Regulators have long required utilities to run energy efficiency programs, but utilities traditionally profited by selling energy. This put a serious damper on utility management’s desire to run effective energy efficiency programs since any good efficiency projects would make the utility becomes less profitable. State regulators tried all sorts of ways to urge utilities to run good efficiency programs, usually involving some method of buying conserved electricity from the utility at higher rates than what the utility was allowed to charge for consumed energy. The idea was to find a way to make it more profitable for utilities to conserve energy than to consume it, thereby encouraging utilities to run effective efficiency programs.
The problem with this unfortunately common system of paying extra for “conserved” energy was that it gave utilities an enormous incentive to lie: if a utility could convince a regulator it conserved a whole ton of energy that actually got used, the utility would receive a payment from the regulator for the “savings” in addition to profit made from selling the electricity in the first place. It turns out it is easy for utilities to stretch the facts with regulators because our regulators are terribly understaffed (New York’s Public Service Commission, for example, which is responsible for regulating all water, electric, natural gas, cable, internet, and phone issues across the entire 20 million person State has roughly 450 employees), and each utility under this puerile system had a multi-million dollar incentive to figure out how to exaggerate efficiency savings.
Unsurprisingly, utility efficiency programs claimed wonderful energy savings that did not significantly lesson our energy appetite. Thankfully, the ranks of our utility regulators and policy makers are loaded with tons of brilliant people like Art Rosenfeld of the California Public Utilities Commission, Amory Lovins of the Rocky Mountain Institute, and Richard Cowart of the Regulatory Assistance Project.
In 1982, after some very careful thought by some very thoughtful people, California adopted an inventive structure for utilities called the Electric Revenue Adjustment Mechanism (ERAM), the first instance of decoupling. Decoupling once and for all eliminated the link between utility profits and energy usage.
At the beginning of every year (or three, depending on the state), each utility predicts how much energy it will sell. The regulator then sets a price per kilowatt-hour that the utility is allowed to charge its customers in order to make a “reasonable return” (utilities are regulated monopolies, remember).
Under the old system, if the utility sold more energy than expected, it kept the profit. If it sold less it ate the loss. (Unsurprisingly, utility load forecasts were often low.) With decoupling, however, any excess revenue generated from extra energy sales is kept in the true-up account and the utility does not see an extra dime. If too little revenue is collected (e.g. the utility’s efficiency programs worked and the utility sold less energy than expected), the utility is made whole by the true-up account. Thus, the utility truly has no incentive to lie about efficiency. The utility is kept truly cost-neutral with regards to successful energy efficiency programs.
It gets better.
Utilities are regulated monopolies, which means they are guaranteed a profit by the State. The amount of this profit is determined through a lengthy process called a rate-case, which is essentially a horrible legal battle between utilities and consumers/regulators overseen by Administrative Law Judges. In this process the utility makes a prediction of its expected costs and expected energy sales. The regulator (after arguing with the utility about the validity of its expected costs and expected energy sales) then assigns a price per unit of energy the utility is allowed to charge.
The trick is, under the decoupled system, everything is trued up at the end of the year: performance-based pay in hindsight is possible. At the beginning of a rate-case, a regulator could offer the utility a $1,500 million in revenue if it has no blackouts, $1,250 million if it is has one blackout, etc, and let the utility best determine how to spend the money. The beauty of this system – performance based decoupling – is that it avoids the regulator having to argue about any costs or load predictions ahead of time and provides a strong incentive to utilities to run effective efficiency programs. The least expensive way to avoid blackouts and keep power quality high is through energy efficiency and demand response, so under this system utilities will aggressively pursue efficiency in order to maximize profits.
If regulators adopt performance based decoupling thoughtfully, as many are beginning to do, they can make it extremely profitable for utilities to pursue real energy efficiency and demand response. Utilities will start running aggressive and verifiable energy efficiency programs, and regulators can be confident in reported savings.