NATURAL RESOURCES DEFENSE COUNCIL

Transcription

1 NATURAL RESOURCES DEFENSE COUNCIL March 13, 2009 Mary Jo Kunkle, Executive Secretary Michigan Public Service Commission P.O. Box Lansing, MI Dear Ms. Kunkle: Re: U Please accept for electronic filing the following comments of the Natural Resources Defense Council and the attached supplemental map. Respectfully submitted, Rebecca Stanfield Senior Energy Advocate Natural Resources Defense Council 2 North Riverside Plaza Chicago, Illinois N. Riverside Plaza, Suite 2250 NEW YORK * WASHINGTON DC * SAN FRANCISCO * LOS ANGELES * BEIJING Chicago, IL TEL FAX

2 BEFORE THE MICHIGAN PUBLIC SERVICE COMMISSION In the matter, on the Commission s ) own motion, to implement provisions ) Case No. U of 97(4) of 2008 PA 295 ) COMMENTS OF THE NATURAL RESOURCES DEFENSE COUNCIL Public policy makers at the state and federal levels have reached unprecedented appreciation of the enormous potential for energy efficiency to play a significant role in our economic recovery and our response to climate change. Because energy efficiency investments simultaneously reduce energy bills, create jobs and reduce greenhouse gases, legislators and regulators in Michigan and elsewhere are wisely moving to adopt policies to spur investment in energy saving technologies in the utility and building sectors. As of February 2009, eighteen states including Michigan had adopted an energy efficiency portfolio standard for their gas or electric utilities, or for both gas and electric utilities. 1 It serves the public interest if electric utilities, as the public s energy resource portfolio manager, save every unit of energy that is less expensive to capture than it is to generate or purchase the equivalent amount of energy. 2 Tried and true utility energy efficiency programs typically save electricity for less than three cents per kilowatt hour, about one-third the average cost of generation. Unfortunately, traditional rate regulation rewards utilities for selling more energy, and punishes utilities for selling less, thereby 1 ACEEE, State Energy Efficiency Resource Standard (EERS) Activity, February 2009, available at 2 This is particularly true given that current electricity prices are based on the historic cost of generating resources, amounts that are far less than the cost of the next round of investment in generating resources. 2

3 pitting the interests of the utility s investors against the interests of the utility customers, and leaving portfolio managers conflicted at best. The phenomenon known as the throughput incentive has been widely recognized as a significant barrier to broad deployment of energy efficiency technologies. 3 This perverse incentive applies to a utility s fixed costs, which are the costs that do not vary directly with customer usage, such as many operations and maintenance expenses and the costs of capital, including return to utility shareholders. Because most utilities recover their authorized fixed costs according to the volume of customer usage, a utility can collect more revenue for fixed costs than the amount authorized in the most recent rate case if sales are above the levels predicted in that rate case. On the other hand, if sales dip below projected levels, the utility may not collect enough revenue for its authorized fixed costs. Because these costs, by definition, do not change much in the short term, 4 collections related to these costs often directly affect the utility s earnings for a given period. Thus, one can conclude that, generally, earnings go up or down based on sales volume. On March 9, Standard and Poor s issued a paper addressing lender views on energy efficiency. The paper concluded that, in the absence 3 See, e.g.: Regulatory Assistance Project, Revenue Decoupling: Standards and Criteria, A Report to the Minnesota Public Utilities Commission, 5 (2008) ( A utility therefore typically has a very strong incentive to increase sales and, conversely, and equally strong incentive to protect against decreases in sales. This is referred to as the throughput incentive, and it inhibits a company from supporting investment in and use of least-cost energy resources, when they are most efficient, and it encourages the company to promote incremental sales, even when they are wasteful ); National Action Plan for Energy Efficiency, Aligning Utility Incentives with Investment in Energy Efficiency Ch1-p3 (2007) ( Energy efficiency programs can have several financial impacts on utilities that create disincentives for utilities to promote energy efficiency more aggressively Utility concerns for these impacts have had a profound effect on energy efficiency investment policy at the corporate and state level for over 20 years, and the concerns continue to create tension as utilities are called upon to boost energy efficiency spending. ). 4 These costs are subject to inflation and other non-consumption related forces, such as accidents and storms. As explained below, decoupling does NOT guarantee that utilities recover their actual fixed costs; these remain the utility s responsibility. Decoupling only permits the utility revenues equal to the fixed costs the Commission found prudent in a rate case. 3

4 of decoupling, increased energy efficiency penetration has the potential to weaken a utility s credit rating due to the under-recovery of authorized fixed cost. 5 NRDC believes that eliminating this powerful utility disincentive by adopting a simple decoupling mechanism is an essential policy prerequisite to capturing all costeffective energy efficiency. Utilities should rely upon energy efficiency as the first fuel, before turning to any other resource to meet demand. It will be the rare utility, however, that can long choose energy efficiency as its first resource if the consequence is declining earnings, falling credit ratings, and diminished future earnings opportunities. Moreover, as discussed below, neither mandatory standards nor moving to a third-party program administrator materially diminishes the need to align utility incentives so that our utilities are willing partners in the effort to capture all cost-effective energy savings. These comments cover: (A) How decoupling works; (B) Why NRDC favors decoupling as the best of several alternative policy mechanisms that have been developed to address the throughput incentive; (C) State and federal movement toward decoupling; and (D) Answers to some commonly-asked questions about decoupling. A. How decoupling works. The goal of decoupling is to break the link between utility fixed cost recovery and sales, so that the utility s business model is to provide energy service, rather than to sell a commodity. The utility s reward derives from providing that service at the least cost, rather than selling ever more energy. A utility s fixed costs are those costs it will incur regardless of customer s usage in a given period, such as the costs associated with maintaining the distribution network 5 Tony Bettinelli, Standard and Poors, Ratings Direct, When Energy Efficiency Means Lower Electric Bills, How do Utilities Cope? March 9, 2009, available at 4

5 or reading the meters. Regulatory commissions review these fixed, and variable, costs in rate cases, determining the level or revenue requirement that is necessary and prudent for the service. Once the regulatory commission determines the revenue requirement, it divides these costs among the customer classes, estimates sales for each customer class, and sets a per-unit rate designed to provide the utility an opportunity to recover its costs of service if it sells the amount assumed and manages its costs well. 6 In reality, the level of sales is almost always higher or lower than assumed in the rate case. When sales are higher than expected, for example when the summer is particularly hot so that air conditioners use more electricity than usual, the utility collects more revenue from customers than the Commission assumed that it would; when the sales are below projected levels, such as when the economy is sluggish or when aggressive efficiency programs are deployed, utilities collect less revenues than the regulatory commission assumed. Costs will likely have changed as well, just not on the basis of consumption. NRDC supports a simple system of periodic true-ups in rates, designed to correct for disparities between the revenue the utility actually collects for its fixed cost revenue requirement and the revenue the regulatory commission assumed it would collect, and gave it an opportunity to collect, in a rate case. The true-ups would either restore to the utility or return to customers the difference between the revenues assumed in ratemaking and those actually collected. In this system, the reason for the over- or under-recovery is irrelevant; instead, the true-up returns the utility to the rate case assumptions. 6 Rate designs for some customer classes are often more complex than this suggests. A simple customer charge and volumetric charge is most common for residential and small commercial customers. Nonetheless, even for other customers, a significant portion of cost recovery depends on projections of usage or demand. 5

6 B. Decoupling compared to other policy alternatives. While decoupling is gaining momentum across the country, as discussed further below, there are alternative means that some suggest as alternatives, including: (1) Lost revenue or lost margin recovery and (2) Straight-fixed variable rate design. 1. Lost revenue recovery Lost-revenue recovery refers to a system in which the utility estimates the volume of sales that will decline as a result of its energy efficiency programs, calculates the lost fixed-cost revenues associated with those sales, and recovers that amount from customers along with the costs of the energy efficiency programs. NRDC does not advocate for lost revenue recovery for two main reasons. First, the result can easily be to restore revenues to the utility that it never actually lost. Lost revenue recovery is not symmetrical; it considers only the impact of the efficiency programs in lowering sales and excludes any factor, such as weather, that might have increased sales over those assumed in ratemaking during the same period. In the hypothetical scenario wherein a refrigerator recycling program saved electricity, but sales were still high due to increased air conditioning, a lost revenue recovery mechanism would allow an increase in rates when in fact there was no under-recovery of the utility s fixed costs. Second, lost revenue recovery mechanisms do not actually break the link between utility sales and earnings. The utility s incentive to increase sales remains. A utility will still likely resist any changes that would decrease sales, such as stricter building codes, because they would not receive lost revenues to compensate for the related sales declines. 2. Straight fixed variable rate design - 6

7 A second alternative to decoupling is a radical departure from traditional ratemaking known as straight fixed variable rate design (SFV). With SFV, the regulatory commission approves rates in which customers pay a fixed charge per billing period for fixed costs and only the revenues related to variable costs come through a volumetric rate. Although in place for a few natural gas distribution utilities, this method is not used anywhere for electric utilities because the fixed charge would be exceedingly high. Although SFV breaks the link between utility revenues and sales, it does so entirely at customers loss. While it is critical that electric and gas utilities be willing and able partners in the quest to capture all cost-effective energy efficiency potential, it is equally important that customers reap the substantial cost-saving rewards from their investments in energy savings technologies and through their participation in energy efficiency programs. SFV makes energy efficiency and conservation less appealing to customers by reducing the proportion of their energy bill that they can reduce with an energy efficiency investment and thereby increasing the length of time over which that investment in new insulation or a new, efficient furnace will pay for itself with bill savings. In addition, SFV shifts cost significantly from high-volume customers to lowvolume customers, creating unacceptable inequities that traditional volumetric rate design has long sought to avoid. For example, in a recent docket before the Wisconsin Public Service Commission (WPSC), the commission staff offered an exhibit showing that SFV rate design for Wisconsin Power and Light company s gas customers would increase the 7

8 average total (fixed and variable) monthly bill for the smallest users by 62.27%, while lowering the monthly bill for the company s largest users by 11.18%. 7 At least two commissions have rejected SFV for the foregoing reasons. On November 14, 2008, the Kansas Corporation Commission issued a final order in its General Investigation Regarding Cost Recovery and Incentives for Energy Efficiency Programs, Docket No. 08-GIMX-441-GIV. In that order, the commission endorses decoupling, and rejects SFV as a way to address the throughput incentive, stating: Although straight fixed-variable rates are attractive for their relative simplicity and lesser administrative burden, the commission is concerned about their effect on customer inclination to save energy The Commission is also concerned with the potential impact such rate structures may have on lower-income and fixed-income customers. Similarly, on July , the Massachusetts Department of Public Utilities issued an order in its Investigation by the Department of Public Utilities on its own Motion into Rate Structures that will Promote Efficient Deployment of Demand Resources. In the order, the Commission endorses decoupling and rejects SFV design saying: [I]t is possible that setting distribution rates that are closer to the theoretical ideal could mitigate some of the financial disincentives that companies currently face regarding the deployment of demand resources, 7 In the Matter of the Application of Wisconsin Power and Light Company for Authority to Adjust Retail Electric and Natural Gas Rates, Docket No UR-116, Exhibit 60 (RCB-3) of Witness R.C. Bauer. 8

9 However, it would not address all such disincentives Further, as noted by several commenters, the Department must establish rates in a manner that balances a key number of ratemaking principles principles that reflect and address the practical circumstances attendant to any individual company s rate case. For example, any attempt to move quickly to full cost-based rates in which a greater portion of distribution costs would be recovered through fixed rates, could have significant impacts on low usage customers, violating the principle of rate continuity, and in the short run reduce the incentive for customers to reduce their energy consumption. C. Decoupling in other states. The past two years have seen a significant increase in the use of decoupling to address the throughput incentive. To date, sixteen states have adopted decoupling mechanisms for at least one gas utility, while eight states have adopted decoupling for at least one electric utility. Decoupling has either been adopted or is under active consideration in twenty-eight states. Attached to these comments is a map of the states indicating where decoupling has been approved for gas, electric or both gas and electric utilities. Moreover, the federal stimulus legislation is likely to spur additional consideration of decoupling. Section 410 of the American Recovery and Reinvestment Act sets a condition for receipt of state energy program funds that the state will seek to implement two conditions as to gas and electric utilities over which they have regulatory authority: 9

10 A general policy that ensures that utility financial incentives are aligned with helping their customers use energy more efficiently; [T]imely cost recovery and a timely earnings opportunity for utilities associated with cost-effective measurable and verifiable savings. In addition, these objectives are to be achieved in a way that sustains or enhances utility customers incentives to use energy more efficiently, precluding the adoption of the straight-fixed-variable mechanism which would clearly and substantially reduce customers incentives for using energy more efficiently. Notably, on December 30, 2008, the Public Service Commission of Wisconsin approved the first electric decoupling proposal in the Midwest. The commission authorized a four-year decoupling pilot program as proposed jointly by the Wisconsin Pubic Service Corporation and the Citizen s Utility Board of Wisconsin. 8 Currently, an electric decoupling proposal is pending in Indiana for Vectren South s service territory. 9 D. Frequently asked questions about decoupling. 1. Will decoupling lead to cost increases for electric customers? Decoupling does not increase the cost of utility service; it simply ensures that customers pay no more and no less than the fixed costs the Commission found necessary and prudent to provide them utility service. What decoupling does facilitate is cost savings to customers, through the reduced bills energy efficiency makes possible. Because these savings reflect both fixed and variable costs of energy consumption, they generally dwarf any amount of fixed cost true-up resulting from decoupling. 8 Public Service Commission of Wisconsin, Final Decision, Application of the Wisconsin Public Service Corporation for Authority to Adjust Electric and Natural Gas Rates, 6690-UR-119, December 30, Indiana Utility Regulatory Commission Cause No

11 In fact, decoupling adjustments can often be credits to customers, not surcharges. For example, the first rate adjustment for Idaho Power s March 2007 mechanism resulted in the return of $2.4 million to its customers because the utility had over-recovered its fixed cost revenue requirement during that period. Without decoupling, Idaho Power s customers would simply have lost that $2.4 million. Similarly, for PacifiCorp in Oregon over a three-year test period, the largest annual rate increase for any customer class was 1.9 percent, and out of a total of 15 rate adjustments, seven resulted in rate reductions. This March, the Lawrence Berkeley Laboratories released a study in which they modeled the impact on customer bills of energy efficiency program with and without full decoupling and other incentives for a prototypical southwestern utility. This study concluded that over a 20-year planning horizon, the energy efficiency programs saved customers between $1 billion and $2.32 billion, lowering bills by 3-6%, with or without the decoupling mechanism. The modeling projected a barely perceptible impact of the decoupling mechanism on the consumer savings totals Why not use 3 rd party energy efficiency administrators to avoid this conflict? In some jurisdictions, ratepayer funds for energy efficiency programs are collected by the utility and passed on to a third party non-profit or government organization to administer the programs. Some argue that this approach eliminates the conflict in utility incentives when energy efficiency goals conflict with the throughput incentive. While there are both pros and cons to this approach depending on the situation, decoupling plays an important role even under third party administration. 10 Financial Analysis of Incentive Mechanisms to Promote Energy Efficiency: Case Study of a Prototypical Southwest Utility. Peter Cappers, Charles Goldman, Michele Chait, George Edgar, Jeff Schlegel, and Wayne Shirley. Ernest Orlando Lawrence Berkeley National Laboratory. March

12 Absent decoupling there is still a significant conflict in that the utility will be seeking ways to increase sales to counteract the impact of the efficiency programs on their revenue recovery. For example, the absence of decoupling helps explain decades of gridlock on building efficiency standards in many jurisdictions as electric and gas utilities fight to maintain market share, and resist any language that might influence fuel choice even marginally. The key here is that the case for decoupling is largely independent of the model states adopt for administering efficiency incentive programs; whatever the model, it doesn t make sense to retain a strong financial incentive for utilities to promote increased retail energy sales. 3. Doesn t decoupling shift risk to customers? Decoupling removes risk from both customers and the utility. Customers no longer have the risk of paying more than the utility s authorized fixed costs and the utility no longer has the risk of collecting less revenue than necessary to cover its authorized fixed costs. Some believe that, prior to decoupling, customers already compensate the utility for its risk of collecting less than its authorized fixed cost as part of the utility s cost of capital. Thus, eliminating this risk with decoupling does not shift it but requires a review of the utility s cost of capital to ensure that it remains comparable to the return on investment achievable in industries with comparable risks. This is not knowable in isolation and before the financial markets gain an understanding of how decoupling will work over time. The effect of decoupling on a utility s cost of debt will become apparent in the basis differential the utility must pay to issue new debt and, if the regulatory commission establishes the cost of debt based on actual issuance cost, customers will receive this benefit over time. Return on common equity is usually the result of 12

13 regulatory commission judgment and the outcome of quantitative analysis, such as the discounted cash flow and capital asset pricing models. Presumably these models will reflect the extent to which equity investors require a lower return on investments in the utility because of decoupling. This is not a process of subtracting so many basis points per individual risk associated with the utility enterprise, however. 4. Is decoupling single issue ratemaking? No. Single issue ratemaking commonly refers to changing rates for an isolated change in the utility s cost structure without an examination whether other cost elements have changed. Many regulatory commissions use this approach for the cost of purchased natural gas for natural gas distribution utilities and the costs of fuel and net power interchange for electric utilities. More recently, this approach has applied to the costs of energy efficiency programs, with environmental remediation, with transmission and distribution system additions or with pipe replacement projects. Decoupling ensures the utility receives no more nor less than the total fixed cost revenue requirement the regulatory commission last approved in a rate case. In other words, it addresses revenue, not cost. Although hypothetically a utility s fixed costs could decline so far that it would be unreasonable to allow it to collect the last approved level, it is difficult to think of a single instance where this has occurred. 5. Doesn t decoupling deprive customers of the benefits of regulatory lag? No. Regulatory lag refers to the period between when a regulatory commission or a utility determines that its last authorized revenue requirement is too high or too low, respectively, triggering a rate case filing, and the resolution of that rate case. Decoupling means that changes in revenues resulting from changes in consumption no longer 13

14 contribute to this determination of need for a rate case. Instead, rates will change when underlying costs change sufficiently to warrant a case. Because cost reductions from the last authorized revenue requirement improve a utility s income for the period, many believe that a relatively long period between rate cases helps ensure that utilities are costconscious and operate efficiently. Others believe that regular rate cases are necessary whether or not costs have changed much. Decoupling does not reduce a utility s incentive to manage costs because the mechanism works only on revenues. Reducing costs will still benefit the utility s income and incurring higher costs will hurt it financially. CONCLUSION: For the foregoing reasons, NRDC respectfully urges the adoption of a decoupling mechanism for both gas and electric utilities in Michigan, to advance the goals set out in P.A. 295 to increase investment in energy efficiency resources and increase reliance on resources that are indigenous to the state. 14

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