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Decoupling

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The House Energy and Finance Committee had several discussions centering around decoupling sales from revenues for gas and electric utilities. Decoupling enables removes the disincentives for energy efficiency and conservation that utilities currently face.

Wayne Shirley from the Regulatory Assistance Project testified in front of both this House Committee (on February 28) and in front of the Senate Energy Committee (on February 27 I think).

Decoupling is a feature that Governor Pawlenty has mentioned and one that Representative Kalin has included in his bill on the conservation improvement programs (CIPs). House Research has a summary of that whole bill - but I am focusing on the decoupling aspect here. If I understand it correctly, H.F. 1221 requires the Public Utility Commission to establish standards for decoupling. Utilities may then enter into pilot projects to see what happens when revenues are decoupled.

So what does decoupling mean? That summary has a good definition of decoupling:

"Decoupling" means separating a utility's revenues from its fluctuations in sales in order to remove utility disincentives to promote energy efficiency.

I'll explore what this means by summarizing Shirley's testimony. If you want to hear his words, I have isolated his audio presentation (6 MB mp3, 36 minutes long) to the House as well as a 15 minute clarification from discussion in the Senate Committee (6 MB mp3).

Currently, the ratemaking process for utilities involves the utility (Xcel for instance) and the Public Utilities Commission determining the appropriate rates for selling electricity (or gas) based on "cost of service regulation." All operating expenses are summed with the necessary returns on capital investments to get the revenue requirement. This is divided by the sales to get the price that at which electricity will be sold.

In the real world, sales will be different from what is expected based on many factors. This may mean higher or lower sales than expected. If the sales are insufficient (over time, perhaps several years later) to recover costs and the needed rate of return, it starts the process over.

As the utilities generally have high fixed costs, it cannot lower costs to make more money. They make more money based upon sales. Higher sales than expected during the ratemaking mean more profits (or higher dividends for cooperatives). This a significant disincentive to encouraging customers to lower consumption.

Decoupling changes the ratecase procedure by adding another step. After the revenue requirement is divided by the expected sales, they compute the average revenue per customer in each class (industrial, commercial, and residential). This is done more frequently (somewhat automatically) than traditional ratecases. For instance, the rate might be adjusted based upon actual consumption every month.

He uses this example:

A utility is determined to require $1 million from a given rate class. They are selling 25 million kilowatt hours of energy over that period. Under the existing system, this means the utility will charge $.04 per kilowatt hour. ($1,000,000/25,000,000 kWhrs).

If many customers became more efficient and reduced overall consumption in that rateclass by 1.5%, the utilities revenues would decline by $15,000.

Under a decoupling arrangement, the rate is adjusted for the next time period so that all ratepayers in that class are now paying $.0406 per kWhr.

At this point, you may be thinking, "Whaaaaa? How is it that the rates go up because people are conserving?" The utilities have to cover their costs and necessary returns on investments. If they are selling less power, they need to price it higher. Bear in mind that those who conserve power and use less of it will see smaller bills even if the rate increases slightly. In the example above, that was a fairly major (and unlikely) sudden reduction in consumption. In real life, the reduction would be smaller and also balanced partially by a growing customer base.

The important part about all of this is that utilities no longer have an incentive to increase their sales. If they increase their sales, the rates will drop in the next period (again, perhaps monthly or quarterly) and they will not profit from those increases (because their rate of return remains fixed). When combined with other aspects of Representative Kalin's improved CIP bill, the utilities have a strong incentive to encourage conservation and efficiency.

Decoupling has the effect of stabilizing the revenue stream of the utilities because its revenues are no longer dependent on sales. Thus, a mild winter will no longer hurt the profits of energy companies whereas a cold winter will no longer boost profits (due to higher than expected sales).