Utility death spiral: Is decoupling a dumb idea?

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In an era that demands conservation and efficiency, the "traditional" utility business model doesn't work anymore. It links a utility's revenues to the amount of electricity it sells. Therefore, it has no economic incentive to be more efficient. (Why spend more to make less.)

 

I've always thought that decoupling was a dumb way to address this challenge. It is arcane, complex and cumbersome. Even so, it may be better than nothing. In the guest article below, the Wired Group's Paul Alvarez provides answers to some of the questions posed by decoupling opponents.

 

Paul recently stopped by to explain the hard questions to ask BEFORE choosing a smart grid communications network. As before, this article is excerpted from his new book Smart Grid Hype and Reality: A Systems Approach to Maximizing Customer Return on Utility Investment. Click the link to buy the book at a special discount for Smart Grid News readers. – Jesse Berst

 

By Paul Alvarez

 

Decoupling and the smart grid lost revenue challenge

More than 50% of the direct economic benefits available in an ideal smart grid deployment stem from energy conservation (as a result of time-varying rates, prepayment, and conservation voltage reduction capabilities).

 

Unfortunately, utilities employing traditional ratemaking practices are economically penalized when sales volumes drop. The implication is that utilities are not maximizing the conservation value of smart grid capabilities. While there are several potential solutions, including radical regulatory reform as currently being contemplated in New York (Case 14-M-0101), decoupled ratemaking is certainly one solution regulators, governing boards, and utilities should be considering in the short term.

 

 â€œDecoupling” sales volumes from revenues in ratemaking

Though the details of decoupled ratemaking can be extremely complicated, we will try to simplify to the basics here. “Decoupled” ratemaking is so named as it eliminates the link between -- that is, decouples -- sales volumes and utility revenue.

 

In doing so, it eliminates utility incentives to increase sales volumes and disincentives to reduce sales volumes once rates are set. Regulators in 13 states and the District of Columbia have implemented decoupling for electric IOUs, and a very small but increasing number of nonprofit utilities are doing so.

 

(California, Delaware, Hawaii, Idaho, Indiana, Maryland, Massachusetts, New Hampshire, New Mexico, New York, Oregon, Vermont, Wisconsin, and the District of Columbia have adopted decoupled electric ratemaking processes for investor-owned utilities.)

 

Decoupled ratemaking is being used with only a handful of the thousands of electric utilities operating worldwide today, hinting at the complexity and controversy associated with it as well as a distinct lack of interest in it exhibited by electric distribution utilities historically.

 

Breaking the link between sales volumes and cost recovery

Though there are a variety of approaches, decoupling eliminates the link between sales volumes and cost recovery by adjusting rates — either up or down — as actual sales volumes become known. As sales volumes drop, rates per kWh increase; as sales volumes rise, rates per kWh decrease. These adjustments are made without a rate case and are usually limited to a defined range (generally, plus or minus 2% or 3%). Adjustment time frames vary, but quarterly adjustments are common.



 

Decoupling reduces a utility’s incentive to reduce costs. Decoupling does not guarantee profits but only assures a level of revenue. By removing the incentive to increase profits by increasing sales volumes, cost reduction remains (outside of capital investment) the only means available for an IOU to increase profits once rates are set in a rate case. In fact, one could argue that a utility’s incentive to reduce costs is actually increased, as decoupling should reduce rate case frequency. (Cost reductions enjoyed by a utility prior to a rate case become customer benefits in the form of reduced rates after a rate case, meaning that utilities prefer to delay rate cases in times of falling costs.)

 

A reduction in rate case frequency is also cited by customer advocates as a drawback to decoupling, but this can be resolved through mandated rate case frequency (for example, every three, four, or five years). This can help ensure that revenues obtained through decoupling mechanisms do not stray too far from a utility’s underlying costs, and that customers are periodically rewarded from a utility’s cost reductions.    

 

Decoupling reduces a utility’s incentive to restore power quickly. Traditional ratemaking provides utilities with an economic incentive to restore power quickly, as every minute the power is out represents lost revenue. It is indeed true that decoupling removes this economic incentive. However, the incentive to restore power quickly can be addressed by removing the impact of outages in the sales volumes used to calculate a decoupled rate adjustment, or by adding or strengthening a “speed of restoration” component to performance-based ratemaking incentives.

 

Of course there are other ways to remove a utility’s disincentive to pursue smart grid conservation opportunities – including adjusting rates for anticipated sales volume reductions, offering DSM program credit for smart grid-related conservation(with corresponding adjustments to conservation targets, of course), increased use of demand rates (also known as straight fixed-variable rates), and radical regulatory reform of the sort underway in the U.K. (Ofgem’s RIIO regulatory model). Each option has its pros and cons. But in the interest of maximizing benefits for customers, regulatory, governance, and ratemaking issues that limit or discourage optimization of smart grid capabilities should be carefully and thoroughly examined as part of every smart grid investment decision.

 

For a more thorough discussion on decoupling concepts, approaches, pros, and cons, please see “Revenue Regulation and Decoupling: A Guide to Theory and Application” by the Regulatory Assistance Project.

About the Author

Paul Alvarez is President of the Wired Group and author of Smart Grid Hype & Reality -- A Systems Approach to Maximizing Customer Returns on Utility Investment. To receive a 20% discount off the Smart Grid Hype and Reality cover price reserved especially for Smart Grid News readers, please click here.