Strategies for Addressing Fixed Cost Recovery Issues

1. Strategies for Addressing Fixed Cost Recovery Issues Dan Hansen Christensen Associates Energy Consulting August 2014

2. Outline • Overview of issue • Regulatory strategies • Revenue decoupling • Forecast test years • Lost fixed cost recovery mechanisms • Riders / Cost Trackers • Rate design solutions • Higher fixed charges • Declining block rates • DG rates (access charges, buy all / sell all) • Time-differentiated rates

3. Utility Fixed Cost Recovery Issues • Traditional regulated rates recover fixed costs through volumetric rates • This leads to utility revenue attrition when sales decrease, without a corresponding reduction in costs • Some incentive issues are also created: • Utility disincentive to promote conservation and energy efficiency • Utility incentive to increase customer usage • Subsidy to distributed generation (DG) customers • Incorrect price signals to customers, compared to marginal cost to serve (caveat: environmental externalities)

4. Sources of Utility Fixed Cost Under-recovery • Distributed generation (residential solar) • Conservation and energy efficiency • “Naturally” occurring or based on customer initiative • Improved appliance efficiency • Phasing out incandescent light bulbs • Building standards • As caused by conservation mandates • Poor economic conditions • Mild weather conditions Stakeholders will not necessarily want to treat all of these causes equally

5. Consequences of Utility Fixed Cost Under-recovery • In the absence of other solutions, the utility will likely file a rate case to increase rates in order to mitigate under-recovery going forward • Does not allow the utility to recover lost revenues in between rate cases • In some situations, cross-subsidies may be created • Non-solar customers subsidizing solar customers • Non-conserving customers subsidizing conserving customers • There is disagreement on the extent to which such cross-subsidies occur, if at all • Rate cases may be filed more frequently

6. Potential Solutions for Utility Fixed Cost Under-recovery Issues • The following slides present a variety of potential solutions to the issue described here • Each is summarized in terms of how it addresses the following issues: • Conservation-induced sales reductions • Sales lost to distributed generation • Sales changes due to economic conditions • Sales changes due to weather conditions • Effect on low-use customers, who some believe are more likely to be low-income customers • Discussion, as applicable, of whether cross-subsidies are affected (created or removed)

7. Regulatory Solutions

8. Forecast Test Year Description • Using a forecast test year (as opposed to an historical test year) can allow the expected effects of conservation or DG generation to be incorporated into rates • Expected effects will likely differ from actual effects • It does not affect rate structure or incentives (utility or customer) once in place • Even with a forecast test year, the utility is better off if it underachieves the conservation forecast (barring other penalties)

9. Future Test Year Scorecard • Conservation • Does not remove the utility’s disincentive to promote conservation • Does not affect customer-level incentive to conserve • Distributed Generation • Makes utility whole for expected (not actual) net metering revenue losses • Does not end cross-subsidies to DG customers • Economy • No effect • Weather • No effect • Low-use customer effect • No effect

10. Revenue Decoupling Description • Revenue decoupling is intended to remove the link between sales and utility revenues • This link exists because some fixed costs are recovered through volumetric (e.g., $ per kWh) rates • By removing the link, the utility is made indifferent to customer usage levels • Does not provide the utility with an incentive to promote conservation • A separate mechanism can do that, if desired

11. Basic Decoupling Concept • Basic concept of revenue decoupling (RD): RD Deferral = Allowed Revenue – Actual Revenue • A positive number means the utility under-recovered, and will lead to a future rate increase • A negative number means the utility over-recovered, and will lead to a future rate decrease

12. Basic Decoupling Concept (2) • Typically every 6 or 12 months, the RD deferral is rolled into rates as follows: Rate change from RD = RD Deferral / E(Usage) • Revenue is usually “re-coupled” to other (non-sales) factors, such as • The number of customers served (called revenue per customer decoupling, or RPCD) • Allowed revenue can be linked to inflation factors, which can incorporate performance-based regulation components

13. Decoupling Scorecard • Conservation • Removes the utility’s disincentive to promote conservation • Does not affect customer-level incentive to conserve • Distributed Generation • Makes utility whole for net metering revenue losses • Does not end cross-subsidies to DG customers • Economy • Surcharges following recessionary years, rate reductions following expansionary years • Weather • May or may not be included (varies by mechanism) • Low-use customer effect • Only if they are less likely to conserve

14. Lost Revenue Adjustment Mechanisms (LRAMs) Description • LRAMs compensate the utility for lost revenues due to utility-sponsored conservation programs • Fixed amount per kWh conserved, as measured in the program evaluation process • LRAMs are more narrow in focus than decoupling • Do not adjust revenues for weather, economic factors • Does not address the utility’s incentive to increase sales • Cannot lead to a rate reduction • Utility may not want to promote programs for which the effects are not easily measured • Can be significant disputes regarding kWh savings estimates

15. LRAM Scorecard • Conservation • Addresses revenue loss from utility-sponsored programs • Does not otherwise affect conservation / load growth incentives • Distributed Generation • No effect • Economy • No effect • Weather • No effect • Low-use customer effect • Bill increase for low-use customers who do not participate in conservation programs (because they pay the LRAM adder)

16. Riders / Cost Trackers: Description • Riders may be used to track specific costs and recover them through rates, without the need to file a rate case • E.g., commonly applied to fuel costs • In the context of this discussion, a rider could be used to track revenue attrition from net metering (if DG is separately metered) for recovery across all sales • Decoupling is a form of a rider • Because riders can vary so much, we do not provide a scorecard

17. Rate Design Solutions

18. Higher Fixed Charges:Description • The fixed cost recovery issue is caused by the recovery of fixed costs through volumetric rates • The problem can be mitigated or eliminated by increasing the amount of revenue recovered through fixed charges • Straight-fixed variable (SFV) pricing: recover all fixed costs through the monthly customer charge • Substitute for decoupling • Can lead to very large % bill impacts for low-use customers • Graduated facilities charges (GFCs): the monthly customer charge varies with usage (e.g., based on the 12-month average) • Can allow for an increase in the average customer charge while mitigating the effect on low-use customers

19. Higher Fixed Charges:Example Bill Impacts

20. Higher Fixed Charges Scorecard • Conservation • Removes the utility’s disincentive to promote conservation • Reduces the customer-level incentive to conserve • Distributed Generation • Removes DG subsidy • Removes utility revenue loss from net metering • Economy • Utility fixed-cost revenue (and customer bills) do not vary with economic conditions • Weather • Utility fixed-cost revenue (and customer bills) do not vary with weather conditions • Low-use customer effect • Potential for very high % bill impacts unless GFCs are employed

21. Declining Block Rates:Description • The rate decreases as usage increases, for example: • 0 to 300 kWh/mo = 10 cents/kWh • 301 to 600 kWh/mo = 8 cents/kWh • Over 600 kWh/mo = 6 cents/kWh • Recovers fixed costs in the initial pricing block, in which all customers consume energy • For higher-use customers, the marginal price more closely reflects the marginal cost to serve • Compared to a flat rate: • Reduces customer-level incentive to conserve for high-use customers • Increases customer-level incentive to conserve for low-use customers • Inclining block rates are more fashionable because of the conservation incentives

22. Declining Block Rate Scorecard • Conservation • Reduces the utility’s disincentive to promote conservation • Customer-level incentive effects vary by usage level • Distributed Generation • Reduces DG subsidy • Reduces utility revenue loss from net metering • Economy • Utility fixed-cost revenue (and customer bills) vary less with economic conditions • Weather • Utility fixed-cost revenue (and customer bills) vary less with weather conditions • Low-use customer effect • Potential for high % bill impacts

23. DG Rates:Description • Some rates may be targeted toward DG customers • Access charge: a $ per month fee based on the DG capacity • Buy all / sell all: DG customers purchase all of their electricity at standard rates, sell DG to the utility at a different rate (that presumably excludes fixed costs) • These can be characterized as discriminatory toward DG customers, since the charges do not apply to all customers • Not true of SFV pricing or declining block rates • Prices may not account for environmental benefits of DG • How to quantify those benefits? • If that benefit is paid to DG customers, the cost must be paid by other ratepayers

24. DG Rate Scorecard • Conservation • Not applicable • Distributed Generation • Reduces or eliminates DG subsidy • Reduces or eliminates utility revenue loss from net metering • Economy • No effect • Weather • No effect • Low-use customer effect • May reduce low-use customer bills if they are less likely to have DG and a cross-subsidy is removed

25. Time-differentiated Rates:Description • Some rate designs include rates that vary by time • Static: rates are known in advance, but vary by time of day or season • Time-of-use (TOU) rates • Dynamic: rates vary with system conditions • Real-time pricing • Critical peak pricing • Time-differentiated rates tend to be focused promoting the efficient use of existing resources, or preventing the need to add generating resources (or transmission capacity) in the future • They are not typically focused on addressing conservation or DG issues (so we omit the scorecard)

26. Summary • Decoupling: • Addresses fixed cost recovery issues due to conservation in a way that minimizes bill impacts (relative to SFV pricing) • Makes the utility whole for revenue loss from DG net metering, but does not address cross-subsidies (still a death spiral!) • LRAMs • Address fixed cost recovery issues from utility-sponsored conservation programs • Is not intended to address DG issues • SFV Pricing • Addresses fixed cost recovery issues due to conservation and DG • Removes DG cross-subsidies • Can have very large bill impacts (bill increase for low-use customers, bill decrease for high-use customers) • DG rates • Can address DG cross-subsidies and utility fixed cost recovery issues • Not intended to address conservation issues

27. Questions? • If you have questions, please contact Dan Hansen at dghansen@caenergy.com