1. An Overview of Revenue Decoupling Mechanisms Dan Hansen Christensen Associates Energy Consulting August 2012

2. 2 Purpose 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

3. August 2012 3 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

4. August 2012 4 Illustrating 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.)

5. August 2012 5 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

6. August 2012 6 Illustrating the Issue (3)  Now add a customer charge (assume 1,500 customers)

7. August 2012 7 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

8. August 2012 8 Basic 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

9. August 2012 9 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)

10. August 2012 10 What Decoupling Is Not  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

11. August 2012 11 What Decoupling Is Not (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

12. August 2012 12 Revenue per Customer Decoupling  Most common form of decoupling  Revenue per customer decoupling (RPCD) changes base revenue with the current number of customers: Deferral t = C t x (RPC Allowed t – RPC Actual t )  C t is the number of customers at time t (the “current” date) and “RPC” refers to revenue per customer  RPC Allowed t can be adjusted according to a formula (e.g., including inflation and productivity adjustments)

13. August 2012 13 Revenue per Customer Decoupling: Pros 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

14. August 2012 14 Decoupling Design and Implementation 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

15. August 2012 15 Arguments 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)

16. August 2012 16 Arguments 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