Strategies for Addressing Strategies for Addressing Fixed Cost Recovery IssuesFixed Cost Recovery Issues

Dan HansenChristensen Associates Energy

ConsultingOctober 2014

October 2014 1

October 2014 2

OutlineOutline

Overview of issue Regulatory strategies

Revenue decoupling Forecast test years Lost fixed cost recovery mechanisms Riders / Cost Trackers

Rate design solutions Higher fixed charges Residential demand charges Declining block rates DG rates (access charges, buy all / sell all) Time-differentiated rates

October 2014 3

Utility Fixed Cost Recovery IssuesUtility 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)

October 2014 4

Sources of Utility Fixed Cost Sources of Utility Fixed Cost Under-recoveryUnder-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

October 2014 5

Consequences of Utility Fixed Cost Consequences of Utility Fixed Cost Under-recoveryUnder-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

October 2014 6

Potential Solutions for Utility Fixed Potential Solutions for Utility Fixed Cost Under-recovery IssuesCost 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)

Regulatory SolutionsRegulatory Solutions

October 2014 7

October 2014 8

Forecast Test Year DescriptionForecast 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)

October 2014 9

Future Test Year ScorecardFuture 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

October 2014 10

Revenue Decoupling DescriptionRevenue 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

October 2014 11

Basic Decoupling ConceptBasic 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

October 2014 12

Basic Decoupling Concept (2)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

October 2014 13

Decoupling ScorecardDecoupling 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

October 2014 14

Lost Revenue Adjustment Lost Revenue Adjustment Mechanisms (LRAMs) DescriptionMechanisms (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

October 2014 15

LRAM ScorecardLRAM 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)

October 2014 16

Riders / Cost Trackers: Riders / Cost Trackers: DescriptionDescription

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

Rate Design Rate Design SolutionsSolutions

October 2014 17

October 2014 18

Higher Fixed Charges:Higher Fixed Charges:DescriptionDescription

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

October 2014 19

Higher Fixed Charges:Higher Fixed Charges:Example Bill ImpactsExample Bill Impacts

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

0 500 1,000 1,500 2,000 2,500 3,000 3,500

Average Monthly kWh

% S

FV

Bil

l Im

pa

ct

October 2014 20

Higher Fixed Charges ScorecardHigher 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

October 2014 21

Residential Demand Charges:Residential Demand Charges:DescriptionDescription

Residential rates typically only include energy rates ($/kWh) and customer charges ($ per customer month)

Demand charges are based on the highest amount of usage during a small interval of time, usually 15 minutes or 1 hour May include a “ratchet”, in which the billing is based on demand in

previous months and the current month

Demand charges have not historically been feasible for residential customers due to higher metering costs

Proliferation of “smart” meters makes demand charges feasible

The demand charge can recover distribution costs Customers pay for the size of the distribution network needed to

serve them during their time of greatest need May reduce cross-subsidies between intermittent DG customers

and other customers that arise from net metering under standard rates

October 2014 22

Residential Demand Charge Residential Demand Charge ScorecardScorecard

Conservation Customer still benefits from all-hours conservation

Distributed Generation Reduces or eliminates DG subsidy Reduces or eliminates utility revenue loss from net

metering

Economy Depends on presence of ratchet and how economic

conditions affect demand

Weather Likely to cause utility fixed-cost revenue (and customer

bills) to vary less with weather conditions

Low-use customer effect If low-use customers are low-demand customers, should

be little to no effect

October 2014 23

Declining Block Rates:Declining Block Rates:DescriptionDescription

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

October 2014 24

Declining Block Rate ScorecardDeclining 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

October 2014 25

DG Rates:DG Rates:DescriptionDescription

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

October 2014 26

DG Rate ScorecardDG 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

October 2014 27

Time-differentiated Rates:Time-differentiated Rates:DescriptionDescription

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)

October 2014 28

SummarySummary 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

October 2014 29

Questions?Questions?

If you have questions, please contact Dan Hansen at dghansen@caenergy.com