Decoupling first appeared in the 1980s to help utilities overcome what is referred to as the throughput incentive which ties a utility’s revenue to its sales of electricity.   The throughput incentive motivates the utility to sell as much power as it can because that increases its revenue.  This worked with rapidly increasing power demand and generation in the 20th Century.  But the current power climate is different.  Consumers are being encouraged to reduce emissions and conserve energy.  In addition and perhaps more importantly alternative sources of energy such as solar PV are achieving grid parity so that consumers can reduce their power bill by generating their own power or buying it from companies like Solar City.

These disruptive challenges have arisen due to a number of factors including the:falling costs of distributed generation (DER), for example, solar PV, demand-side management (DSM), government programs to incentivize solar PV and other technologies; and the very low price of natural gas.  The financial risks created by these disruptive challenges include declining utility revenues, increasing costs, and lower profitability.  As DER and DSM programs become broadly adopted, utility revenues will tend to decline. The higher costs to integrate and subsidize DER and DSM could squeeze profitability, which will affect investor returns. As a result the availability of capital for the electric utility industry could be adversely impacted.  Ultimately this could result in upward pressure on consumer electric power rates.

Decoupling revenue and energy sales

A decoupling mechanism attempts to separate a utility’s revenues from its unit sales volumes without affecting the design of customer rates. In other words, utility customers continue to pay for service primarily according to the amount of energy they use.

Decoupling adjusts rates periodically to ensure that the amount a utility books as revenue for fixed cost recovery is no more and no less than the amount of revenue authorized by the regulator. Under traditional ratemaking methodologies for residential and smaller-usage commercial customers, a utility’s revenues come from customer energy usage (kilowatt-hours) and the rates the regulator has approved.  Periodically, a decoupling mechanism causes a rate adjustment to ensure that customers receive refunds or pay surcharges based on whether the revenues the utility actually received from customers is less or greater than the amount the regulator has approved. This difference can occur for several reasons but chiefly it is intended to support energy efficiency programs and incentives and customer conservation behavior that reduces electricity or natural gas usage from the amounts assumed in the ratemaking process.

For example, in a recent filing with the Minnesota PUC, Xcel Energy has proposed a partial decoupling for residential and small commercial and industrial customers.  If electricity sales were lower than forecasted for a given year, the utility would be allowed to make up the difference by charging a higher rate the following year.  If electricity sales exceeded forecasts, the utility would refund the surplus to customers through a lower rate the next year.   What this could mean is that as energy sales are eroded by energy conservation and alternative sources of energy, rates would be adjusted upwards to keep the utility’s revenue constant so that it can continue to maintain its infrastructure.

For Xcel Energy, the motivation for decoupling is clearly financial: “While the Company has thus far been willing to promote its [conservation] programs as effectively as it can in order to meet energy efficiency goals, the financial pressures … increase the importance of removing the Company’s financial disincentives to promoting conservation and energy efficiency.”

A Decade of Decoupling for US Energy Utilities

A recent report (Graceful Systems Feburary 2013) assesses the decoupling mechanisms that 52 local distribution companies (LDCs) and 25 electric utilities have used since 2005.  This includes 1269 decoupling rate adjustments in 25 states in the U.S.

The study found that historically the decoupling rate adjustments have been mostly small. Across all utilities the study considered 64% of the adjustments were within 2% of the retail rate.  The adjustments amounted to about $2.30 per month for the average electric customer and about $1.40 per month for the average natural gas customer.

Secondly, decoupling adjustments can generate both refunds and surcharges.  The study found that across all electric and gas utilities 63% were surcharges and 37% were refunds, so about 2/3 led to increased revenue to the utility.

Conclusions

The study’s conclusions are very interesting. 

First of all the report found that historically “the rate impacts of decoupling are small to miniscule. The amounts that flow through utility cost adjustment clauses, such as power cost or purchased gas adjustment clauses or trackers for capital additions, environmental remediation expenses or any of a myriad of other large costs dwarf decoupling adjustments.”   But I wonder with the disruptive forces that many see affecting the electric power and gas industries which could lead to dramatic reductions in energy demand from the tradtional grid, whether in the future decoupling adjustments will tend to increase and possibly quite considerably.

But the study concludes that the real question that needs to be answered is what should the 21st Century utility’s objective be ?  In the 20th Century it was to sell as much energy as the utility could get people to buy.  Now it could be to maximize utilization of the existing physical infrastructure or to become an energy services company that gets most of its revenue from services instead of from selling a commodity.  Decoupling is a first step in moving utilities from the 20th Century to the 21st Century, but it is not yet clear to many utilities where this path will lead.  Some utilities have already decided that the future is in energy services.