Breaking Down Barriers to Energy Efficiency Utility Revenue Decoupling and other Revenue Stabilization Tools Jim Lazar, RAP Senior Advisor Presented to: Keystone Energy Efficiency Alliance

2 Energy Efficiency Is BY FAR the Cheapest Resource Available Energy efficiency costs much less than existing or new generation, and avoids transmission, distribution, line losses, and environmental impacts. Because it’s cheaper than supply-side options, it effectively achieves carbon reductions at a negative cost compared with a conventional resource strategy.

3 BUT: Energy Efficiency Will Not Happen Without Support Many barriers to efficiency: –Access to capital –Time horizon –Renters will not invest their own money, and landlords don’t pay the bill –Lack of adequate information Utility Programs Are A Proven Tool To Achieve High Levels of Efficiency. –Utilities have long time horizons –Utilities have access to capital

4 Tactics for Overcoming Barriers to Efficiency Energy Efficiency Performance Standard –Mandate to distribution utility –Funded by system benefit charge –Penalties for Underperformance Supplier Obligation (Europe) –All retail energy providers required to provide Third Party Administrator (Vermont)

5 Energy Efficiency Can Impair Utility Net Income Higher costs and lower sales mean less revenue to cover costs fixed in short run. With efficient rate design – pricing incremental usage at long-run incremental cost, lost revenue greatly exceeds short- run avoidable expense. SO: a means to make the utility whole is needed.

6 How Changes in Sales Affect Earnings One Example Utility 12.31%11.88%$11,076,180$1,176,180$1,809, % 13.61%23.76%$12,252,360$2,352,360$3,619, % 14.92%35.64%$13,428,540$3,528,540$5,428, % 16.23%47.52%$14,604,720$4,704,720$7,238, % 17.53%59.40%$15,780,900$5,880,900$9,047, % 11.00%0.00%$9,900,000$0 0.00% 4.47%-59.40%$4,019,100-$5,880,900-$9,047, % 5.77%-47.52%$5,195,280-$4,704,720-$7,238, % 7.08%-35.64%$6,371,460-$3,528,540-$5,428, % 8.39%-23.76%$7,547,640-$2,352,360-$3,619, % 9.69%-11.88%$8,723,820-$1,176,180-$1,809, % Actual ROE% ChangeNet EarningsAfter-taxPre-tax % Change in Sales Impact on EarningsRevenue Change

7 Methods For Recovery of Lost Utility Margin Lost Revenue Accounting Mechanism (LRAM) Straight Fixed / Variable Rate Design Shared Savings Mechanisms Bonus Rate of Return Annual rate cases Decoupling

8 The Essential Characteristic of Decoupling Traditional Regulation: Constant Price = Fluctuating Revenues Decoupling: Precise Revenue Recovery = Fluctuating Prices

9 Revenue Decoupling: The Basic Concept Basic Revenue-Earnings Decoupling has two primary components: 1.Determine a “target revenue” to be collected in a given period In the simplest form of revenue decoupling (sometimes called “revenue cap” regulation), Target Revenues are always equal to Test Year Revenue Requirements Other approaches have formulas to adjust Target Revenue over time 2.Set a price which will collect that target revenue This is the same as the last step in a traditional rate case – i.e. Price = Target Revenues ÷ Sales

10 The Decoupling Calculation Utility Target Revenue Requirement determined with traditional rate case –By class & by month (or other period coinciding with how often decoupling adjustment is made) Each future period will have different actual unit sales than Test Year The difference (positive or negative) is flowed through to customers by adjusting Price for that period (see Post Rate Case Calculation)

11 Decoupling is Not Really “New” Fuel adjustment clauses decouple utility earnings from fuel and purchased power costs. Conservation cost recovery clauses decouple utility earnings from expenditures for Energy Efficiency implementation. Other adjustment clauses include nuclear decommissioning, infrastructure replacement, renewable energy costs, renewable energy production tax credits, pollution control costs. Decoupling is dramatically simpler than implementing a fuel adjustment mechanism.

13 Risks and Other Issues Affected By Decoupling Weather Economic Cycle Regulatory Lag Financial & business risk of utility –Cost of capital implications –Focus of utility management on controllable costs, not sales growth

14 How Big are the Price Adjustments? Northwest NaturalPower Year PGA % Change Decoupling % Change PCA % Change (Res) Decoupling % Change 1995(6.2) 1996(4.8) (12.7) (18.9) (0.27)(14.0) 2007(8.7)(0.1) <(1.0)8.45(0.8)

15 Do Prices Always Go Up?

16 Comparison of Traditional Regulation and Decoupling Issue/TopicTraditional RegulationDecoupling Revenue RequirementCost of serviceSame, but may allow a “revenue path” between rate cases Likelihood allowed revenue requirement will be over- or under-collected HighLow – revenue collected equals “target” revenue Weather riskCustomers and company bear weather risk with opposite “signs”; Results in wealth transfers based on weather Customers and company shielded from weather risk; Earnings stability means lower equity ratio required Economic cycle riskCompany primarily bears economic cycle risk Company shielded from risk; results in lower cost of capital Need for rate casesLikely need more often when growth or other factors are changing Reduced to 3-5 year periodicity at commission’s discretion Rate DesignSee company’s current rate design No change required, but income stability concerns addressed.

17 How States Have Approached Decoupling?

18 One Innovative Proposal Tucson Electric - Arizona Annual decoupling adjustment Inverted seasonal residential rate design Any surcredits applied to initial block Any surcharges applied to end blocks

The Regulatory Assistance Project (RAP) is a global, non-profit team of experts that focuses on the long-term economic and environmental sustainability of the power and natural gas sectors. RAP has deep expertise in regulatory and market policies that:  Promote economic efficiency  Protect the environment  Ensure system reliability  Allocate system benefits fairly among all consumers Learn more about RAP at Jim Lazar: