Decoupling From Throughput and Conservation Rate Cases: A Case of Give and Take? Prepared by: Malcolm R. Ketchum Concentric Energy Advisors, Inc. September 21, 2006

2 How Did We Get Here? History of the Gas Bubble and its Impacts on Conservation  Energy crisis of  Passage of “National Energy Act” 1978 (PURPA, PPIFUA, NECPA, NGPA, E.T.A).  Repeal of PPIFUA (1987).  Low natural gas prices, efficient generating technology (Late 1980’s to 2000).  90% of the 200,000 mw of generation added in period was gas fired.  Low cost energy in real terms makes energy conservation un-economic in the 1990’s.

3 Recent History A New Energy Crisis?  Hurricanes  Mideast crisis  U.S. Conventional Natural Gas production declines. 1  LNG imports – increase dramatically in next decade.  Energy Act – EIA, Annual Energy Outlook 2006.

4 What is Decoupling?  Decoupling is the process of separating the volumetric variations in consumption from the realization of allowed revenues.  Because of the way in which utility rates are designed, recovery of fixed cost depends on energy use / throughput. Rate design is a historical reality that is once again seeking the spotlight. Rate Design

5 Example of Decoupling Mechanisms Monthly Rate Adjustment The Delivery Price under Schedules D and C is adjusted to reflect test year base rate revenues established in the latest base rate proceeding, after adjustment to recognize the change in the number of customers from the test year level. The change in revenues associated with the Customer Charge is the change in number of customers multiplied by the Customer Charge for the rate schedule. The change in revenues associated with throughput is the test year average use per customer multiplied by the net number of customers added since the like-month during the test year and multiplying that product by the Delivery Price for the rate schedule. The change in revenues associated with Customer Charge and throughput is added to test year revenue to restate test year revenues for the month to include the revised values. Actual revenues collected for the month are compared to the restated test year revenues and any difference is divided by estimated sales for the second succeeding month to obtain the adjustment to the applicable Delivery Price. Any difference between actual and estimated sales is reconciled in the determination of the adjustment for a future month. The Monthly Rate Adjustment is calculated separately for Schedule D, Schedule C, excluding Daily Metered customers, and Schedule C Daily Metered customers only. Details of the calculation of the billing adjustment are filed monthly with the Public Service Commission.

6 What is the “Problem”? Viewpoint of The Stakeholders  Consumer – High and volatile energy prices.  Regulator – Customer complaints, rate case expense, and strained staff resources.  Environmentalist – Global warming / fossil fuel dependency.  Utility / Shareholder – Declining use per customer (gas utilities), near impossibility of earning allowed return.

7 High and Volatile Energy Prices Consumer Perspective Source: Electric Energy Prices (PJM West): EIA study using Intercontinental Exchange data. Natural Gas Prices (Henry Hub): Platt's Gas Daily.

8 High and Volatile Energy Prices Consumer Perspective (Continued)  Consumers do not understand that LSEs do not make money on the higher energy prices.  Utility bills are confusing.  Energy costs, including gasoline, are a larger share of personal budgets.

9 Regulator Perspective  Customer Complaints  Increases in LIHEAP Funding  Rate cases to address: –LAUF costs –Bad debt –Working Capital Requirements –Declining Use (On top of taxes / PBOB / insurance, etc.) –Bad political vibes

10 Environmentalist Perspective Is Global Warming a Reality?  Seems to be scientific consensus now that this is indeed the case. 2  More efficient use, reduction of fossil fuel use is the byword. 20% increase in CO 2 emissions from fossil fuel  Can this interest be aligned with the energy industry?  It must be – one way or another Ibid., Inventory of U.S. Greenhouse Emissions and Sinks: According to the National Academy of Sciences, the Earth's surface temperature has risen by about 1 degree Fahrenheit in the past century, with accelerated warming during the past two decades ( 4

11 Utility / Shareholder Perspective Declining Use Problems  AGA findings; per customer usage has been declining for many years. 5  High cost of gas – Exacerbates, spotlights the problem.  Inability to earn allowed return. Rate case revenue based on volumes that are too high.  Increasing bad debt expense.  High cost of LAUF. 5 American Gas Association: Patterns in Residential Gas Consumption, June 16, 2003.

12 Utility / Shareholder Perspective (Continued) How Does Conservation Fit In?  This is the other half of the equation. –“The give and take”  It doesn’t necessarily follow that conservation program must be implemented. –Good reasons to implement appropriate rate design without conservation. HOWEVER… –Appropriate rate design with conservation accomplishes more.

13 Where Does Conservation Fit In?  Intersection of controlling prices at the end user level and lack of incentive on the part of utility to promote conservation.

14 The Magic of Alignment of Interests Can all of these “problems” be mitigated at once?

15 AGA / NRDC Statement The July 2004 statement jointly issued by the Natural Resources Defense Council and AGA stimulated interest in the issue in the regulatory community. “State regulators should consider rate reform proposals that break the link between utilities’ financial health and their energy sales, ending an unintended penalty on utilities that encourage consumers to use energy more efficiently.”

16 NARUC Endorsement Whereas, Innovative rate designs including “energy efficient tariffs” and “decoupling tariffs” (such as those employed by Northwest Natural Gas in Oregon, Baltimore Gas & Electric and Washington Gas in Maryland, Southwest Gas in California, and Piedmont Natural Gas in North Carolina), “fixed-variable” rates (such as that employed by Northern States Power in North Dakota, and Atlanta Gas Light in Georgia), other options (such as that approved in Oklahoma for Oklahoma Natural Gas), and other innovative proposals and programs may assist, especially in the short term, in promoting energy efficiency and energy conservation and slowing the rate of demand growth of natural gas

17 How Does Decoupling / Rate Design Address the “Problem”?  Overcomes declining use problem.  Eliminates utility disincentive to the promotion of (gas) conservation.  Rate design especially, can reduce high winter bills.  Stabilizes prices.  Actually can lead to a reduction in commodity prices (in conjunction with conservation).

18 Rate Design vs. Volumetric or Revenue Decoupling Mechanisms Rate Design  SFV  Flat fixed delivery charge Decoupling  Volumetric true up to weather norm  Full Revenue true up

19 Pros and Cons of Rate Design Solutions Pros  Offset high winter bills.  Reduces cross subsidization within the class (economically correct). Current pricing based on the wrong billing determinant.  Understandability – simplicity.  Customer acceptance. Cons  Breaks new regulatory ground.  Smallest users see biggest increases.  Reduces conservation price signals.

20 Pros and Cons of Decoupling Mechanisms Pros  May be more readily accepted by some regulators.  Does not change the way rates are designed.  Doesn’t impact small users as much as flat or SFV rate design solutions. Cons  Difficult to administer, costly regulatory review required.  Complicated mechanisms.  Difficult to explain.

21 Hand in Hand at Last All of the “problems” can be addressed with a combination of:  Rate Design and Conservation All of the stakeholders can work together with a little “give and take”.

22 Source: The National Regulatory Research Institute; and Concentric Energy Advisors Research States with Declining Use Initiatives Approved Decoupling Approved Fixed Variable Proposed Decoupling or Fixed Variable Decoupling Initially Rejected

23 The Promise of Decoupling / Rate Design and Conservation  High bills can be mitigated.  Winter bills reduced.  Conservation signals preserved.  Conservation implemented – (in the aggregate reducing demand and thus reducing prices).  Regulatory expense reduced.  Bills simplified – understanding improved. Is Everybody Happy?