Strategies for Addressing Fixed Cost Recovery Issues Dan Hansen Christensen Associates Energy Consulting October

2 Outline  Overview of issue  Regulatory strategies  Revenue decoupling  Forecast test years  Lost fixed cost recovery mechanisms  Riders / Cost Trackers  Rate design solutions  Higher fixed charges  Residential demand charges  Declining block rates  DG rates (access charges, buy all / sell all)  Time-differentiated rates

October Utility Fixed Cost Recovery Issues  Traditional regulated rates recover fixed costs through volumetric rates  This leads to utility revenue attrition when sales decrease, without a corresponding reduction in costs  Some incentive issues are also created:  Utility disincentive to promote conservation and energy efficiency  Utility incentive to increase customer usage  Subsidy to distributed generation (DG) customers  Incorrect price signals to customers, compared to marginal cost to serve (caveat: environmental externalities)

October Sources of Utility Fixed Cost Under-recovery  Distributed generation (residential solar)  Conservation and energy efficiency  “Naturally” occurring or based on customer initiative – Improved appliance efficiency – Phasing out incandescent light bulbs – Building standards  As caused by conservation mandates  Poor economic conditions  Mild weather conditions Stakeholders will not necessarily want to treat all of these causes equally

October Consequences of Utility Fixed Cost Under-recovery  In the absence of other solutions, the utility will likely file a rate case to increase rates in order to mitigate under-recovery going forward  Does not allow the utility to recover lost revenues in between rate cases  In some situations, cross-subsidies may be created – Non-solar customers subsidizing solar customers – Non-conserving customers subsidizing conserving customers – There is disagreement on the extent to which such cross-subsidies occur, if at all  Rate cases may be filed more frequently

October Potential Solutions for Utility Fixed Cost Under-recovery Issues  The following slides present a variety of potential solutions to the issue described here  Each is summarized in terms of how it addresses the following issues:  Conservation-induced sales reductions  Sales lost to distributed generation  Sales changes due to economic conditions  Sales changes due to weather conditions  Effect on low-use customers, who some believe are more likely to be low-income customers  Discussion, as applicable, of whether cross-subsidies are affected (created or removed)

Regulatory Solutions October

8 Forecast Test Year Description  Using a forecast test year (as opposed to an historical test year) can allow the expected effects of conservation or DG generation to be incorporated into rates  Expected effects will likely differ from actual effects  It does not affect rate structure or incentives (utility or customer) once in place  Even with a forecast test year, the utility is better off if it underachieves the conservation forecast (barring other penalties)

October Future Test Year Scorecard  Conservation  Does not remove the utility’s disincentive to promote conservation  Does not affect customer-level incentive to conserve  Distributed Generation  Makes utility whole for expected (not actual) net metering revenue losses  Does not end cross-subsidies to DG customers  Economy  No effect  Weather  No effect  Low-use customer effect  No effect

October Revenue Decoupling Description  Revenue decoupling is intended to remove the link between sales and utility revenues  This link exists because some fixed costs are recovered through volumetric (e.g., $ per kWh) rates  By removing the link, the utility is made indifferent to customer usage levels  Does not provide the utility with an incentive to promote conservation  A separate mechanism can do that, if desired

October 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

October 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)  Revenue is usually “re-coupled” to other (non-sales) factors, such as  The number of customers served (called revenue per customer decoupling, or RPCD)  Allowed revenue can be linked to inflation factors, which can incorporate performance-based regulation components

October Decoupling Scorecard  Conservation  Removes the utility’s disincentive to promote conservation  Does not affect customer-level incentive to conserve  Distributed Generation  Makes utility whole for net metering revenue losses  Does not end cross-subsidies to DG customers  Economy  Surcharges following recessionary years, rate reductions following expansionary years  Weather  May or may not be included (varies by mechanism)  Low-use customer effect  Only if they are less likely to conserve

October Lost Revenue Adjustment Mechanisms (LRAMs) Description  LRAMs compensate the utility for lost revenues due to utility-sponsored conservation programs  Fixed amount per kWh conserved, as measured in the program evaluation process  LRAMs are more narrow in focus than decoupling  Do not adjust revenues for weather, economic factors  Does not address the utility’s incentive to increase sales  Cannot lead to a rate reduction  Utility may not want to promote programs for which the effects are not easily measured  Can be significant disputes regarding kWh savings estimates

October LRAM Scorecard  Conservation  Addresses revenue loss from utility-sponsored programs  Does not otherwise affect conservation / load growth incentives  Distributed Generation  No effect  Economy  No effect  Weather  No effect  Low-use customer effect  Bill increase for low-use customers who do not participate in conservation programs (because they pay the LRAM adder)

October Riders / Cost Trackers: Description  Riders may be used to track specific costs and recover them through rates, without the need to file a rate case  E.g., commonly applied to fuel costs  In the context of this discussion, a rider could be used to track revenue attrition from net metering (if DG is separately metered) for recovery across all sales  Decoupling is a form of a rider  Because riders can vary so much, we do not provide a scorecard

Rate Design Solutions October

October Higher Fixed Charges: Description  The fixed cost recovery issue is caused by the recovery of fixed costs through volumetric rates  The problem can be mitigated or eliminated by increasing the amount of revenue recovered through fixed charges  Straight-fixed variable (SFV) pricing: recover all fixed costs through the monthly customer charge  Substitute for decoupling  Can lead to very large % bill impacts for low-use customers  Graduated facilities charges (GFCs): the monthly customer charge varies with usage (e.g., based on the 12-month average)  Can allow for an increase in the average customer charge while mitigating the effect on low-use customers

October Higher Fixed Charges: Example Bill Impacts

October Higher Fixed Charges Scorecard  Conservation  Removes the utility’s disincentive to promote conservation  Reduces the customer-level incentive to conserve  Distributed Generation  Removes DG subsidy  Removes utility revenue loss from net metering  Economy  Utility fixed-cost revenue (and customer bills) do not vary with economic conditions  Weather  Utility fixed-cost revenue (and customer bills) do not vary with weather conditions  Low-use customer effect  Potential for very high % bill impacts unless GFCs are employed

October Residential Demand Charges: Description  Residential rates typically only include energy rates ($/kWh) and customer charges ($ per customer month)  Demand charges are based on the highest amount of usage during a small interval of time, usually 15 minutes or 1 hour  May include a “ratchet”, in which the billing is based on demand in previous months and the current month  Demand charges have not historically been feasible for residential customers due to higher metering costs  Proliferation of “smart” meters makes demand charges feasible  The demand charge can recover distribution costs  Customers pay for the size of the distribution network needed to serve them during their time of greatest need  May reduce cross-subsidies between intermittent DG customers and other customers that arise from net metering under standard rates

October Residential Demand Charge Scorecard  Conservation  Customer still benefits from all-hours conservation  Distributed Generation  Reduces or eliminates DG subsidy  Reduces or eliminates utility revenue loss from net metering  Economy  Depends on presence of ratchet and how economic conditions affect demand  Weather  Likely to cause utility fixed-cost revenue (and customer bills) to vary less with weather conditions  Low-use customer effect  If low-use customers are low-demand customers, should be little to no effect

October Declining Block Rates: Description  The rate decreases as usage increases, for example:  0 to 300 kWh/mo = 10 cents/kWh  301 to 600 kWh/mo = 8 cents/kWh  Over 600 kWh/mo = 6 cents/kWh  Recovers fixed costs in the initial pricing block, in which all customers consume energy  For higher-use customers, the marginal price more closely reflects the marginal cost to serve  Compared to a flat rate:  Reduces customer-level incentive to conserve for high-use customers  Increases customer-level incentive to conserve for low-use customers  Inclining block rates are more fashionable because of the conservation incentives

October Declining Block Rate Scorecard  Conservation  Reduces the utility’s disincentive to promote conservation  Customer-level incentive effects vary by usage level  Distributed Generation  Reduces DG subsidy  Reduces utility revenue loss from net metering  Economy  Utility fixed-cost revenue (and customer bills) vary less with economic conditions  Weather  Utility fixed-cost revenue (and customer bills) vary less with weather conditions  Low-use customer effect  Potential for high % bill impacts

October DG Rates: Description  Some rates may be targeted toward DG customers  Access charge: a $ per month fee based on the DG capacity  Buy all / sell all: DG customers purchase all of their electricity at standard rates, sell DG to the utility at a different rate (that presumably excludes fixed costs)  These can be characterized as discriminatory toward DG customers, since the charges do not apply to all customers  Not true of SFV pricing or declining block rates  Prices may not account for environmental benefits of DG  How to quantify those benefits?  If that benefit is paid to DG customers, the cost must be paid by other ratepayers

October DG Rate Scorecard  Conservation  Not applicable  Distributed Generation  Reduces or eliminates DG subsidy  Reduces or eliminates utility revenue loss from net metering  Economy  No effect  Weather  No effect  Low-use customer effect  May reduce low-use customer bills if they are less likely to have DG and a cross-subsidy is removed

October Time-differentiated Rates: Description  Some rate designs include rates that vary by time  Static: rates are known in advance, but vary by time of day or season  Time-of-use (TOU) rates  Dynamic: rates vary with system conditions  Real-time pricing  Critical peak pricing  Time-differentiated rates tend to be focused promoting the efficient use of existing resources, or preventing the need to add generating resources (or transmission capacity) in the future  They are not typically focused on addressing conservation or DG issues (so we omit the scorecard)

October Summary  Decoupling:  Addresses fixed cost recovery issues due to conservation in a way that minimizes bill impacts (relative to SFV pricing)  Makes the utility whole for revenue loss from DG net metering, but does not address cross-subsidies (still a death spiral!)  LRAMs  Address fixed cost recovery issues from utility-sponsored conservation programs  Is not intended to address DG issues  SFV Pricing  Addresses fixed cost recovery issues due to conservation and DG  Removes DG cross-subsidies  Can have very large bill impacts (bill increase for low-use customers, bill decrease for high-use customers)  DG rates  Can address DG cross-subsidies and utility fixed cost recovery issues  Not intended to address conservation issues

October Questions?  If you have questions, please contact Dan Hansen at