Aligning Interest with Duty: Accomplishing Energy Efficiency Goals. Todd Schatzki, Ph.D. Analysis Group, Inc.

Transcription

1 Aligning Interest with Duty: Revenue en e Decoupling as a Key Element of Accomplishing Energy Efficiency Goals Todd Schatzki, Ph.D. Analysis Group, Inc. Presentation to: National Conference of State Legislatures Fall Forum Advisory Council on Energy BOSTON CHICAGO DALLAS DENVER LOS ANGELES MENLO PARK MONTREAL NEW YORK SAN FRANCISCO WASHINGTON

2 Energy Efficiency Has Become a Central Element of Energy Policy in Many States Energy efficiency supports: Achievement of environmental policy objectives (e.g., climate change) Efforts to reduce consumers total energy costs through implementation of cost-effective energy efficiency State legislatures and regulators are taking action to encourage the development of cost-effective energy efficiency Combination of measures including targets, new incentives and funding, and eliminating market failures (e.g., removing disincentives through decoupling) Massachusetts Green Communities Act (legislature) includes utility requirements and new funding Revenue Decoupling Order (regulator) ARRA provided billions in funding to states for energy efficiency Page 2

3 Revenue Decoupling is Designed to Eliminate a Utility s Disincentive to Promote Energy Efficiency Under traditional regulation, once rates are set in a rate case, reductions in energy use lead to reductions in utility revenues needed to cover costs Linkage between sales and revenues creates a disincentive to the promotion of energy efficiency Revenue decoupling aims to eliminate this disincentive Full revenue decoupling fixes the revenues the utility is allowed to recover A Revenue Decoupling Mechanism (RDM) adjusts rates in each year to account for changes in sales that result in over- or under-collection of revenues in the prior year If actual revenues are greater than the allowed revenue requirement, rates are adjusted downward If actual revenues are less than the allowed revenue requirement, rates are adjusted d upward Page 3

4 Revenue Decoupling is an Important Element of State Energy Policies that Support Energy Efficiency Rankings of State Energy Efficiency Policies Rank State Score Decoupling 1 California 44.5 Yes 2 Massachusetts 39 Yes 3 Connecticut 37.5 Yes 4 Oregon 36.5 Yes 5 New York 34.5 Yes 6 Vermont 33.5 No 7 Washington 33 No 8 Minnesota 30.5 Yes 9 Rhode Island 27.5 No 10 Maine 26 No 11 Wisconsin 24 Yes 11 Maryland 24 Yes Only two of remaining 38 states utilize revenue decoupling (Hawaii and Idaho). Rhode Island is considering i a rate filing including a revenue decoupling proposal. Source: ACEEE, The 2009 State Energy Efficiency Scorecard, October Page 4

5 Effective State Policies Include a Suite of Measures Aimed at Eliminating Disincentives Revenue decoupling complements other state policies and initiatives Revenue decoupling does not substitute for these other policies Why isn t a mandate for the utility to pursue all cost-effective energy efficiency sufficient? Creates a conflict between a utility s obligation to shareholders and obligation to customers (under the law) Fails to align utility s incentives with its duties The desire of reward is one of the strongest incentives of human conduct; the best security for the fidelity of mankind is to make their interest t coincide id with their duty. Alexander Hamilton, The Federalist Papers (essay series), 72, 21 March 1788 Page 5

6 Is Revenue Decoupling Radical? Revenue decoupling is not Traditional but has the same foundations as the traditional approach Both approaches start with a cost-based determination of the allowed revenues Approaches differ in whether rates or revenues are fixed Allowed Revenue Requirement Rates Fixed Total Revenues Vary with Use Total Revenues Fixed Rates Vary to Avoid Over- or Under-Recovery Traditional Ratemaking Ratemaking with Revenue Decoupling Page 6

7 Revenue Decoupling has Important Implications for Other Aspects of Utility Ratemaking Under traditional ratemaking, utilities typically rely upon rising revenues from growing sales to recover increasing costs of operation and capital Decoupling eliminates this source of revenue needed to cover rising costs by fixing revenue requirements Current market environment exacerbates the economic challenges of covering costs 190 Price Indices for Distribution Plant and Consumer Goods 170 Price Index (Janu uary 2000 = 100) Handy-Whitman Distribution Plant - North Atlantic Region CPI - U.S. City Average Jan-00 Apr-00 Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Sources: Bureau of Labor Statistics, accessed April 30, The Handy-Whitman Index of Public utility Construction Costs, Cost Trends of Electric Utility Construction, updated January Page 7

8 Revenue Decoupling has Important Implications for Other Aspects of Utility Ratemaking Two approaches have been used and proposed to adjust allowed revenues Customer growth Allowed revenues set based on per customer revenue requirement But, customer growth has little relationship to actual changes in costs Adjustments designed to track changes in costs Operations and maintenance costs Adjust revenues to level of inflation and level of utility productivity (similar to PBR) Capital costs Adjust revenues given actual capital expenditures as approved by the commission Adjusts the timing of revenue recovery but not the amounts approved for recovery (since under traditional ratemaking, such capital expenditures would roll into rate base in next rate case) Page 8

9 Common Misconceptions Regarding Revenue Decoupling Misconception #1: Revenue decoupling shifts risks from the utility to customers Decoupling allows customers and the utility to share risks associated weather and other factors outside their control that change energy use Misconception #2: Revenue decoupling guarantees the utility s earnings While revenue decoupling does provide revenue stability, it does not guarantee earnings since the utility still must manage its operational costs and is still subject to cost-side risks Misconception #3: Revenue decoupling will lead to large swings in rates Page 9

10 Rate Adjustments from Existing RDMs Have Typically Been Small Revenue Decoupling Adjustments as a Proportion of Total Customer Rates Refund 35 Surcharge Number of annual rate adjustm ments >3% <=3% <=2% <=1% <=1% <=2% <=3% >3% Decoupling rate adjustment Gas Electric Source: Pamela Lesh, Rate Impacts and Key Design Elements of Gas and Electric Utility Decoupling: A Comprehensive Review, June 30, 2009, at Page 10

11 Revenue Decoupling Helps Align Consumer and Utility Interest in Reducing Customer s Total Expenditures on the Much Larger Commodity Charges Commodity and Distribution Rates Under Alternative Ratemaking in Rhode Island RDM and Comprehensive RDR Plan (with Inflation and Capital Cost Adjustments) $14 $12 Standard Offer Energy Commodity Rate Price (Cents/kWh) $10 $8 $6 Distribution Rate Assuming the RDRPlan Had Been in Place for 2003 to 2008 $4 $2 Distribution Rate Assuming an RDM Had Been in Place for 2003 to 2008 $0 Standard Offer Price History Distribution Rate (RDR Plan) Distribution Rate (RDM Only) Page 11

12 Revenue Decoupling as a Key Element of Accomplishing Energy Efficiency Goals Successful pursuit of all cost-effective energy efficiency and other resources (e.g., distributed generation) key to achieving new energy and environmental policy priorities requires a new regulatory framework: Component 1: Revenue decoupling to: Eliminate a utility s disincentive to reducing its sales (historically relied upon to cover rising costs) Better align utility and customer incentives in promoting pursuit of cost-effective energy efficiency By itself, revenue e decoupling may leave e the utility ty with insufficient revenues e to cover rising costs addressing this deficiency requires: Component 2: Ratemaking mechanisms to provide a source of revenues between rate cases to cover rising costs (e.g., future test year, capital adjustment mechanisms) These changes are not radical: Changes are grounded in traditional cost of service principles Changes are a logical evolution needed to achieve new policy priorities and align utility and customer interests in reducing customer energy costs through pursuit of cost-effective energy efficiency Page 12

13 For More Information Contact t Information: Todd Schatzki Analysis Group Inc. 111 Huntington Ave., 10 th Floor Boston, MA tschatzki@analysisgroup.com Page 13

14 Appendix Materials Additional Materials Related to National Grid s Massachusetts Revenue Decoupling Rate Filing Page 14

15 Appendix Materials National Grid s Revenue Decoupling Ratemaking Plan ( RDR Plan ): Basic Framework After the Company s 2009 Rate Case* Class-Specific Base Rates RDR Plan Adjustment Factor Distribution Rates (for each rate class) (for each rate class) (annual change in /kwh) (reflecting the effect of decoupling revenues from sales) + = Reflects the impact of four components: 1. Decoupling revenues from kwh deliveries 2. Impact of inflation since the rate case 3. Impact of cumulative capital additions since the rate case 4. Impact of capital expenditures in the upcoming year, based on formula reflecting average capital spending in last two years. * Note that the first RDR Plan filing occurs at the end of 2010, for an RDR Plan Revenue Adjustment Factor to go into effect on January 1, Page 15

16 Appendix Materials National Grid s Revenue Decoupling Ratemaking Plan ( RDR Plan ): Basic Framework After the Company s 2009 Rate Case* Base Rates (for each rate class) + RDR Plan Adjustment Factor (for each rate class) (annual change in /kwh) = Class-Specific Distribution Rates (reflecting the effect of decoupling revenues from sales) Established in 2009 Rate Case Calculation of the annual RDR Plan Adjustment Factor: Sum of revenues from (1) and (2), below, divided by forecasted kwh deliveries in upcoming year: 1. RDR Plan Revenue Reconciliation: prior year s Annual Target Revenues ( ATR ) minus prior year s actual billed revenue 2. RDR Plan Revenue Adjustment, reflecting three separate components to adjust upcoming year s revenues (using historical information) to reflect the impacts of (a) net inflation, (b) cumulative net capital additions, and (c) incremental net capital additions in the coming rate year. * Note that the first RDR Plan filing occurs at the end of 2010, for an RDR Plan Revenue Adjustment Factor to go into effect on January 1, Page 16

17 Appendix Materials National Grid s Revenue Decoupling Ratemaking Plan ( RDR Plan ): Basic Framework After the Company s2009ratecase* Case The Look Back portion of the process The Look Ahead portion of the process The annual RDR Plan adjustment A RDR Plan Revenue Reconciliation (for each Class) /kwh + B RDR Plan Revenue Adjustment (for each Class) /kwh = C RDR Plan Adjustment Factor (by Class) /kwh Class-Specific: Annual Target Revenue v. Actual Revenue Sum of All Classes Revenue Gaps Divided by Total Company-Wide kwh for upcoming year = Class Revenue Gap Class-specific Revenue Requirement divided by class kwh for upcoming year Adjustment to each class s revenue requirement in the upcoming year allocated using factors from rate case. Annual Target Revenues ( ATR ) = the sum of: (1) Allowed Revenue from Rate Case, plus (2) cumulative Net CapEx for years after the rate case, plus (3) cumulative Net Inflation. 1. Adjustment for Net Inflation: reflecting change in inflation over two previous years less 0.5% productivity offset, plus 2. Adjustment for Cumulative Net CapEx since the rate case 3. Adjustment for Current Year Net CapEx: set at 75% of average annual historical Net CapEx in two prior years. * Note that the first RDR Plan filing occurs at the end of 2010, for an RDR Plan Revenue Adjustment Factor to go into effect on January 1, Page 17