Decoupling Design: Customizing Revenue Regulation to Your State’s Priorities
Many states have adopted utility decoupling, or revenue regulation, which breaks the link between electricity sales and revenues to the utility. Originally, it was conceived as a way to make utilities indifferent to annual sales volumes by addressing the net revenue volatility associated with weather, changes in local economic conditions, and energy efficiency programs. More recently, it has been recognized as a primary tool to deal with potential revenue shortfalls from deployment of distributed energy resources. But whatever the context, perhaps its most important virtue lies in its risk-mitigation benefits for both utility and consumer.
The design process of a decoupling mechanism contains a number of decision points that address policy and stakeholder priorities. This paper, the third in a trilogy of RAP work on the topic of decoupling, lays out how to make decoupling design decisions that best complement the facts on the ground and the goals of each state, each commission and its stakeholders.
The issues that regulators will face, and the decisions they must make, fall into three broad categories:
- Applicability of revenue regulation: Decide what’s covered. Regulators must first decide what (or who) a decoupling mechanism covers by deciding which utility functions and customer classes will be included, as well as whether to include all costs in the mechanism or exclude some.
- How a decoupling mechanism works: Choose how to adjust utility revenue. This is perhaps the most significant decision that regulators must make in a decoupling proceeding. The options include:
No revenue adjustment mechanism: No adjustment is made to the revenue requirement until a utility files a rate case to increase it; in the meantime, rates are adjusted via periodic true-ups.
Stair-step: Adjustments are pre-determined in a rate case and are usually based on forecasts of projected cost increases.
Indexing: Adjustments are tied to multiple factors such as general or industry inflation, industry productivity, customer growth, and changes in capital.
Revenue per customer (RPC): Regulators determine the revenue requirement on a per-customer basis (usually by customer class), and the total system revenue requirement is determined by multiplying the number of customers in each class by the revenue requirement for each customer in that class.
Annual review (or attrition): Periodic reviews are used to adjust base rates for known and measurable changes in rate base and operating expense. More controversial larger changes such as major plant additions are left for a full rate case.
K Factor: An adjustment used to increase or decrease overall growth in revenues between rate cases, if a key assumption (such as increased efficiency or growth in rooftop solar) is likely to vary significantly during the decoupling period.
Hybrid: Basically a combination of regulatory mechanisms; for example, RPC and K Factor.
After making this determination, regulators must also consider how frequently the revenue requirement of a utility should be reviewed and how utility risk should be factored into the mechanism.
- Decoupling adjustments: Select how to handle refunds or surcharges. Decoupling is designed to assure that actual revenues match authorized revenues during the life of the mechanism. Typically, however, these do not line up exactly. Decoupling adjustments serve to either refund revenue surplus or recover revenue deficits. One of the key objectives of decoupling in the eyes of consumer representatives is a mechanism whose adjustments are symmetrical—over-collections are treated in the equivalent, but opposite, manner as under–collections. A further series of regulatory decisions must be undertaken to ensure this:
Allocating over- and under-recoveries to customers, either by a uniform surcharge or credit per kilowatt-hour to all decoupled classes, a uniform percentage surcharge or credit to all rate elements, or “class-by-class” decoupling, in which allowed revenue is computed separately for each class and used to produce a uniform adjustment (either by kWh or percentage) for all customers in that class.
Adjustment to base rates or through a purpose-built rider, which normally can be done at regulators’ discretion, particularly if there is no mandate for frequent rate cases.
Frequency of true-ups, either monthly, quarterly, or annually.
Caps on the size of decoupling adjustments.
Carrying charges, to be considered if true-up of charges occurs over an interval, such as a year, so that a portion of the accumulated true-up amount remains unrecovered between reconciliation, or if there is a cap on the size of the reconciliation adjustment permitted in any given adjustment period and the unrecovered portion of the adjustment is carried over for the subsequent time period.
Additional considerations for regulators include performance evaluations for utilities (though the question of performance metrics is distinct from the consideration of decoupling), rate design questions (i.e., how to fairly compensate distributed energy resource owners), and bill simplification.
This paper creates a decision matrix and from there draws three scenarios for regulators to consider. The first applies to a distribution-only utility or a vertically integrated electric utility that has adopted decoupling for distribution services only. The second is similar but also includes industrial customers, and the third applies to both distribution and generation functions.
The paper points to certain pathways that RAP recommends over others. They include:
- Symmetry in over- and under-recoveries;
- Exclusion of costs recovered through separate tariff riders, to avoid over-collection of costs;
- Reduction in equity ratio, rather than an adjustment of the return on equity, to reflect lower risk; and
- Performance requirements to foster energy efficiency, the development of distributed resources, and quality service levels.
Ultimately, a good decoupling mechanism may best be driven by a consensus among the stakeholders, reached via a collaborative process in which the mechanism chosen and the decisions made balance the interests of all parties.