For over two decades advocates of ratepayer-funded energy efficiency and load reduction programs have recommended that the “link” between the utility’s revenues and its sales be “decoupled” to eliminate a utility’s disincentive to sponsor such programs. The argument is that the combination of the utility management’s fiduciary duty to shareholders and the use of rates based on a revenue requirement, that includes sales in its calculation, discourages utilities from being competent vendors of energy efficiency and load reduction services.
Revenue decoupling (RD) is generally defined as a ratemaking mechanism that is designed to eliminate or reduce the dependence of a utility’s revenues on system throughput (i.e., sales). It is adopted with the intent of removing the disincentive a utility has to administer and promote customer efforts to reduce energy consumption and demand or to install distributed generation to displace electricity delivered by the utility’s T&D system. In regulatory parlance, revenue decoupling takes the form of a tracker or attrition allowance in which authorized per customer margins are subject to a true-up mechanism to maintain or cap a given level of revenues. In a significant departure from traditional cost-of-service principles, which historically provides utilities with only the opportunity to earn a fair return, RD guarantees actual earnings at the level of authorized earnings. Under RD, a utility is indifferent to the impact of sales levels because of changing economic conditions, weather, or new technologies.
ELCON members are strong supporters of energy efficiency and world-class practitioners of innovative technologies that reduce their energy costs to improve their competitiveness. But ELCON strongly opposes decoupling because it disrupts and distorts the utility core business functions and is not a particularly effective way of promoting energy efficiency or anything of benefit to the utility’s customers. Time and time again decoupling has been tried in several states, only to be suspended because it unduly interferes with the overall regulatory process. ELCON believes that there are other ways to promote energy efficiency and load reduction services that have proven to be more effective.
ELCON Position & Recommendations
- Decoupling promotes mediocrity in the management of a utility.
The primary function of a regulated electric utility is and will always be to efficiently sell and deliver electric energy to customers. For investor-owned utilities, the profit-motive is a legitimate and practical means to incent utility managers to operate their business in a competent and efficient manner. There also need not be any conflict with “unselling” the business’ primary product by offering energy efficiency and load reduction services.
Firms in many industries meet the competition by selling competitive products to their own. But in regulated industries, such as electric utilities, rate structures and regulatory policies may have to be aligned to make this work. The attractiveness of revenue decoupling to many utility executives is that it will make the utility “whole” regardless of the source of earnings or revenue loss. This can only promote mediocrity and indifference to the utility’s core business, a situation that should not be in the best interests of either advocates of selling or unselling the energy product.
- Decoupling shifts significant business risk from shareholders to consumers with only dubious opportunities for offsetting consumer benefits.
Decoupling does not create any economic incentive promoting greater energy efficiency or load reduction except to the extent higher than necessary rates reduces price-elastic loads. That is a cynical way to induce energy conservation. Decoupling only removes an alleged disincentive while at the same time creating real disincentives for competent management of the business. The Maine Public Utilities Commission stated in 2004:
- Revenue decoupling does not … provide any positive incentive for utilities to promote or support energy efficiency or conservation programs; it only makes them financially neutral to such activities.
There is growing national concern that utilities are under-investing in infrastructure and not adequately planning for the future needs of their customers. Why this situation has been allowed to happen is troublesome given that for many utilities their allowed return is already above their actual cost of capital. Regulatory policies need to refocus utility management on its core responsibilities to efficiently sell and deliver electric energy and to make prudent long-term investments. Regulators must not bargain with their utilities from a weak position that assumes that financial incentives in excess of a reasonable return is necessary for ordinary business behavior. For all practical purposes RD mechanisms put utility management on autopilot and this will only further encourage them to ignore their core business, the value of economic development in their franchise area, and the broader needs of the utility’s customers. These objectives are at least as important as promoting energy efficiency.
An important feature of the financial structure of investor-owned utilities is that the utility’s shareholders assume normal business risk. This is the risk-reward model that pervades private businesses in the US and global economies. Shareholders are best able to diversify business risk and market-based economies strive on this basis. Utility ratepayers are least able to do so; yet it is the expressed intent of RD mechanisms to shift risk from shareholders to consumers, a departure from any regulatory policy intended to balance the interests of equity owners and ratepayers. Under a RD mechanism, equity owners are guaranteed their allowed ROE, while ratepayers receive no guarantee that they will receive benefits.
Proponents of RD mechanisms almost always support preserving the utility’s allowed return on equity at a level that assumes the shareholders retain such risk. Getting utility management to buy into the scheme would be difficult otherwise. Hence RD mechanisms are an attempt to force energy efficiency and load reduction programs at any cost and with no regard for the economic welfare of the impacted ratepayers.
Unless there are compensatory rate-of-return reductions, RD mechanisms produce the anomaly that customers who conserve on their own are rewarded with higher rates because RD causes rates to increase to compensate for the loss in revenues. Using RD mechanisms in conjunction with general rate cases also can have a ratchet effect on revenues and rates to the extent the RD adjustments in between rate cases are memorialized in the next rate case. For these and other reasons there is ample justification for dismissing the value of RD mechanisms in ratemaking.
- Decoupling eliminates a utility’s financial incentive to support economic development within its franchise area. This includes the incentive to support the well-being of manufacturers and their workforce.
Revenue decoupling is often portrayed as a “blunt instrument.” While its sole purpose is the elimination of an alleged disincentive to a utility’s active support for energy efficiency and load reduction programs, it also eliminates the financial incentive to actively promote the economic development of the utility’s franchise area. More specifically, it neutralizes the financial incentive to attract new commercial and industrial businesses to the utility’s franchise area, and to support the well-being of its existing commercial and industrial customers, unless those customer classes are specifically exempt from the RD mechanism. ELCON believes that regulatory policies should promote greater customer focus, not less.
- Revenue decoupling mechanisms tend to address “lost revenues” and not the real issue, which is lost profits.
To the extent that rates based on sales create a disincentive for utility efforts to promote energy efficiency and load reduction, the problem is in the rate design and the failure to abide by long-standing cost-of-service ratemaking principles. RD mechanisms have the effect of shifting the recovery of the utility’s fixed costs into the customer (or demand) charge of base rates where they belonged in the first place. Thus, from one perspective, RD can be viewed as a stopgap ratemaking mechanism to overcome rate designs that have been used and abused for other misguided policy objectives such as the imposition of cross-class subsidies and stranded cost recovery. The complexity of RD mechanisms also makes them very expensive to administer and regulate. This greatly reduces the transparency of the ratemaking process and, even more so in the public mind, reduces the logic of cost causation.
The ability of a utility to have the opportunity to earn a fair return on assets that are prudently incurred and that remain used and useful is a grand compromise of regulation that has withstood the test of over a hundred years of practice. Any increased opportunity for a utility to earn its authorized rate of return must be commensurate with an increase in business risk, not the reverse!
There is no inherent inconsistency that a utility would both sell and “unsell” electric energy if rates are appropriately designed for the different services. Selling competing products and services is a common business choice and need not be a moral dilemma only for utility executives. There are many examples of state ratemaking practices such as lost revenue adjustment mechanisms and shareholder performance incentives that create more explicit economic incentives for promoting energy efficiency and load reduction. These practices avoid the collateral damage created by the “blunt instrument” nature of RD mechanisms.
- The first and most important step regulators can take to promote energy efficiency is to send the proper price signals to each customer class.
The first and most important step regulators can take to ensure that consumers themselves are induced to make energy efficient investments and behavioral changes is to implement retail rates that send the proper price signals to each customer class. This includes allocation of fixed costs to customer (or “demand”) charges and time-variant energy charges. Large industrial customers are almost always on some form of time-of-use rate, with a demand charge, and this rate structure is extremely valuable to the customer for evaluating the cost-effectiveness of energy efficiency improvements in their manufacturing facilities. Large industrial customers do not look for guidance from utilities on how to co-optimize their energy consumption and manufacturing activities, and “decoupling” does not make utilities experts in these matters. Without belittling the importance of energy efficiency as a national policy, ELCON members believe that a utility’s fundamental responsibility is to efficiently sell and deliver energy at the lowest possible cost, and appropriate price signals are an essential component of that objective.
- Several states have successfully used alternative entities—including government agencies—for “unselling” energy. This creates an entity whose sole mission is to promote energy efficiency, and retains a separate entity whose responsibility is to efficiently sell and deliver energy.
Some states that believe that simultaneously selling and unselling electric energy is a real conflict of interest have assigned the administration of the unselling function to an independent entity or agency whose mission is dedicated to promoting energy efficiency and load reduction. This policy recognizes that another entity—the utility—must be responsible for efficiently selling and delivering electric energy. States that have taken this path are Wisconsin, Maine, New Jersey, Ohio, Vermont, Oregon, New York, and Connecticut.
In New York, for example, the New York State Energy and Research Development Authority (NYSERDA) is charged with the responsibility for energy efficiency and load reduction programs, and is funded by a systems benefit charge that is collected by the utilities.
Wisconsin established Focus On Energy as a public-private partnership offering energy information and services to residential, business, and industrial customers throughout the state. There services are delivered by a group of firms contracted by the Wisconsin Department of Administration’s Division of Energy.
Electricity Consumers Resource Council, Revenue Decoupling: A Policy Brief of the Electricity Consumers Resource Council, Washington DC, 2007
Electricity Consumers Resource Council, Revenue Decoupling and Its Alternatives – An Intervener’s Guide to Retail Ratemaking Policies on Decoupling, Washington DC, 2009