Decoupling: Shelling out fewer Buckeye State bucks for energy

Energy efficiency - getting the same hot showers and cold beers using less energy - is our cheapest and cleanest energy option. It costs one-half to one-third the price of any other technology for meeting future energy needs. Ohio Governor Ted Strickland gets the idea. It's why he signed a law in 2008 that requires electric distribution utilities - AEP, Duke, FirstEnergy, and DP&L - to save energy. Done right, the resulting energy efficiency programs will lower electricity bills and prevent the construction of pricey, and potentially dirty, new power plants.

Unfortunately, because of the way they have historically been regulated, doing the right thing by encouraging energy efficiency could cost utilities tons of cash. This is because electric utilities have fixed costs - costs that don't change when customers use less energy. Regulators and utilities set rates to cover those costs assuming a certain level of consumption. When electricity usage drops below that level, a utility won't cover its fixed costs. And no utility company executive wants to put his company in the red.

And the problems don't end there: utilities also make more money if they encourage their customers to use more energy. If the utility can sell more energy than that level assumed when rates were set, they make a profit by collecting more than their fixed costs of service. This provides a lucrative incentive for the utility to increase sales of energy beyond a level that is environmentally or economically optimal.

Modern utility regulation, which for good reason requires utilities to invest in energy efficiency, has to address these twin problems. And there is an interesting discussion underway in Ohio about how best to do so.

The Public Utilities Commission of Ohio regulates the gas and electric utilities in the state. It has already deployed in Ohio's gas utilities one imperfect option for addressing the problems described above: moving all fixed costs to a fixed charge that doesn't vary with usage. This makes a utility indifferent to lower energy consumption, but it reduces customer incentives to use less energy because their energy bill doesn't change as much when they use less energy. It also punishes customers who already use less energy than average.

A second, differently problematic, way to address the revenue consequences of energy efficiency is currently being used by Duke, AEP, and FirstEnergy. In "lost revenue recovery," a utility measures the energy saving impacts of its energy efficiency programs, and charges customers for the revenue it would have received had these programs not taken place. This can restore to the utility revenue that was never "lost" in the first place. For example, the reduced energy use and revenues from a successful energy efficient light bulb program could be more than offset by some event that increases sales (like economic growth or an abnormally hot summer), but the utility would still be able to charge customers for revenues that it "lost." Despite NRDC's objections, FirstEnergy is allowed to collect lost revenues for six years after an efficient device like a CFL is installed. That's crazy. If it's allowed to continue, Ohio's energy efficiency efforts will lead to unreasonable costs to consumers.

NRDC has a better way to address the problem: revenue decoupling, which PUCO Commissioner Cheryl Roberto mentioned in a speech to the Northeast Ohio Public Energy Council on October 10. Under "revenue decoupling," a utility regularly adjusts its rates to ensure that it collects from customers exactly the fixed costs that regulators determined were necessary, regardless of fluctuations in sales. Decoupling, unlike lost revenue recovery, goes both directions: if the utility collects more than authorized, customers get a refund; if the utility collects less than authorized, it is made whole.

NRDC recently conducted an analysis of the 8 electric decoupling mechanisms currently operating in the United States. The mechanisms produce both refunds and surcharges, and the majority of these are less than 1% of base rates.

Michigan recently passed an energy bill similar to the one in Ohio. The utility regulator there authorized a pilot revenue decoupling mechanism for Consumers Energy two weeks ago that could provide a useful model for Ohio electric utilities. Consumers Energy gets to decouple, but the mechanism can only continue if the utility exceeds the energy efficiency benchmarks in the law and meets strict reliability standards. This would be a far better model than the one that FirstEnergy is limping along with at the moment.

If Ohio's electric utilities had revenue decoupling, FirstEnergy wouldn't be charging its customers $14 in lost revenue for $3 light bulbs - and getting universally trashed in the press as a result. Ohio's utilities would be free to aggressively implement cost effective energy efficiency investments without the fear of revenue erosion. All customers would benefit from these investments, which would be reflected in a reasonable charge on their monthly bills.