How Electricity Might Compete with Alternate Fuels for Certain End Uses

1. How Electricity Might Compete with Alternate Fuels for Certain End Uses Presented to: 2006 Business and Financial Workshop American Public Power Association Minneapolis, MN Presented by: Tim Miller, Senior Rate Analyst Missouri River Energy Services (MRES) Sioux Falls, SD September 19, 2006 Contact Information: Phone: 605-330-6960 Email: tmiller@mrenergy.com

2. Background Information • MRES information: • Joint action agency with long-term contracts • Serves 60 municipal utilities in Iowa, Minnesota, North Dakota, and South Dakota • Rate studies completed - 47 members plus others • Members receive 50% of power from MRES, 50% from Western Area Power Administration (WAPA) • Wholesale power rates – traditional demand and energy rates; actual demand billed each month • Presentation will focus on heating applications, but could be applied to other uses

3. Customer Viewpoints - Heating • Natural gas and other fuel costs up 75% or more; volatile • Forecasts indicate prices may not return to historical levels • Many rural coops offer rebates and low off-peak rates • Customers asking municipals what rates are available for electric heating and water heating • One utility – number of dual fuel customers jumped by 20% in just a few years after stable for many years • Should we as a municipal utility attempt to serve customers where possible, as long as we don’t subsidize?

4. Current Residential Heating Saturations • 52% Natural Gas • 31% Electricity • 9% Heating Oil • 6% Propane • 2% Other • 70% of new homes choosing gas or propane Source: American Gas Association, 2003 Residential Natural Gas Market Survey

5. Factors Impacting Utility Rates • Rising power costs and distribution materials costs; greater risk of serving new loads • Qualified distribution employees harder to find; salary and insurance cost pressures • Low sales growth rates due to: • Flat or declining population in some cases • Service territory laws and disputes with coops • Low growth rates lead to less contribution margins as fixed costs rise • In some cases, pressure from local government to provide additional funds through transfers

6. Considerations for a Competitive Rate • Comparison of electric to other fuels • Possible places to compete or not to compete • Cost considerations: • On or off peak power costs • Average or marginal costs • Impact of transfers on rates • Rate concepts: • Off-peak rate design • Recovery of direct costs in rates • Water heater credits • Rebates and incentives • Customer payback

7. Comparison of Electric to Other Fuels – Residential Heating • 90% Efficient Forced Air – recent price levels • $1.10 / therm gas = 4.2 cents / kWh electric • $2.25 / gallon heating oil = 6.2 cents • $1.50 / gallon propane = 6.2 cents • 200% Efficient Heat Pump – recent price levels • $1.10 / therm gas = 8.4 cents • $2.25 / gallon heating oil = 12.4 cents • $1.50 / gallon propane = 12.4 cents

8. Places to Compete • In general, should be controlled or off-peak usage • For heating, areas with more heating degree days • Residential: • Forced air, dual fuel plenum heat • Off-peak storage heat – typically on 11 PM-7 AM • Heat pumps • Storage water heaters • Commercial and Industrial: • Storage or slab heat • Dual Fuel – plenum or boilers • Some heat pumps

9. Places Not to Actively Compete • In general, uncontrolled heating where the bulk of usage occurs during daytime, on-peak hours • (If rates don’t match marginal costs) • Many commercial and industrial uses would fit into this category • In many cases, predominately on-peak demands • C & I might also have access to lower natural gas prices and/or interruptible rates

10. On or Off Peak Power Costs • Must look at utility resource mix and characteristics: • Purchased power – short or long term contract • Owned generation • Market purchases • Utility load shape • Identify marginal fuel and other variable costs for off-peak hours • Many potentially lower cost hours – Mon-Fri. 10 PM-6 AM plus weekends equals 52% of hours • Should regional market prices dictate your retail pricing?

11. Average or Marginal Costs • Covered at many previous APPA sessions • Which costs change as a result of this decision or action? • Should each kWh sold carry an equal “allocation” of fixed costs? • Most generation, distribution, administrative, and customer service costs are irrelevant when pricing off-peak services that directly compete with other fuels • Transfers to other city funds may be relevant

12. Impact of Transfers on Rates • MRES Study of 62 area utilities • Median transfer is 9% • Range is 0% to 52% • How transfer is assessed is key • If it varies by units sold or percentage of revenue, must consider in off-peak rate design • If flat amount or free services provided to city, not a factor • Gas customers may pay franchise fee of perhaps 5% • High transfers may make electric utility less competitive • $0.034 marginal cost + 20% transfer = $0.041

13. Off-Peak Rate Design • Upper Midwest – Typical Off-Peak Rates • Currently range from 3.2 to 3.7 cents for many utilities • Rate depends on whether cycled or off for several consecutive hours • Separate meter or combined meter • If no time of use rates, better to separate the off-peak usage instead of combining all power in one meter • Apply the power cost adjustment to off-peak rate? • Calculation based on total power costs or just fuel • Make sure capacity costs aren’t rising faster than energy • Customers want stability – advantage over other fuels • But don’t guarantee the rate for a long time period!

14. Off-Peak Rate Design (Continued) • Should only the controlled customers receive the benefit of not contributing to the peak? Or are we just giving them the rate that matches the costs? • Is a lower profit margin acceptable on off-peak sales? Is getting “something” better than “nothing”? • Mandatory Time of Use Rates • Would be good fit for these concepts • Automatic incentive to use power off-peak • Might be tougher to market – customer has to interpret rate schedule instead of flat discounted rate

15. Recovery of Direct Costs in Rates • Direct costs of providing off-peak service • Marginal power costs (energy rate) • Additional meter • Load management receiver • Load management system – portion of costs • Maybe some customer service costs • Many utilities prefer flat energy rate with no additional customer charge • Example – direct costs billed as $0.003 vs. $2 / month • Disadvantage to higher volume users

16. Water Heater Credits • Used for controlled water heaters not on separate meter • Typical credits are $2 - $4 per month, depending on cycle times and avoided costs • Advantage of credit: Easy for customer to understand and see savings on bill • Might specify a minimum usage per month to qualify for credit

17. Rebates and Incentives • Pay the customer to buy power from you? • Rebates are several hundred dollars in many cases • Chips away at sales margin; calculate utility payback of rebate divided by additional annual margins • In some states, utilities must spend money on efficiency - rebates targeted to efficient appliances • High efficiency water heaters • Heat pumps • Low or no interest loans are another option • Make sure incentive isn’t a complete give-away – creates excess demand even if current appliance is working

18. Customer Payback • Compare upfront costs of adding off-peak capability against annual savings to determine payback years • Can help set ceiling for proposed rate • Could shorten payback period if tied together with controlled water heating and/or air conditioning • Converting to dual fuel / electric plenum • Payback shorter for fuel oil than natural gas • Some residential customers still switching despite relatively long paybacks (7 to 10 years) • Some gas companies charge for gas service line if not primary heating source

19. Conclusion • Electricity can be competitive with alternate fuels for certain end uses • Make sure off-peak rates aren’t subsidized by other customers • Provide what the customer is asking for if you can!