Revenue decoupling mechanisms remove disincentives to pursue energy efficiency

Authored by Brian Kim

Many local distribution electric and natural gas utilities mandate peak demand energy or gas savings targets are achieved through energy efficiency and demand-side management (EE/DSM) activities. However, the traditional utility ratemaking process — in particular, for investor-owned utilities — overemphasizes customer consumption for recovery of fixed costs and does not anticipate the impact of EE/DSM programs/activities on sales.

Alternative regulatory mechanisms, such as revenue decoupling, allow for cost relief. By weakening the link between sales and revenue streams, distribution utilities can address prudent fixed cost recovery and revenue attrition and to remove inherent disincentives to pursuing energy efficiency.

Common revenue decoupling mechanisms are described below; they differ slightly and have seen precedent across different states in various regulatory proceedings.

The lost revenue adjustment mechanism (LRAM) recovers estimated revenues lost due to EE/DSM programs. It focuses primarily on estimating revenues that would have been billed if these programs did not exist. The LRAM allows the utility to recover the fixed costs associated with the lost revenues as part of the revenue requirement.

Fixed variable pricing is a rate design approach that relies on recovering a greater portion of the revenue requirement through the tariff’s fixed components (i.e., customer charge) and not through the tariff’s variable components. Essentially, fixed variable pricing recognizes distribution costs do not vary with volumes of energy. As a result, fixed costs are recovered primarily through the fixed monthly charge, which may better reflect an electric or gas distribution utility’s variable and fixed costs.

The decoupling true-up mechanism reconciles customer revenues to an established baseline (e.g., revenues per customer). Rates are adjusted periodically to ensure utilities do not over-collect or under-collect their authorized revenue requirement. The true-up component includes a variance account between actual revenue and the revenue requirement and is often recorded in a decoupling tariff tracker adjustment. Under a decoupling true-up, revenues are reconciled to the baseline level that adjusts for variations due to sales reduction from EE/DSM, customer counts, atypical weather conditions or economic conditions.

When considering implementing these different revenue decoupling mechanisms, it is necessary to also consider certain jurisdictional and accounting matters:

  • Frequency of rate filings or forecasts – Whether legislation, ordinance or regulation allows for periodic rate filing updates and sales forecasts adjustments.
  • Cost deferrals accounts – Utilities in some states are assured estimated cost recovery from their commission or utility board in a future period at the time a deferral account is approved, subject to prudence review and true-ups. In other jurisdictions, a commission may approve only the rate rider and require the utility to seek approval later of actual tracked costs.
  • Test-year design – Whether utilities can utilize future test years to mitigate regulatory lag instead of historical test years.

Revenue decoupling mechanisms for distribution utilities have emerged to better align fixed distribution costs, decrease the impact of fluctuating sales on revenues, and remove barriers to pursuing energy efficiency. These rate design treatments are complex and require careful consideration. A balanced approach that addresses utility structure and unique regulatory and governmental policies and practices is essential to establish fixed cost recovery and removes the disincentives to pursuing energy efficiency.

For more information on this topic, or to learn how Baker Tilly energy and utility specialists can help, contact our team.