National Association of State Utility Consumer Advocates NASUCA

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Regulatory Issues for Consumer Advocates in Rate
Design, Incentives Energy Efficiency
David E. Dismukes, Ph.D. Professor Associate
Director Center for Energy Studies Louisiana
State University
National Association of State Utility Consumer
Advocates (NASUCA) Gas Committee Monthly
Meeting Tuesday, February 13, 2007
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Current Motivations for Energy Efficiency

• High natural gas prices and volatility.
• Gas impacting power more significantly at the
  margin.
• Changing usage patterns.
• Emerging need for baseload capacity.
• Regulatory need to do something soon.
• Increasing environmental concerns and perceived
  long-run fossil fuel supply risk.

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Daily Henry Hub Prices (1998 to Present)
Increased price levels and volatility faced by
LDCs
As of January 31, 2007, natural gas was trading
at 7.75/Mcf
average for period since 2000-2001 heating
season 5. 71 (standard deviation 2.31)
Dollars per Mcf
5-year average through 2000 2.89 (standard
deviation 1.46)
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Source The Intercontinental Exchange
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Natural Gas Impacting Power at the Margin
Increased natural gas prices are also impacting
electric utilities through their own generation
and purchased power.
Natural Gas Spot Price - /Mcf
Electric Spot Price - /MWh
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Source The Intercontinental Exchange
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Perceived Utility Incentive Issues

• Rate design practices send the wrong signals to
  utilities.
• Rates are tied to sales, and in order to increase
  profits, utilities need to increase sales.
• Utilities will not promote energy efficiency
  since lower sales result in lower profits.
• The profit incentive to increase sales is
  extremely powerful.

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Basic Rate Design Structure (Base Rates)
Distribution Bill Fixed Customer Charge
Variable Charge

• Traditional distribution rate design in utility
  regulation is referred to as two-part tariff
  consists of a fixed customer charge, and variable
  usage charge exclusive of fuel (kWh, MMBtu).
• Also referred to as a non-linear tariff since
  average rates will fall as usage increases.
• Use of this type of pricing claimed to date back
  to Jules Dupuits work on the Utility of Public
  Works, with further work by Frank Ramsey (1927).
  see Wilson, Non-Linear Pricing.
• Use of this type of tariff in utility pricing is
  dated back to the early part of the 20th century
  by an English engineer named John Hopkinson. see
  Kahn, Economics of Regulation.
• Since that time, there have been numerous utility
  pricing structures based off the two-part tariff
  approach.

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Examples of Various Rate Design Structures
flat rate per period, no usage charge
uniform flat rate per unit
declining block
inverted block
seasonal or time-of-use
Period2
Period1
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Source From similar example provided by NRRI.
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Common Types of Revenue Neutrality Programs

• Straight-Fixed Variable Rate Design eliminates
  all variable distribution charges and assigns
  fixed customer charge alone (gas LDCs).
• Sales-Revenue Decoupling separates revenue
  recovery from sales (sets annual revenues to a
  per-customer target.)
• Sales-Margin Decoupling separates margin
  recovery from sales (sets margin per customer
  target).
• Lost Revenue allows specific recovery of lost
  revenues associated with specific DSM program
  offerings.

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States with Energy Efficiency Programs
Decoupling Status
State has energy efficiency program, decoupling
is not used (13 states)
State has energy efficiency program, decoupling
was proposed but not adopted (5 states)
State has energy efficiency program, currently
investigating decoupling (5 states)
State has energy efficiency program, decoupling
has been approved for at least one utility (6
states)
State has no energy efficiency program,
decoupling has been approved for at least one
utility (1state)
Note In Connecticut, the electric utilities do
not have decoupling, but two natural gas LDCs
have a partial decoupling mechanism in connection
with their energy efficiency programs for
low-income customers (a conservation adjustment
mechanism). Washington has utilities with
decoupling, but rejected the most recent utility
proposal (January 2007).
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States With Decoupling Mechanisms
Program Conditions
State
Utah

• Pilot program, open to review at the end of 2007
  with potential modification.

• Only 50 percent of revenues eligible for revenue
  decoupling, 25 percent used for E.E. programs,
  and 25 percent used for rate reduction

North Carolina
Oregon

• Revenue decoupling capped at 90 percent of
  balances.

Maryland

• Revenue per customer cap, with monthly true-up

• Three year pilot program, no changes in rates
  allowed until a full year of usage has occurred.

New Jersey
California

• Full, traditional revenue decoupling approach.

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States that have Considered SFV
State has rejected SFV (3 states)
State has rejected SFV but allowed some increase
in customer charge (3 states)
State has adopted SFV (2 states)
State has been proposed but still under
consideration (1 state)
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Arguments In Favor of Revenue Neutrality

• Aligns utility incentives with energy efficiency.
• Assists utility in earning its authorized rate of
  return that is challenged by the decreasing use
  per customer problem (gas).
• Easier for customers to understand and reduces
  bill volatility.
• Reduces regulatory costs and the need for
  frequent rate cases.

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Common Reasons for Rejecting Revenue Neutrality

• Represents a significant departure from
  traditional regulation.
• Shifts sales risks from utilities to customers.
• The impact of changes in use per customer for the
  gas industry are overstated and address the wrong
  causes on changes in margins. Power industry
  faces an entirely different set of usage trends.
• At best, the incentive issue is not resolved and
  never can be with revenue decoupling.

• Current proposals, offered in conjunction with
  other regulatory remedies diminishes the
  simplicity argument and raises questions about
  the purpose of proposal.
• Proportionality issue changing the rate design
  for all customers based upon programs for which
  an exceptionally small percentage of the
  customers will participate.
• Is actually contrary to sound economic
  principles and well-grounded regulatory
  policies.

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Shift in Regulatory Approach

• Base rates are typically fixed and based upon an
  allowed rate of return under traditional
  regulation
• Between rate cases, actual rates of return can
  vary from allowed.
• Regulatory lag can provide important incentives
  and has been harnessed in many incentive
  regulation structures.
• Between rate cases, it is up to the utility to
  manage risk associated with sales (revenue) and
  find opportunities for efficiency (cost).
• Revenue decoupling and other revenue neutrality
  mechanisms substantially reduce, if not eliminate
  the need to manage sales risk between rate cases.

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Revenue Decoupling Changes Profitability Risk
Traditional Regulation
Revenues Variable
Costs Variable
p R - C
(Profits Revenue less Costs)
Revenue Neutrality
Revenues Fixed
Costs Variable
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Risks that are Shifted to Ratepayers
Economy
Weather
Commodity Prices
Other Unanticipated Factors
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US Residential Natural Gas Use
While overall use per customer is decreasing,
overall residential natural gas usage is flat to
increasing.
Total Consumption - Tcf
Per Customer Consumption - Mcf
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Source Energy Information Administration, US
Department of Energy
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US Natural Gas Price Trends Wellhead to
Burner-Tip Price
Retail prices have increased significantly since
2000-2001.
Prices - per Mcf
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Source Energy Information Administration, US
Department of Energy
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US Natural Gas Price Trends Wellhead as a Percent
of Burner-Tip Price
The commodity share of overall natural gas rate
has increased over recent years.
Wellhead as Percent of Burnertip -
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Source Energy Information Administration, US
Department of Energy
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DNG Revenue per Customer
Yet despite high prices, and decreases in use per
customer, overall DNG revenues per customer are
at close to historic highs.
per customer
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Source Energy Information Administration, US
Department of Energy
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Declining Average Use State Comparison
States with highest decreases in use per
customers tend to also have the highest overall
customer growth. New, fast growing areas present
growth problems for LDCs.
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Summary Financial Impact of Changes in Use and
Customers, Wild West Utility (2001-2005)
Wild West LDC is facing significant growth
challenges ROE impacts of decreases in use per
customer pale in comparison to change in rate
base and new customer capital expenses.
Is decoupling a solution to the use per customer
problem or an end-run on a rate case?
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Wild West Utility Average and Incremental Investme
nt Trends
Wild West LDC is seeing big differences between
average plant cost per customer and incremental.
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Wild West Utility, Estimated DNG Revenue Loss
Assumes 1 Reduction in GS-1 Annual Decatherms
Typical energy efficiency advocate/LDC example
one percent decrease in annual sales will result
in significant revenue (financial) harm to
utility.
Do you really want the LDC to suffer a 9 million
loss for doing the right thing?
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Incremental Impact of DSM Implementation on
Shareholders, Wild West Utility

• Reduced revenues/income reduces overall taxes and
  needs to be considered.
• A one percent per year (3 percent cumulative)
  reduction is beyond current experience.
• The additional income created by customer growth
  from the test year is completely ignored (and its
  corresponding income effects).
• Net impact for a growing LDC is moderate the
  net income impact is still positive, not negative.

Exaggerated Example
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Incentive Issue

• Revenue decoupling, at best, removes a
  disincentive and does not provide an active
  incentive for utilities to promote DSM/energy
  efficiency.
• In many instances, utilities will argue for
  additional mechanisms to incent the utility to
  promote energy efficiency.
• These mechanisms, rarely address some real
  incentive issues for energy efficiency
• Corporate culture
• Earnings and rate base

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Common Proposals Accompanying Revenue Neutral
Difficult to accept the simplicity argument
when utilities typically propose a potpourri of
adders and trackers alongside revenue neutrality.

• Purchased Gas Adjustment/Power Recovery
  Mechanisms
• Weatherization Clauses
• Shifts to 15 Year Normalization Periods
• Infrastructure Recovery Riders
• Lost and Unaccounted for Gas (LAUF) in PGA/GCR
• Uncollectibles Rider

Customer groups are tracker fatigued.
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Proportionality Issue
Significant change in rate design for a very
small change in overall sales and very limited
number of customers.
Generally, less than one-half of one percent.
Source S. Tegen and H. Geller, Natural Gas
Demand-Side Management Programs A National
Survey. Boulder, CO Southwest Energy
Efficiency Project. January 2006. Based upon
surveyed findings of the top ten gas utilities in
2004.
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Sound Economic Principles
Efficiency criteria SRMC P
Tempering Principle and Practice
Challenge

• Economic principles alone would suggest that all
  costs should be variable and based on marginal
  costs
• Problem meeting this criteria for natural
  monopolies with declining costs.
• Suggests that some level be recovered in fixed
  charge, but how much?
• Wide range of literature on price discrimination.

Cost Characteristics

• Often expensive or impossible to make finely
  tuned calculations.
• Difficult to perfectly segment demand to allocate
  those fixed costs failure to do so would
  represent another form of inefficiency.
• Joint common costs can confound.
• Optimal rate design could suggest that
  (relatively) low load factor/low elasticity
  customers should have relatively higher variable
  charges, and vice versa.

Measurement Issues

• SRMC can be at, above, or below ATC at any point
  in time.
• Fixing all capacity costs to a single charge
  challenges short run versus long run capacity
  utilization and can ultimately lead to
  overcapitalization.
• Embedded costs versus long run forward looking
  costs one cant be ignored at the expense of the
  other.

Dynamic Considerations
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What About Sound Policy Principles?

• Equity do these proposals impact customer
  classes equally and it not are there any sound
  reasons for the departure?
• Fairness is this fair within customer classes?
  How does this impact low usage or low income
  customers?
• Continuity what are the resulting rate impacts?
  Do these result in significant changes and how
  will those be accepted by ratepayers?
• Cost of Service Principles do the pricing
  proposals follow precedent and are there any good
  reasons for departure?
• Conservation do the pricing proposals promote
  the efficiency use of distribution services?

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Revenue Neutrality Mechanisms Are Not the Only
Options

• Projected test years forecasts could account
  for anticipated energy efficiency savings.
• Cost-effectiveness tests screening on
  RIM-passing measures only.
• Lost Revenues (ex post) periodic filings on
  proven, ex post lost revenues/sales.
• Rate design (inclining blocks) higher rates in
  upper blocks.
• Repression adjustments usage adjustment to
  correct of DSM-related reductions in usage.
• Direct Incentives performance-based incentives
  for programs.
• Risk Management if volatility is an issue, then
  manage it.
• More frequent rate cases traditional approach at
  correcting rates that get out of balance.

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Revenue Neutrality Adjustments

• Caps absolute dollar caps can be placed on the
  balances to ensure any pass throughs are limited.
  
• Statistical Recoupling using empirical
  information from load forecasts to recouple the
  risk associated with weather, economy, and prices
  back to utility.
• ROE Adjustment lower the allowed ROE to reflect
  changing risk.
• K Factor or Z Factor built in efficiency
  adjustment to recouple risk back to utility.

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Recommendations on ROE Risk Factor Adjustments
For Revenue Neutrality Mechanisms
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Natural Gas Usage Share of Total Consumption
Total Natural Gas Usage
Increase by Sector
4.4 increase
Commercial 3 percent
Electric Power 97 percent
Industrial consumption has decreased in the past
decade, residential usage flat.
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Opportunities on Generation Supply Side Efficiency
There are considerable power generation
(supply-side) options laying on the floor right
now. In 2004, there was some 1.6 Tcf of
gas-fired generation associated with high
heat-rate units.
Perhaps utilities should address issues
associated with their own efficiency before
drawing sweeping conclusions about their
customers
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States with Third-Party Administrators
NYSERDA administers the New York Energy mart
program, designed to support certain public
benefit programs.
Efficiency Vermont is a state-wide residential
rebate program.
The Maine PUC may use a third-party administrator
for electric DSM, but to date has administered
these in house.
In Wisconsin, DSM programs are implemented
statewide by a third-party administrator (Focus
on Energy).
Energy Trust of Oregon began in 2002. It is
charged with investing in cost-effective energy
conservation, helping to pay above-market costs
of renewable resources and encouraging energy
market transformation.
The Energy Conservation Management Board in
Connecticut has the responsibility to approve
energy efficiency plans and budgets
New Jerseys Clean Energy Program, administered
by the BPU promotes energy efficiency and offers
financial incentives, programs and services.
Vectren, (Indiana Gas Company and Southern
Indiana Gas and Electric Company) will use an
independent third-party administrator for its
natural gas DSM programs.
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Conclusions

• Highly contentious issue among many consumer
  groups environmental/efficiency advocates bring
  a new dimension to the debate.
• Represents a significant regulatory change for
  the gas industry that many believe will be
  difficult to unwind. Is a big change for
  relatively small overall rewards.
• Bigger picture question is should we continue to
  use a 1988 regulatory approach, and its
  corresponding justifications, for promoting
  energy efficiency in the information age and one
  based increasingly on competition?
• Growing trend to just move these activities away
  from utilities do you really need utilities in
  this business? Decreases in use per customer
  could be interpreted as justification that
  utilities are not needed for gas efficiency.
• There are a wide range of less dramatic
  alternatives that should probably be explored
  prior to moving with revenue neutrality.

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Questions, Comments, Discussion
dismukes_at_lsu.edu www.enrg.lsu.edu
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