Energy Efficiency and Utility Rates: the Concept of Decoupling

The gist:

By “decoupling” sales from earnings, regulators can let gas and electric utilities earn money when their customers use energy more efficiently. This helps write energy efficiency and security into utilities’ bottom lines, turning them into vanguards of clean energy.

Decoupling: Turbocharging Efficiency Programs

What is decoupling?

Utilities are not like other companies. Their profits are dictated by state utility regulators, based on complicated formulas. Since profits rise in direct proportion to sales, investments in improving efficiency can drain away profits. By “decoupling” sales from earnings, utility regulators can write efficiency and security into utilities’ bottom lines and turn them into vanguards of clean energy.

Why decoupling? More profits and less energy

A host of studies, along with years of Northwest experience, show that the most promising—and environmentally sound—new “source” of energy is energy efficiency. But investments in efficiency are often beyond the reach, knowledge, or time horizon of residential consumers and businesses. Only the deep pockets that finance the energy infrastructure—especially electric and natural gas utilities—can seize the full potential of efficiency.

Some Northwest utilities, such as Seattle City Light, are aggressive in helping their customers save energy. But other utilities hold back, in part because they know that more-efficient consumers will buy less energy, possibly trimming company profits.

How does it work?

Under decoupling, utility rates are structured so that a utility’s profit margins can rise when consumption falls. (In other words, a utility’s earnings are “decoupled” from its gross sales.) This simple change can make it profitable for utilities to promote conservation. And as a result, decoupling aligns the utility’s incentives with the incentives of its customers: everyone has an incentive to use energy more efficiently.

Decoupling is one of those nifty little ideas with a huge potential payoff for a seemingly insignificant change. It doesn’t take much to make decoupling a reality—it relies on a simple alteration to the rules, rather than regulatory strictures or costly upgrades to technology.

What’s happening in the Northwest?

Utilities in the Pacific Northwest are conflicted about helping their customers save energy. On the one hand, they’re legally obligated to do it. On the other hand, if they do it successfully, they don’t make as much money.

  • NW Natural, an Oregon gas company, has been operating under a decoupled rate structure since 2002. One result: it’s shifted staff from marketing (trying to get people to buy more gas) to customer service.
  • California decoupled all its utilities in one sweeping move a few years ago.
  • Surprisingly, since March of 2007, Idaho Power has operated under the most progressive decoupling rules in the Pacific Northwest.

Oregon’s electric companies and most of Washington’s utilities operate under the conflicted old rules. But we may see progress soon. Decoupling is an ideologically neutral innovation that helps save energy, lower customer bills, reduce greenhouse gas emissions, and unlock green-collar jobs. Interestingly, both “blue” California and “red” Idaho have wholeheartedly embraced decoupling.

Case Study: NW Natural
In the case of NW Natural, decoupling works like this:

  • At the beginning of a financial period, the state’s utility commission authorizes a target “rate of return” on NW Natural’s capital investments.
  • Each month, if the utility sells less energy than expected because of conservation (that is, not simply because of a slow economy or warm weather), then rates increase slightly to reach the target level for revenues.
  • If sales are higher than expected, because of a lack of conservation, then rates and profits diminish.

Decoupling puts the heat of the bottom-line on NW Natural’s efficiency efforts. It also has the effect of reducing uncertainties to the utility and their customers. Customer bills vary less than without decoupling.

Related information:

Published: January 21, 2009