1. Rate and Revenue Considerations When Starting an Energy Efficiency Program APPA’s National Conference June 13 th, 2009 Salt Lake City, Utah Mark Beauchamp, CPA, CMA, MBA President Utility Financial Solutions Phone: 616-393-9722

2. Objectives  How will rates be impacted if an energy efficiency program is implemented  How is industry responding to the changes  What impacts on contributions to City  What types of cost structures place the utility most at Risk  How rates may need to change  What rate structures should be considered

3. Utilities Incentive is to grow  Improved profitability for IOU’s If sales were above projected amount between rate cases- Profitability improved Increasing return to shareholders  IOU’s had incentive to construct new power plants New investment increased the rate of return (in dollars) More investment the greater the allowable rate of return in dollars  Public Power Systems Growth helped to keep rates low Added to reserve levels Funded capital programs to improve reliability

4. Movement Toward Energy Conservation  Pressure started in the early 90’s to promote energy conservation Started experimenting with decoupling rates to reduce the utilities incentive to promote usage Focus changed to energy restructuring  Many Regulatory Commissions promoted the use of inclining block rate structures Social reasons to help low income customers  Low use does not relate to low income Promote energy conservation  Little residential conservation occurred

5. Inclining Block Rates  Inclining Block Rate Structures created additional incentive for Utilities to not promote energy efficiency Most profitable usage was at higher blocks Inclining Block Rate Structure  Customer Charge: $5.00  First 500 kWh’s 0.065/kWh  Excess 0.105/kWh

6. Assessment of Risk of Under Recovery

7. Power Supply Costs – Limited Risk  Due to Off system sales Fixed cost of generation may be recovered through sales to others  Purchased Power If the utility purchases power, energy portion of purchased power rates will decline Some of the demand portion of the rate will decline

8. Power Supply Costs – Limited Risk  Power Supply Cost Adjustments If structured properly will protect utility  Marginal generation costs may exceed average costs Marginal costs may be impacted by cost related to carbon  Any risk related to power supply is short term risk All costs are variable in the long term

9. Sample Utility Cost Breakdown

10. Recovery of Delivery Costs  Fixed Costs related to distribution investments: Utility Basis  Depreciation Expense  Operation and Maintenance  Rate of Return  Contribution to City

11. Cost of Service Breakdown of Costs

12. Customer Charges  Recovers cost that do not vary based on usage Meter Costs Meter Reading Costs Billing Costs Customer Service Service Drop Portion of Distribution System

13. Sample Utility 5% Reduction in Usage Assumed Utility Charged Cost Based Rates

14. Rate Structures that Place Utilities Most At Risk

15. Rate Design  Types of Residential Rate Structures: Flat Rates – Typically contain a customer charge and flat energy charge (Often these are cost based charges) Inclining Block Rates – Rates increase with increased usage. Promoted by many state public utility commissions to send price signal to reduce usage Declining Block Rates – Rates decrease with usage. Illegal in some states. Used often by rural utilities to help recover distribution investments as quickly as possible

16. Cost of Service Rates, 5% Reduction, 1,000 kWh’s

17. Residential Rate Structures  Inverted Block rates Inverted block rates may result in largest under recovery of distribution costs Distribution recovery tend to occur in end blocks

18. Inclining Block Rate Impacts of 5% reduction in usage

19. Residential Rate Structures  Flat Rates Tend to be cost based rates Cost of service does not differentiate on how much energy is used but on usage patterns Distribution recovery tends to occur in all kWh blocks

20. Flat Rate Impacts of 5% reduction in usage

21. Residential  Declining Block Rate Structures Recovers distribution costs as quickly as possible Tends to be used by rural systems due to substantial distribution investments Many states have discouraged declining block rate structures

22. Declining Block Rate Structure Impacts of 5% reduction in usage

23. Rate Structure

24. Industry Responses  Some utilities have promoted high customer charges to recover 100% of the distribution costs Highly controversial  Contrary to Energy Conservation  Is not supported by Cost of Service  Potential social impact on low use customers (perceived as low income)

25. Industry Responses  Push toward declining block rates to recover fixed delivery charges as quickly as possible Social concern over impact on low use customers Rate does not promote energy efficiency Reduces the savings to customers by implementing energy efficiency programs

26. Decoupling Rates  Breaks the cycle of linking revenue to sales of electricity  Reduces Utilities disincentive and opposition to energy conservation programs  Reduces the risk to utilities to help ensure recovery for the delivery service

27. Issues around decoupling  Should true up be applied to all customer classes equally or classes where under recovery is occurring  Should weather be considered  Frequency of occurrence of True–Ups  Utilities could reduce some of the issues by moving to cost of service rates

28. Change of Rate Forms  Implementation of demand charges for all customer classes Many utilities recover distribution costs through the kWh charge  In-line water heaters Reduces kWh consumption of electricity Creates demands on system between 15kW and 28 kW Typical residential is around 5 kW

29. Rate Impact based on Density of System with a 5% reduction in Usage

30. Impacts on Contribution to City  Energy efficiency may have a greater impact on City than Utility  Five percent reduction in usage may have a direct 5% reduction in City Contribution  Can City sustain revenue loss

31. Summary  Rates reviewed more frequently implementation of Decoupling?  Movement toward distribution charges recovered in demand charges rather than energy component  Movement toward cost based customer charges  Power Cost Adjustments