Utility revenues are reduced if they successfully promote conservation or energy efficiency

August 2012 6

Illustrating the Issue (3)Illustrating the Issue (3)

Now add a customer charge (assume 1,500 customers)

Customer Charge RateShortfall @ 18

million kWhShortfall as a

% of Cost$0 / mo. $0.0500 $100,000 10.0%

$15 / mo. $0.0365 $73,000 7.3%$55.56 / mo. $0.0000 $0 0.0%

August 2012 7

Where is Decoupling Used?Where is Decoupling Used?

Electricity: CA, CT, DC, HI, ID, MA, MD, MI, NY,

OR, RI, VT, WI (Pending: DE, IA, MN, NH, NM, OH, UT)

Natural Gas: AR, AZ, CA, CO, DC, IL, IN, MA, MD,

MI, MN, NC, NJ, NV, NY, OR, TN, UT, VA, WA, WI, WY

Sources:

Electricity: Institute for Electric Efficiency, July 2012

Natural Gas: NRDC, June 2010

August 2012 8

Basic Decoupling ConceptBasic Decoupling Concept

Basic concept of revenue decoupling (RD):

RD Deferral = Allowed Revenue – Actual Revenue

A positive number means the utility under-recovered, and will lead to a future rate increase

A negative number means the utility over-recovered, and will lead to a future rate decrease

August 2012 9

Basic Decoupling Concept (2)Basic Decoupling Concept (2)

Typically every 6 or 12 months, the RD deferral is rolled into rates as follows:

Rate change from RD = RD Deferral / E(Usage)

August 2012 10

What Decoupling Is What Decoupling Is NotNot

Save-a-Watt Duke Energy program that provides the utility

with an incentive to reduce usage levels Program pays the utility 90% of avoided

generation costs for verified usage reductions

Lost Revenue Adjustments Compensate the utility for lost revenues

associated with utility-sponsored conservation and energy efficiency programs

May or may not separately compensate the utility for program costs

August 2012 11

What Decoupling Is What Decoupling Is NotNot (2) (2)

Straight Fixed Variable (SFV) Rates Recover all fixed costs through fixed

charges, such as monthly customer charges Recover all variable costs through

volumetric rates

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Revenue per Customer DecouplingRevenue per Customer Decoupling

Most common form of decoupling Revenue per customer decoupling (RPCD)

changes base revenue with the current number of customers:

Deferralt = Ct x (RPCAllowedt – RPCActual

t) Ct is the number of customers at time t (the

“current” date) and “RPC” refers to revenue per customer

RPCAllowedt can be adjusted according to a

formula (e.g., including inflation and productivity adjustments)

August 2012 13

Revenue per Customer Decoupling:Revenue per Customer Decoupling:Pros and ConsPros and Cons

Pros: Provides an incentive to add

customers, which could be consistent with economic development

“Recouples” revenues in a comparatively simple way

Cons: Changes in revenues may not be

closely related to changes in costs

August 2012 14

Decoupling Design and Decoupling Design and Implementation IssuesImplementation Issues

Class-specific RD adjustments versus pooled Which classes to include

Large C&I may be excluded

Reduce the allowed return on equity (ROE)? Cap the annual surcharges? Earnings test? Ties to specific energy efficiency goals? Monitoring / reporting requirements

August 2012 15

Arguments for DecouplingArguments for Decoupling

Removes utility disincentive to promote conservation and energy efficiency

Removes utility incentive to promote load growth

Does not alter fixed charges, so there are minimal distributional effects (i.e., does not harm low-use customers like SFV does)

Retains customer-level to conserve in “standard” rates

Does not require measurement of DSM load reductions

Expands the range of conservation activities that the utility is likely to engage in (relative to LRAs)

August 2012 16

Arguments against DecouplingArguments against Decoupling

“Too broad”: leads to rate changes that far exceed the effects of utility-sponsored DSM programs

Single-issue ratemaking: focus is only on conservation

Shifts normal business risks from the utility to its ratepayers

Provides clear benefit to utility; no clear benefits to ratepayers

Concern about rate impacts for customers who do not conserve