Strategies for Addressing
Fixed Cost Recovery Issues
Dan Hansen
Christensen Associates Energy Consulting
October 2014
October 2014
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Outline
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Overview of issue
Regulatory strategies
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Revenue decoupling
Forecast test years
Lost fixed cost recovery mechanisms
Riders / Cost Trackers
Rate design solutions
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Higher fixed charges
Residential demand charges
Declining block rates
DG rates (access charges, buy all / sell all)
Time-differentiated rates
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Utility Fixed Cost Recovery Issues
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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)
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Sources of Utility Fixed Cost
Under-recovery
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Distributed generation (residential solar)
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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
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Poor economic conditions

Mild weather conditions
Stakeholders will not necessarily want to treat all of
these causes equally
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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
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Rate cases may be filed more frequently
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Potential Solutions for Utility Fixed
Cost Under-recovery Issues
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The following slides present a variety of potential
solutions to the issue described here
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Each is summarized in terms of how it addresses the
following issues:
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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)
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Regulatory Solutions
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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
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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)
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Future Test Year Scorecard
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Conservation
 Does not remove the utility’s disincentive to promote conservation
 Does not affect customer-level incentive to conserve
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Distributed Generation
 Makes utility whole for expected (not actual) net metering revenue
losses
 Does not end cross-subsidies to DG customers
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Economy
 No effect
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Weather
 No effect
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Low-use customer effect
 No effect
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Revenue Decoupling Description
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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
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Basic Decoupling Concept
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Basic concept of revenue decoupling (RD):
RD Deferral = Allowed Revenue – Actual Revenue
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A positive number means the utility underrecovered, and will lead to a future rate
increase
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A negative number means the utility overrecovered, and will lead to a future rate
decrease
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Basic Decoupling Concept (2)
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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
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Decoupling Scorecard
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Conservation
 Removes the utility’s disincentive to promote conservation
 Does not affect customer-level incentive to conserve
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Distributed Generation
 Makes utility whole for net metering revenue losses
 Does not end cross-subsidies to DG customers
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Economy
 Surcharges following recessionary years, rate reductions following
expansionary years
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Weather
 May or may not be included (varies by mechanism)
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Low-use customer effect
 Only if they are less likely to conserve
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Lost Revenue Adjustment
Mechanisms (LRAMs) Description
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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
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LRAMs are more narrow in focus than decoupling
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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
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LRAM Scorecard
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Conservation
 Addresses revenue loss from utility-sponsored programs
 Does not otherwise affect conservation / load growth incentives
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Distributed Generation
 No effect
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Economy
 No effect
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Weather
 No effect
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Low-use customer effect
 Bill increase for low-use customers who do not participate in
conservation programs (because they pay the LRAM adder)
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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
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E.g., commonly applied to fuel costs
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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
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Decoupling is a form of a rider
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Because riders can vary so much, we do not provide a scorecard
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Rate Design
Solutions
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Higher Fixed Charges:
Description

The fixed cost recovery issue is caused by the recovery of fixed
costs through volumetric rates
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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
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Higher Fixed Charges:
Example Bill Impacts
60.0%
50.0%
40.0%
% SFV Bill Impact
30.0%
20.0%
10.0%
0.0%
0
500
1,000
1,500
2,000
-10.0%
-20.0%
Average Monthly kWh
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2,500
3,000
3,500
Higher Fixed Charges Scorecard
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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
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Weather
 Utility fixed-cost revenue (and customer bills) do not vary with
weather conditions
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Low-use customer effect
 Potential for very high % bill impacts unless GFCs are employed
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Residential Demand Charges:
Description

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
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Demand charges have not historically been feasible for
residential customers due to higher metering costs
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Proliferation of “smart” meters makes demand charges feasible
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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
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Residential Demand Charge
Scorecard
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Conservation
 Customer still benefits from all-hours conservation
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Distributed Generation
 Reduces or eliminates DG subsidy
 Reduces or eliminates utility revenue loss from net metering
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Economy
 Depends on presence of ratchet and how economic conditions
affect demand
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Weather
 Likely to cause utility fixed-cost revenue (and customer bills) to
vary less with weather conditions
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Low-use customer effect
 If low-use customers are low-demand customers, should be little to
no effect
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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
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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
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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
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DG Rates:
Description

Some rates may be targeted toward DG customers
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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
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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
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DG Rate Scorecard
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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
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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)
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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
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Questions?

If you have questions, please contact Dan Hansen at
dghansen@caenergy.com
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