Revenue Regulation and Decoupling

Transcription

1 January 18, 2018 Revenue Regulation and Decoupling An EUCI Workshop John Shenot Senior Associate The Fort Collins, Colorado United States raponline.org

2 From : Retail sales of electricity in the U.S. increased by just 2.5% nationally... and DECLINED in 27 states

3 Introduction The Regulatory Assistance Project is a global, nonprofit team of veteran regulators advising current regulators on energy sector issues. ( Foundation-funded; some contracts Non-advocacy; no interventions John Shenot joined RAP in 2011 after serving three years as policy advisor to the Public Service Commission of Wisconsin and 15 years with the Wisconsin Department of Natural Resources as an air pollution regulator and electric utility specialist. 3

4 Outline for Today s Workshop 1. Brief Review of Traditional Rate of Return Regulation 2. Understanding the Need for Changes to Traditional Rate of Return Regulation 3. What is Decoupling and How does It Address the Throughput Incentive? 4. Options for Designing a Decoupling Mechanism 5. Experiences to Date with Decoupling 6. Alternatives and Complements to Decoupling 4

5 1 Brief Review of Traditional Rate of Return Regulation

6 The Traditional Approach to Revenue Regulation

7 Step 1: Revenue Requirement Revenue Requirement = Test Year Expenses + Depreciation + Taxes + (Rate Base * Rate of Return) 7

8 Steps 2 & 3: Functionalization and Classification

9 Step 4: Allocation The revenue requirement is allocated to different customer classes, e.g.: Residential Commercial Industrial Retail rates are then designed for each customer class to recover the class portion of the revenue requirement 9

10 Step 5: Rate Design Retail rate can consist of separate lines for: Customer charge ($/month) Volumetric charge ( /kwh) May vary with usage, time of year, time of day Demand charge ($/kw) Usually for commercial/industrial customers only Other charges (e.g., taxes) 10

11 How Volumetric Charges Are Set Price/kWh = (Revenue Requirement Customer Service Charge Revenues Demand Charge Revenues) Projected Sales 11

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13 2 Understanding the Need for Changes to Traditional Rate of Return Regulation

14 Drawbacks of Traditional Regulation Averch-Johnson Effect: since utilities earn profit on rate base, they have an incentive to overbuild infrastructure Throughput Incentive: since utilities earn income through selling kwh, they have an incentive to maximize sales 14

15 Actual Revenues Revenues = Customer Service Charge Revenues + Demand Charge Revenues + (Actual Sales * Volumetric Charge) 15

16 Impact on Earnings is Amplified Revenue Change Impact on Earnings % Change in Sales Pre-tax After-tax Net Earnings % Change Actual ROE 5.00% $9,047,538 $5,880,900 $15,780, % 17.53% 4.00% $7,238,031 $4,704,720 $14,604, % 16.23% 3.00% $5,428,523 $3,528,540 $13,428, % 14.92% 2.00% $3,619,015 $2,352,360 $12,252, % 13.61% 1.00% $1,809,508 $1,176,180 $11,076, % 12.31% 0.00% $0 $0 $9,900, % 11.00% -1.00% -$1,809,508 -$1,176,180 $8,723, % 9.69% -2.00% -$3,619,015 -$2,352,360 $7,547, % 8.39% -3.00% -$5,428,523 -$3,528,540 $6,371, % 7.08% -4.00% -$7,238,031 -$4,704,720 $5,195, % 5.77% -5.00% -$9,047,538 -$5,880,900 $4,019, % 4.47% 16

17 Disruptive Forces Could Contribute to a Vicious Cycle Source: EEI 17

18 So, What s the Problem with the Throughput Incentive? Discourages end use energy efficiency Discourages customer-sited resources Distracts from a focus on service, policy goals Is a Risk Factor, promoting revenue volatility Too much other stuff matters for throughput to matter so much! 9

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20 3 What is Decoupling and How Does It Address the Throughput Incentive?

21 What Does Decoupling Do? Adjusts retail rates (prices) and usually revenues between rate cases Relies on found revenue requirement When sales deviate from rate case assumption, rate is adjusted to collect calculated revenue Basis can reflect changes owing to trends or forecasted events, an added level of complexity 21

22 The Decoupling Calculation Periodic Decoupling Calculation From the Rate Case Target Revenues $10,000,000 Test Year Unit Sales 100,000,000 Price $ Post Rate Case Calculation Actual Unit Sales 99,500,000 Required Total Price $ Decoupling Price $

23 Comparing Decoupling with Traditional Regulation Traditional regulation sets prices and lets revenues rise and fall with sales volumes Most non-power costs vary little in the short run with respect to sales If prices are set to recover non-power costs by volume, then lower/higher sales means lower/higher revenues (and profits) Decoupling resets revenues to recover target non-power costs by adjusting the price 23

24 Decoupling Can Reduce the Throughput Incentive Focuses on allowed revenue Rates change to reconcile revenue No change in retail rate design required Multi-year solution Can be designed to achieve desired policy outcomes and protect consumers 24

25 Decoupling Downsides Rates change more frequently (generally by less than power costs) and outside of a general rate case Great success with EE and DG will increase rates, even as total costs may Note that EE participants tend to save far more than rates tend to rise PUC, others unfamiliar with decoupling Delays rate cases, which can be illuminating 25

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27 4 Options for Designing a Decoupling Mechanism

28 RAP Publication

29 RAP Publication

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32 What s Covered?

33 What s Covered?

34 What s Covered?

35 What s Covered?

36 What s Covered?

37 Double Recovery Issue Concern if generation costs are included in the decoupling mechanism that uses RPC. Risk - number of customers increases while generation costs decrease due to depreciation; Fuel, purchase power costs recovered in fuel adjustment mechanisms without an offset of declining investment cost which would be captured in a rate case. If regulators retain FAC, then FAC must account for changes in investment and operating costs if rate cases are not occurring to adjust. Otherwise, the value of generation is overstated.

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41 How to Adjust Revenue?

42 How to Adjust Revenue?

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44 Decoupling & the Cost of Capital Earnings are more stable Utility can carry a lower equity ratio and still protect bondholders from risk of insolvency S&P: ~3% more debt for a utility with decoupling, for the same bond rating 3% more debt (and less equity) means about $3+ million/year in lower revenue requirement per $1 billion of rate base

45 How to Adjust Revenue?

46 The Revenue Adjustment Mechanisms No RAM No adjustment made to revenue requirement; rates adjusted at next rate case Stair-Step These are predetermined adjustments made in the last rate case based on forecasts of projected cost increases Indexing Adjustments to the revenue requirements are tied to factors such as inflation, industry productivity, customer growth

47 The Revenue Adjustment Mechanisms Revenue Per Customer Revenue requirement determined on a per customer basis and adjusted for the total number of customers served Annual Review Decoupling (aka Attrition Decoupling) Rates are periodically adjusted for incremental and decremental known and measurable changes to rate base and operating expenses

48 The Revenue Adjustment Mechanisms K Factor An adjustment used to increase or decrease overall growth in revenues between rate cases Hybrid Allows regulators to combine various RAM mechanisms to adjust rates

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54 How to Handle Refunds/Surcharges

55 How to Handle Refunds/Surcharges

56 How to Handle Refunds/Surcharges

57 How to Handle Refunds/Surcharges

58 How to Handle Refunds/Surcharges

59 How to Handle Refunds/Surcharges

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61 Design Approaches to Protect Customers Symmetry ensure that credits are provided. Stability: cap on rate changes or bands around size of rate adjustment, (e.g. plus or minus 3%) Provisions for carry-over of over or under recoveries Bill simplification

62 Design Approaches to Protect Customers Direct more energy efficiency/ders Decoupling conditioned on comprehensive programs and minimum EE requirements Direct more distribution efficiency Low income provisions Rate design approaches EE programs directed towards LI

63 Design Approaches to Protect Customers Changes to capitalization ratio to reflect risk reductions (Recommended Approach); or Reductions in utility return on equity to reflect reduced risk (e.g., 50 basis points) Controversial among utilities, environmental groups, and consumer groups

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65 5 Experiences to Date with Decoupling

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67 How States Have Approached Decoupling Feature Gas Decoupling Electric Decoupling Revenue change between rate cases Revenue-per-customer 23 4 Attrition adjustment 3 4 No change 3 1 No separate tariff 3 3 Timing of Rate True-ups Annual 19 8 Semi-annual/quarterly 2 1 Monthly 4 3 Weather Not weather-adjusted Weather-adjusted 8 2 Limit on adjustments and/or dead-band 9 6 Per class calculation and adjustments 25 7 Earnings Test 4 Pilot/known expiration date 11 4 Surcharges only 3 Total Utilities Analyzed 28 12

68 Decoupling Rate Adjustments Have Generally Been Small Source: Pamela Morgan 68

69 RAP Publication

70 Six Revenue Regulation Plans Studied Utility Pacific Gas and Electric Idaho Power Company Baltimore Gas and Electric Wisconsin Public Service Corporation National Grid Hawaiian Electric Company State California Idaho Maryland Wisconsin Massachusetts Hawaii

71 Type of Revenue Adjustment Mechanism (RAM) Utility Pacific Gas & Electric Idaho Power Company Baltimore Gas & Electric Wisconsin Pub. Serv. Corp. National Grid Hawaiian Electric Company State Hybrid RPC RPC RPC No RAM; potential capital expenditure adjustment Hybrid

72 Customer Classes Included in Revenue Regulation Utility Pacific Gas & Electric Idaho Power Company Baltimore Gas & Electric Wisconsin Pub. Serv. Corp. National Grid Hawaiian Electric Company State All customer classes Residential & small gen. svc. Residential & small gen. svc. All customer classes All customer classes All customer classes

73 Utility Functions Excluded in the Revenue Regulation Plan Utility Pacific Gas & Electric Idaho Power Company Baltimore Gas & Electric Wisconsin Pub. Serv. Corp. National Grid Hawaiian Electric Company State Energy procurement costs All variable costs Energy supply costs Energy costs Energy supply costs for basic service customers, transmission costs, the energy efficiency system benefits charge and reconciling charge, and costs recovered through the residential assistance adjustment factor Fuel and purchased power

74 Rate Case Requirements

75 Timing & Collection Mechanisms

76 Allocation of Surpluses & Credits

77 Application of Carrying Charges

78 Rate Caps and Collars

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80 6 Alternatives and Complements to Decoupling

81 Alternatives and Complements To Decoupling Alternatives: Lost Margin Recovery Weather-only Normalization Shared Savings Incentive/Penalty Mechanisms Fixed/Variable Rate Design Alternatives/Complements: Rate of Return Incentive Third-Party Administration of EE Programs 81

82 Lost Margin Recovery Lost margin mechanisms measure lost sales due to utility EE programs & provide recovery of the foregone margins Positives: Eliminates utility profit attrition from EE programs Impact on customers easy to explain Negatives: Contentious to calculate May result in utility resistance to codes and standards No measurable benefit to cost of capital Example: Hawaii,

83 Weather-Only Normalization Form of limited decoupling to reflect changes in usage due to weather only, not conservation or economic conditions Positives: Easy to administer Achieves cost of capital benefits nearly equal to decoupling Negatives: Does not address throughput incentive relative to energy efficiency Example: Brooklyn Union Gas Company 83

84 Shared Savings Incentive/ Penalty Mechanism Divide the net benefit of EE investment between utility and consumers; can be in lieu of or in addition to decoupling Positives: Gives utility a combination incentive to both achieve high levels of EE, and to do it at low total cost Negatives: Difficult to explain; complex to administer Utility share must be ~35% to cover lost margins Examples: Washington (PSE ) 84

85 Higher Fixed Charges More distribution costs are recovered in a fixed monthly charge unrelated to usage; charge can be different for different customer types Positives: Simple to administer Effective for utility earnings stabilization Cost of capital benefits Negatives: Usage prices far below long-run incremental cost, impairing economic efficiency Causes significant increases in customer usage Severe bill impacts for small-use consumers Undermines value of efficiency to consumer Example: East Ohio Natural Gas 85

86 Rate of Return Incentive Allow utility a premium rate of return on energy efficiency investment, over and above that earned on general rate base Positives: Creates a positive profit incentive for EE investment Easy to explain to consumers Negatives: Creates a positive incentive to invest, not to conserve Examples: Washington ( ); Nevada ( ) 86

87 Third Party Administration of EE Programs Delegating energy efficiency to a non-utility third-party provider puts programs in the hands of an entity without a lost-margin bias Positives: Throughput incentive is irrelevant Performance has been very good Higher level of oversight is common Negatives: Lower level of coordination with T&D planning Utility still faces lost margins and rate case pressure Examples: Efficiency Vermont; Energy Trust of Oregon 87

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89 7 Closing Remarks

90 Key Take-Aways on Decoupling Traditional approaches to regulation and rate design create a throughput incentive that is inconsistent with the public interest Decoupling addresses the throughput incentive, and: It s flexible, customizable It s been done before, models exist It can serve policy goals It can be designed to protect consumers 90

91 Decoupling Resources Revenue Regulation and Decoupling: A Guide to Theory and Application Decoupling Case Studies: Revenue Regulation Implementation in Six States A Decade of Decoupling for US Energy Utilities: Rate Impacts, Designs and Observations Decoupling Design: Customizing Revenue Regulation to Your State s Priorities raponline.org 91

92 About RAP The is an independent, non-partisan, non-governmental organization dedicated to accelerating the transition to a clean, reliable, and efficient energy future. Learn more about our work at raponline.org John Shenot Senior Associate The Fort Collins, Colorado United States jshenot@raponline.org raponline.org