1. Sonny Popowsky KEEA/PBI Energy Efficiency Conference Harrisburg, PA October 1, 2013

2.  In the words of the economist Alfred Kahn, “All regulation is incentive regulation.”  The question is who are we incentivizing and what are we incentivizing them to do.  In the case of utility ratemaking, incentives can affect the actions of both the utility and the customers. 2

3.  Many retail electric providers (REPs) in Texas now charge residential customers an additional fee if their monthly usage falls below a specified minimum level, typically 1000 kwh per month.  According to an August 2013 report, 36 of the 44 REPs offering fixed price residential service in the Oncor (Dallas/Fort Worth area) service territory charge their customers anywhere from $6.95 to $20.00 per month if they use less than the specified amount. (Texas ROSE Report on REP Fees 2013).  Note: these same Oncor customers also pay monthly surcharges averaging $2.19 per month for smart metering systems and $1.23 per month for an Energy Efficiency Cost Recovery Factor (EECRF) to support energy efficiency programs. 3

4.  In recent years, a number of electric and natural gas utilities – including some in Pennsylvania – have proposed a movement toward straight fixed variable (SFV) rate design.  Under SFV rate design, all of a utility’s “fixed” costs are moved into a flat monthly customer charge and only “variable” costs are charged on a per kwh or per mcf basis.  Since utilities contend that most of their costs (particularly distribution costs) are fixed, this can lead to very high monthly customer charges and very low variable usage charges.  With SFV rate design, the utility’s revenue stream is more assured, but the customer’s incentive to conserve energy is greatly reduced. 4

5.  In establishing rates for utilities, there are two ways to incentivize a desired action. One is to reward the utility for achieving or exceeding a specified goal; the other is to penalize the utility for failure to meet that goal. 5

6.  In 2006, National Fuel Gas Distribution Company (NFG) in Erie filed a rate case that included a proposed rate “decoupling” mechanism under which the Company’s revenues would be decoupled from its level of sales. That is, if the Company’s sales declined due to the utility’s energy conservation efforts or for any other reason, the utility’s distribution rate per unit of gas sold would increase. If sales increased between base rate cases, the Company’s distribution rate per unit of gas sold would decrease. 6

7.  Over 1,260 individual consumer complaints were filed against the NFG rate case, nearly all in opposition to the decoupling proposal.  Consumers perceived decoupling to be a “penalty” for conservation. That is, the less gas they used, the higher the price per unit they had to pay.  Public hearings were held in which numerous customers opposed the decoupling proposal.  The NFG case was settled, with the Company withdrawing its proposed decoupling clause. 7

8.  After the NFG decoupling fiasco, legislation was introduced in the Pennsylvania House of Representatives (HB 2954 of 2006) that would have required the PUC to “disallow any proposed rate, rate increase or rate surcharge based in whole or in part on the utilization of a revenue decoupling mechanism.”  The legislation was never taken up for a vote. 8

9.  In 2008 the General Assembly passed Act 129 of 2008, requiring Pennsylvania electric utilities to help their customers save money by reducing energy usage and peak demand. 9

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11.  Act 129 for the first time imposed mandatory energy efficiency and peak demand reduction goals on Pennsylvania electric utilities.  But Act 129 did not provide for, and arguably prohibited, revenue decoupling for electric utilities. 11

12.  By July 1, 2009, each electric utility was required to file an energy efficiency and conservation plan.  Under the plan, the utility was required to reduce total annual electricity consumption by at least 1% by May 31, 2011; and by 3% by May 31, 2013.  The utility also was required to reduce peak demand during the 100 highest use hours of the year by at least 4.5% by May 31, 2013. 12

13.  Act 129 allowed each utility to spend up to 2% of its annual revenues to implement the plans, and allowed the utility to recover all reasonable and prudent costs of the programs from its customers through an automatic adjustment clause.  Under the statute, however, costs recovered through the automatic adjustment clause, could not include “decreased revenues of an electric distribution company due to reduced energy consumption or changes in energy demand.” 13

14.  Act 129 stated that “decreased revenues” resulting from conservation measures could only be recovered through normal base rate proceedings.  This provision effectively precluded a “decoupling” mechanism between base rate cases. 14

15.  Act 129 provided no special “incentives” or “rewards” for meeting the requirements of the law.  Instead, Act 129 authorized the PUC to impose penalties on utilities, in the form of $1 million to $20 million fines, for failure to meet any of the usage and peak demand reduction standards.  To quote Samuel Johnson (according to Boswell): “Nothing concentrates one’s mind so much as the realization that one is going to be hanged in the morning.” 15

16.  According to the preliminary reports filed by the utilities in July 2013, each of the electric distribution companies exceeded the mandatory cumulative energy efficiency savings required for the Phase One plan period ending May 31, 2013.  Utilities reported achieved results ranging from 107% to 125% of the cumulative compliance requirements as follows: Penelec -107%; Met Ed - 108%; West Penn Power -108%; Penn Power - 114%; PECO -121%; PPL – 124%; Duquesne – 125%. 16

17.  After reviewing the results to date of the initial Act 129 Plans, the Commission proposed to move forward with new energy efficiency requirements for the period June 2013 through May 2016, but did not adopt new goals for peak demand reductions at this time.  EDCs’ new energy efficiency goals vary by company and are based on the reductions that can be obtained within the 2% annual revenue limits that were included in the original legislation. 17

18.  Under full decoupling, a utility’s revenues are “trued up” between rate cases based on actual vs. projected sales, regardless of whether or not any reduction in sales is due to utility conservation efforts. As such, decoupling makes a utility whole for lost sales due to economic recessions, weather, etc., but the utility also does not get to keep additional revenues resulting from sales increases.  Under a “lost revenue” approach, the utility is made whole only for revenues lost due to utility conservation efforts. So, for example, if a customer replaces incandescent light bulbs with utility-subsidized compact fluorescent bulbs, the utility recovers the lost revenue; but if that same customer goes out and buys a 68” plasma television, the utility keeps those additional revenues as well. 18

19.  Is it more important to give conservation incentives to utilities or to customers?  In the same 2006 case in which NFG proposed a decoupling mechanism, the Company proposed to increase the fixed monthly customer charge by 72% (from $12.00 to $20.64) and to reduce the distribution “tail block” rate by 87% (from $1.95/mcf to $0.25/mcf).  Both of those proposed rate design changes would have clearly reduced the benefits to customers of conservation efforts. 19

20.  Where decoupling, lost revenue recovery, or SFV rate design is utilized, it reduces a utility’s risk of reduced profits due to sales losses between rate cases.  Should that reduced risk be reflected in a lower rate of return granted to the utility in its rate cases? Or should utilities with successful energy efficiency programs be rewarded with a higher rate of return or a share of customer savings? 20

21.  While the distribution rates of Pennsylvania electric distribution companies are regulated by the PUC, most of those utilities have major unregulated generation affiliates, who still make more money by selling more generation at higher prices.  Even if a utility’s distribution revenues and profits are made indifferent to sales losses due to decoupling, does the utility corporation’s overriding incentive still lie in supporting higher generation sales and higher generation market prices? 21

22.  One way to reduce the impact of the utility disincentive issue is to assign the task of providing energy efficiency to another entity.  Independent third party efficiency providers have been established in a number of states. ◦ Efficiency Vermont ◦ Energy Trust of Oregon ◦ Wisconsin Energy Conservation Corporation ◦ Efficiency Maine Trust 22

23. Sonny Popowsky spopowsky@gmail.com 215-279-2915 23