Southern California municipal utilities innovate with decoupling
Posted April 11, 2014
This is a guest post by Lisa Xue, a Sustainable Energy Fellow at the Natural Resources Defense Council, working on energy efficiency issues in California. She received her M.A. in International Policy from Stanford University and B.A. in Economics and B.A. in Development Studies from the University of California, Berkeley.
The utilities serving Los Angeles and nearby Glendale are now the nation’s first publicly owned electric providers to tweak their business model to help residential, business and commercial customers save energy even when it might lead to lower electricity sales.
As we noted in an article published in the Electricity Journal this week, this kind of innovation in Southern California is important to supporting the progress of energy efficiency, the cheapest and cleanest way to meet growing demand for energy services.
And hopefully, this significant step by the country’s largest public utility and its neighbor signals the beginning of an important clean energy trend for the other 44 public utilities also providing one-fourth of California’s electricity sales, as well as the remainder of the 2,000 municipally and cooperatively owned utilities serving America.
Why energy efficiency can be a financial challenge for utilities
Electric utilities today are investing significantly more in energy efficiency. In fact, energy efficiency investments from the electric utility sector have increased threefold from 2006-2012, and publicly owned utilities have more than doubled their investments, according to the Consortium for Energy Efficiency’s latest report.
Saving energy benefits utilities because it’s cheaper than building new power plants, and transmission and distribution infrastructure. And it benefits customers in the form of lower electricity bills.
However, energy efficiency also can create a financial challenge for utilities. A utility’s costs are fixed in the short term (such as the power plants and power lines that provide electricity), but revenues from electricity sales are collected in per-kilowatt-hour rates. Therefore, utilities thus have an incentive to sell more electricity in order to ensure financial stability—a strategy that directly conflicts with cost-effective efficiency programs such as helping customers weatherize their homes and businesses, upgrade to more efficient appliances, or change to better light bulbs.
The solution—“decoupling” revenues from sales—was first proposed to the California Public Utilities Commission in 1981 and has now been adopted by electric and natural gas investor-owned utilities in 25 states. Decoupling allows the utility to maintain financial health by ensuring that utilities receive the revenue authorized by their governing board—no more and no less—through a small rate adjustment on the bill. s. In fact, 7 of the 10 states that lead the nation in energy efficiency investment use the mechanism.
Until now the challenge of revenue recovery has remained largely unaddressed among publicly owned utilities. At the beginning of this year, Los Angeles Department of Water & Power (LADWP) serving over 3.8 million residents became the first publicly owned utility to implement a decoupling mechanism for its electric services, a move approved in 2012. Glendale Water & Power (GW&P), the second publicly owned utility in the nation to decouple and providing service to 194,000 residents, will begin implementing its mechanism as early as July 1. This not only brings significant benefits to the two utilities and the customers they serve, their bold move also provides leadership and sets example of other public utilities.
My colleague Dylan Sullivan and I met with administrators from LADWP and GW&P early this year to discuss the process, design, and results of decoupling, and our findings were published in this week’s edition of the Electricity Journal.
The impetus for decoupling
LADWP and GW&P’s decisions to adopt decoupling as part of their rate structure were efforts to address revenue recovery risks and the conflicting incentives to promote energy efficiency and increase sales. . Furthermore, decoupling also removes financial risks associated with weather variability. For example, even in years with cool summers, when the utilities expect lower than usual sales, decoupling ensures that utilities will be able to recover their costs.
The impacts of decoupling
Both LADWP and GW&P agreed that there was no significant challenge in getting decoupling approved by their governing City Councils and implemented. The only factor preventing this policy from being adopted earlier is awareness and knowledge of the mechanism. Decoupling has led to a change in the corporate culture because the policy has allowed city managers and planners to shift focus from revenue recovery through increasing sales to other goals, like increasing energy savings through efficiency programs. For customers, the only change is a line on the bill that accounts for small adjustment surcharges or credits. Concurrent with approving decoupling, the LADWP board also approved a big budget increase for energy efficiency programs, and the utility has already saved enough energy this year to power 35,000 households.
By ensuring that the utilities will recover their authorized revenues, decoupling also strengthens expected financial performance. Credit agencies have viewed the policy as a positive shift that will improve revenue stability and operating results. In fact, the two utilities are so pleased with the potential from their rate adjustment mechanisms that both are considering incorporating decoupling for their water services rates as well.
A call to publicly owned utilities
The risks to revenue recovery and as a result of increasing investment on energy efficiency and weather variability —the main issues that LADWP and GW&P are trying to address through decoupling—are common to all utilities. LADWP and GW&P have set examples for the rest of the nation and other publicly owned utilities should take advantage of the lessons from these policies to help their municipalities save energy, lower customers’ bills, and provide cleaner air for all.