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.
Thanks for that overview. It does seem like there are some other factors that are involved though. For example, while a utility doesn’t necessarily make money off of selling more electricity directly now, they are allowed to profit off of capital improvements to the T&D systems. Does this lead to the company still having an incentive to increase usage and therefore justify spending on assets? In the hopeful scenario that efficiency programs actually creates consistent negative growth in usage or a substantially lower peak such that assets are not be fully utilized, will there be a problem for utilities (and PUCs) to maintain sufficient revenue without public rath over rising cost per kWh?
Emma, great question! This is where performance-based decoupling is important: if the regulator only issues the utility a flat revenue (e.g. $750 million for the year), regardless of how the utility spends that money, then the utility will pursue efficiency. If the decoupling is non-performance based, e.g. the utility still receives returns based on its capital expenditures then you definitely run into the problem you bring up. Given that the vast majority of decoupled utilities are not truly performance-based (e.g. flat revenue based solely on blackout numbers and power quality), your point is important for regulators to address.
I was just talking with my coworker about this today at lunch . Don’t remember how we landed on the subject actually , they brought it up. I do recall eating a amazing chicken salad with ranch on it. I digress…
Thanks this made for very intresting reading. I really love your site, the theme is really cool. I have come here a number of times but never commented, just wanted to let you know… Keep up the excellent work!
Your website seems truly great. Being a blog writer myself, I appreciate the time you took in creating this write-up.
hey man, nice blog…really like it and added it to bookmarks. keep up with good work
Thanks for the share, I’ve been reading online all day and this was actully worth reading. Thanks a terrific deal
Thanks very much for posting all of the great content! I am looking forward to seeing more blogs!
I really enjoyed this post, thanks
Excellent information, I just passed this onto a colleague who was doing a little homework. And he in fact bought me breakfast because I found it for him ~
What a blogpost!! Very informative and also easy to understand. Looking for more such posts!! I recommended it on digg. Thank you for this blog.
Hey I like this place so much that I just bookmarked it….
Decoupling seems to give utilities a couple of interesting options. To my mind, it gives them the flexibility to pursue either conservation or efficiency (which I don’t think are necessarily the same).
To the utility, there seems to be parallel benefits. With reduced load requirements, construction/capital requirements for generation and T&D may be avoided. Energy efficiency, or conservation, could be added in a distributed and modular fashion. And during peak hours, they number of peaker plants or standby generation could be reduced.