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High Prices Driving Interest in LDC Rate Decoupling

The era of cheap natural gas is over, most would say. Talk of a 32 Tcf market by 2015 has been supplanted, in part, by a growing debate over how best to encourage efficiency and conservation among consumers, with the goal of lowering prices for all.

That places local distribution companies (LDCs) in an odd position. If they encourage conservation through demand-side management (DSM) and other programs, they will reduce their throughput. If they cut throughput, they cut revenue. Cutting revenue cuts profits as it is impossible to reduce costs by a corresponding amount. That doesn't sit well with Wall Street.

"Without meaning to, traditional state rate-making discourages natural gas utilities from vigorously promoting energy efficiency because utility profits often suffer when consumers reduce their energy use," said James DeGraffenreidt, Jr., chairman of the American Gas Association (AGA) Government Relations Policy Committee and CEO of Washington Gas. He made those remarks almost two years ago (see NGI, July 19, 2004) when AGA and the Natural Resources Defense Council (NRDC) jointly called on the industry to embrace "conservation tariffs."

One type of conservation tariff involves decoupling a utility's revenue stream from volumetric sales. Hence, a reduction in consumer demand for natural gas, for instance, does not lead to a corresponding reduction in utility revenue, and this removes the disincentive to the utility to encourage conservation. Utilities and regulators are starting to pick up on the idea.

"There is a great deal of activity, all of it around the AGA-NRDC proposal and specific applications," Ralph Cavanagh, co-director of NRDC's energy program told NGI last week. "There is a very clear linkage between this [revenue decoupling] mechanism and expanded natural gas industry involvement in energy efficiency."

Back in the mid 1990s environmental groups were advocates for revenue decoupling, Janine Migden-Ostrander, Ohio consumers' counsel, told NGI. "What's happened is the fact that gas prices have gone through the roof. When I became consumer advocate, gas prices were at $2, $3. This year we had a high of $15."

And high gas prices have now made demand-side management and other energy efficiency programs cost effective where they weren't before. The last step is removing the disincentive to utilities to promote them. With their allowed revenues guaranteed through decoupling, utilities are far more likely to embrace programs such as rebates to consumers for the purchase of Energy Star appliances, offer home energy audits and credits for weatherization.

While at least some environmentalists, regulators and utilities believe revenue decoupling can be a boon for conservation, others believe decoupling could be a bust for consumer pocketbooks, at least if not implemented correctly.

Decoupling has been more prevalent among natural gas utilities, and it still is not widespread. State regulatory commissions have approved revenue decoupling for five gas utilities: Baltimore Gas and Electric, Washington Gas Light (Maryland), Southwest Gas (California), Northwest Natural (Oregon), and Piedmont Natural Gas (North Carolina), according to an April National Regulatory Research Institute briefing paper on decoupling by Ken Costello, senior economist for the institute, which is based at Ohio State University. Rejection or withdrawal of revenue decoupling proposals has occurred in Arizona, Minnesota, and Nevada. Additionally, Costello writes that several gas utilities have filed revenue decoupling proposals with commissions in Indiana, New Jersey, Ohio, Utah, and Washington.

One proposal is from Questar Gas, now before the Public Service Commission of Utah. Questar has asked its regulator to approve a "Conservation Enabling Tariff (CET)" as a three-year pilot program. As proposed by Questar, implementation would take place in three steps. First, a figure for allowed revenue per customer per month would be established based on historical patterns. Second, allowed revenues are compared to actual and the difference is booked into a balancing account. Third, at least twice a year, possibly in conjunction with regular pass-through rate cases, Questar would file for a percentage adjustment to block rates in an amount to amortize the balance of the account.

In essence, a reduction in Questar's sales volume as might result from conservation measures, such as demand-side management, would not reduce revenue because the revenue requirement would be collected in rates on a per-customer basis rather than a per-volume basis. Customers still would be billed on a volumetric basis, but these rates would be trued-up periodically based upon actual revenues collected per customer.

Questar made its initial filing in December 2005, and a hearing is scheduled at the commission for June 26. Last month David Dismukes, a consulting economist with Acadian Consulting Group, filed testimony on behalf of the Utah Committee of Consumer Services.

Among the typical concerns with/objections to decoupling is that it shifts to ratepayers business risk that has traditionally been borne by the utility. Dismukes' objections to the Questar plan are illustrative of the concerns some have with decoupling in general.

He says the plan as proposed makes Questar whole for revenue declines that stem not just from conservation but from other reasons, such as warmer-than-normal winter weather and economic decline in its service territory. "As a regulatory policy mechanism, revenue decoupling is like using a steam-roller to crack a peanut: it more than over corrects for the purported DSM-disincentive and includes guaranteed recovery for revenue changes associated with a wide range of normal business risks."

Ohio consumer advocate Migden-Ostrander told NGI this is a valid concern that regulators should take into account when considering a decoupling proposal. However, she said that concerns such as this can be addressed through a weather-normalization mechanism. For instance, instead of allowing a utility a 100% return, a regulator might shave off 10% to account for declines in gas consumption that do not result from conservation programs but rather from warmer than normal weather, for instance.

"I think I prefer the weather normalization in there because I don't want customers taking on the weather risk," Migden-Ostrander said. "Secondly, if there is a concern because there is a huge amount of response to an energy efficiency program, they can put a cap on the increase in rates for each year."

For example, say consumers embrace energy efficiency to a degree that causes consumption to decline so much that a more than 3% rate increase is needed to make up for the utility's lost revenue. The utility is allowed a 3% increase in the current year and "banks" the amount it is still owed. The next year the shortfall from allowed revenue requires only a 2% increase, but the utility is allowed 3% to make up for the previous shortfall.

Decoupling does not and should not make up for revenue losses realized by utilities that do not stem from energy conservation programs, proponents of the mechanism generally maintain. There can be an allowance for "organic" conservation that would have occurred without the utility's conservation program. Additionally, reduced consumption that stems from an economic downturn in the utility service territory also can be accounted for. "You can do an elasticity adjustment," Migden-Ostrander said. "Instead of allowing them to recover 100% of the revenues, you might discount and say 90% or 80% of the revenues, which would then lower the impact on customers."

Migden-Ostrander has had some experience with revenue decoupling. Last week she gave a presentation on the topic at a meeting of the National Association of State Utility Consumer Advocates, among whom the topic is garnering increasing interest, she said. In Ohio, Vectren Corp. and the Office of Consumers' Counsel entered into a settlement that allows Vectren to decouple sales from revenue and puts in place a comprehensive energy efficiency program, Migden-Ostrander said.

The increased interest in revenue decoupling is not something that has originated exclusively on either the regulatory or the utility side of the fence. "In some states it's the utilities that are pushing this because they're trying to insulate themselves... from the downside of customers decreasing their consumption as a response to high prices," said Migden-Ostrander. "It's coming from both directions. In my state I've got some utilities that have embraced this much more quickly than others, and others that I still have to work on.

"There are some that think this is the right answer, and there are some that have some skepticism about it. I don't think that you can say this is just an industry thing or this is just a consumer thing."

In Utah where Questar's revenue decoupling proposal is still before the commission, consultant Dismukes says that Questar is putting the cart before the horse in requesting approval of a decoupling plan prior to laying out specifics on any DSM or other conservation plan. "[T]he need for such a departure from traditional regulatory approaches is not supported by any well-defined commitments by the company to pursue any level of demand side management programs or savings -- which is the ostensible justification for the proposal."

Before it approves any revenue decoupling for Questar, Dismukes says the commission should insist on a DSM plan. "A complete listing of DSM programs, estimated costs, and estimated savings and participation levels for the CET pilot period should be required," he says. "A defined three-year set of DSM programs, which match the CET pilot period, should be provided."

The NRDC's Cavanagh, who is scheduled to testify on behalf of Questar later this month, said that objection to the utility's proposal largely results from a lack of understanding. Costello's briefing paper on decoupling is supportive of decoupling when it comes with conservation initiatives. "The central theme of his report is that conservation is critical to the argument for decoupling, which I agree with," said Cavanagh. "I think it's clear from Ken's [Costello's] perspective you've got to link decoupling with a strong, expanded conservation effort in order for it to make sense from a consumer perspective. Decoupling wouldn't make sense to me in the absence of a substantial and increased commitment to energy efficiency."

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