Decoupling is all the rage. The Obama campaign has made it a key part of their plan (as David gushed here), and many states have instituted decoupling proceedings to change the way that their electric and gas utilities get paid.
The good news on decoupling is directional; utilities currently have a strong incentive to keep their customers from investing in energy efficiency, and decoupling provides a way to address that.
But decoupling is hardly a panacea. We need quick, large-scale changes in fossil energy consumption to address climate change. From my vantage point, we need a long-yardage pass play, and decoupling -- while still heading down the field -- is a short-yardage running play up the middle.
In all cases though, as the decoupling concept gains momentum, it is critical we understand the nuances. Here is my attempt to provide some .
First off, I must admit that I have learned almost everything I know about decoupling from the good people at the Regulatory Assistance Project. (Note to any policy-makers reading this post: If you want to institute decoupling proceedings, go directly to RAP. Do not pass go.)
Theory of Decoupling
The basic idea of decoupling is as follows: regulated utilities have to spend a lot of money on capital investment that is fixed (power plants, wires, pipes, etc.) They have to pay for this capital regardless of how much energy they sell. Meanwhile, their revenues are earned largely on a variable basis (e.g., per MWh of power consumed). As a result, a small reduction in their sales has a big impact on their profits, and therefore on their ability to return money to their shareholders. As Wayne Shirley of RAP points out here [PDF] (see p. 14 in particular), a 5 percent fall in sales for a utility can reduce their profits by 59 percent. Needless to say, this provides a strong incentive to make sure sales don't fall.
Historically, this has led to a plethora of utility rates that stand in direct opposition to the public interest from tiered pricing schedules that depress the value (to the consumer) of a MWh of conservation to special "cogen-killer" rates that provide big industrial customers with discounts as long as they agree never to cogenerate their own power. In a competitive business, such rates would be anti-trust violations ... but monopoly utilities aren't subject to anti-trust regulations, and have therefore promulgated a century of rates and practices that create massive barriers to energy efficiency.
Enter decoupling. The idea behind it is that if you "decouple" utility revenues from their sales, you remove the implicit penalty to utility shareholders caused by efficiency.
... But It's Tricky
As you might imagine, it's a bit complicated. The easiest way (which amazingly, I have heard utilities ask for) is simply to convert all utility tariffs from a c/kWh charge to a $/month charge. Presto: rates are decoupled! Utilities get paid the same amount of money every month, regardless of what their customers do.
The problem with such an approach, of course, is that it also removes any incentive for the customer to conserve. (If your monthly utility bill doesn't vary with use, there not only is no incentive to install a solar panel on your roof, but there's also no incentive to close your refrigerator door.) The best approaches (like RAP's) work by keeping customer rates on a $/MWh basis, but changing the way the way that these rates translate into utility revenues.
Without getting into the details, you can think of this as essentially a formula to reset utility revenue targets (and therefore c/kWh rates) on a regular basis, such that as total kWh sales change, utilities always get the same amount of money.
The good news is fairly obvious: Utilities no longer get penalized every time their customers conserve. But the bad news isn't to be dismissed. In particular:
- It removes a disincentive, but doesn't actually create an incentive. To RAP's credit, they have recognized this and recommend that decoupling be coupled with a so-called "Performance-Based Rate" that lets utilities make more money if the efficiency of their system goes up. It's a good idea, but far from universal in the decoupling conversation.
- It essentially transfers risks from the utility to the customer. In a pre-decoupling world, utilities are exposed to the risk of economic, weather, and efficiency-related load volatility. In a decoupled world, some or all of these risks are transferred to customers, who can now see higher rates per MWh as their MWh consumption falls. Maybe this is a net positive, but there is clearly a cost that ought to be acknowledged any time one is transferring risk to the consumer.
And now, the complicated news. Here we get into the really interesting parts and the nuance lost in much of the decoupling conversation.
- The theory of modern utility rate design is that utility returns on capital should be commensurate with utility risk. This is a central idea of all capital budgeting, which makes perfect sense on a moment's reflection. (If you were considering two investments, and in one of them you could lose all your money while in the other one you could never lose your money, you would be unlikely to invest in the first idea unless it had a much higher "upside.") So since decoupling reduces the risks faced by the regulated utility, shouldn't it also reduce their returns on equity? (In other words, shouldn't decoupling be "coupled" to a reduction in utility rates?) The answer is an overwhelming yes, especially since decoupling is transferring that risk to the consumer, who ought to be compensated. But to the best of my knowledge, this is largely omitted from the current decoupling conversation.
- The fact that utility profits fall disproportionately as their revenues fall also works the other way, with utilities earning massive increases in their overall profitability with small increases in revenues. As a result, the utilities that have been quickest to embrace decoupling are those with falling sales, while those who are most hostile to the concept are those with rising sales. This creates odd bedfellows and odd tensions, but most interestingly, it forces rate-makers and utilities to acknowledge a flaw in the regulatory process that has previously been easy (and convenient) to overlook.
But the biggest issue goes back to the need for a long-bomb to the end zone. The problem with modern utility regulation isn't rate design, but the innate conflict of a for-profit company with a government-guaranteed monopoly. Such an enterprise always finds itself in a situation where the interests of its customers are directly opposed by the interests of its shareholders. Decoupling doesn't address this problem; it simply adds a wrinkle to the rules within that framework. This "tweaking within the paradigm" has the benefit of being politically relatively easy, but when the world needs a paradigm shift, it is not sufficient.
So should we decouple? That depends on your ambition and political calculus. But in all cases, we should not confuse this short-term triage with a long-term solution.
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Comments
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EJLightning Posted 6:47 am
04 Nov 2008
The one thing you mention (and something I hear often about decoupling) is the idea that all this risk is shifted to the customer. I can't speak for all utilities and rate plans, but ultimately this belief can be placed into question since utilities already recapture losses with fuel charges, rate increases, etc. It seems more that the shift is simply in the timing in which the customer sees the impact of events, with decoupling keeping charges more up to date.
Also, one bonus that wasn't mentioned was that with the utility's disincentive to promote efficiency removed, there's a better chance for costly load building projects to be delayed and for other costs to be kept lower over the long run, helping to keep rates below what they would have been (which, sadly, is a really ambiguous savings to conceptualize).
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Sean Casten Posted 7:33 am
04 Nov 2008
RAP has pointed out in their analyses that you can structure these adjustments so that they are not automatically done for weather-related load increases/decreases. I suppose theoretically you could probably also come up with a way to also protect the customer from changes associated with economic activity (in other words, separate the adjustments associated with factory shutdown from those associated with factory conservation). I mention that only because there is at least a concept out there where not all the risk for load variability is transferred to the customer - although again, this nuance is not necessarily built into every decoupling conversation.
To the extent that current risks are transferred to customers, you are right in the long-term, but not in the short term. A modern rate case is a big, complicated thing that neither the utility nor the utility commission wants to do very often. (Indeed, a part of the reason that fuel-riders are so popular is that the regulator and the regulatee both benefit from not having to file for a new rate when fuel prices swing.) As a practical matter, this puts something like a 5+ year lag between rate cases. Once passed though, a utility only has an incentive to request another rate case if their cost structure has changed unfavorably - and as such, you can make a reasonably-informed judgment about your utility's profits by the time since they last filed a rate. The longer that time, the more likely that they think the light of a rate case might lower their rates, and are happy to stay silent. This matters because while the risks of cost increases are transferred to customers (at least in 5 year intervals), the utilities get to keep a disproportionate amount of the gain when cost structures change in their favor. (This most often happens when sales increase but costs do not.) In other words, while your read is right that decoupling impacts the timing of those changes, don't underestimate the time-value of money, or the ways in which current rate making disproportionately shares that value. To try and boil this all down somewhat more clearly, modern rates do allow mechanisms for the risks associated with cost increases to be passed along to consumers. They do not provide nearly as effective a mechanism for risks associated with revenue changes, nor for cost decreases to be transferred to consumers.
Last point is semantic, but important. You wrote that decoupling removes "the utility's disincentive to promote efficiency". This isn't quite right. It removes the utility's disincentive from load-sited efficiency, regardless of whether or not they promote it.
(As to your question about the value of deferring capex, RAP has good suggestions to do that as well... but that's another conversation. Check their website!)
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EJLightning Posted 2:48 am
05 Nov 2008
As for semantics... yes, if my wording sounded otherwise, my intention was along the lines you mentioned. It was probably my personal belief that, in such a case, promoting efficiency would make the most logical sense.
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stopgreenpath Posted 3:55 am
05 Nov 2008
the biggest scam of all is the 100% guarantee on all "infrastructure" projects, whether or not those projects are in the ratepayers' best interest. frankly, ratepayers owning their own PV/microwind systems and getting FITs is the only program that is in the ratepayers, taxpayers and environment's best interest, and is a fairly effective "decoupling" mechanism. we do not need a single additional remote power plant or lengthy powerline in a renewable era - the only reason they make sense is because of poor policy, including amortization of capital costs across all ratepayers
the second biggest scam is having the utility in charge of all conservation and efficiency programs for the state. the highest rates of ratepayer conservation are consistently found with feed in tariffs (not net metering, not decoupling), yet since utilities are greedy and want to own all the generation capacity, they will NOT support the truly effective conservation programs. there is no way around the blatant, mercenary and totally environmentally devastating impacts of having companies who are only in the business of increasing energy consumption, be the only ones overseeing conservation programs.
it would be laughable if hundreds of millions of acres of wilderness were not now under the axe for more of their bullsh** "infrastructure" and if millions of CA ratepayers weren't being totally ripped off, both in real costs and opportunity costs, because the CPUC and state govt. are totally in the pockets of Big Energy, including Big Solar and Big Wind.
massive deployment of ratepayer owned, oversized renewable energy systems, coupled with feed in tariffs, is the only program that makes any sense at all for conservation, for GHG reduction, for environmental protection, for taxpayer value, for eminent domain prevention, for increased system reliability and decreased grid congestion, for property values, for local skilled jobs, for economic stimulus, and for PUBLIC PARTICIPATION in the green energy paradigm as more than mouth-breathing hijacked consumers of increasing amounts of energy.
the greenest energy is that which you needn't ever produce.
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anotherID Posted 10:07 am
05 Nov 2008
BANANA or CAVE dweller?
let the people decide
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