How Decoupling Creates Win-Win for Power Companies and Customers

Article by

Lewis Verduyn
October, 2011

Clutha River Forum PO Box 124, Lake Wanaka 9343, New Zealand cluthariverforum@gmail.com

It saves energy, cuts electricity bills, creates 'green collar' jobs, protects the environment, sets the agenda for cleantech energy, and reduces climate change impacts. Decoupling is a proven energy efficiency strategy that ticks all the boxes. Energy efficiency (EE), negawatts, the fifth fuel whatever you want to call it, is the cheapest, fastest, smartest way to add supply capacity. It can save us billions of dollars annually.1 It can create jobs and future-proof our economy. It can save our rivers from unnecessary dams, and its carbon-free. Better still, energy efficiency has emerged as the largest single lever to limit climate change. The United Nations Foundation has estimated that a 2.5 percent improvement in efficiency worldwide would keep carbon dioxide (CO2) concentrations in the atmosphere below 550 parts per million, minimizing climate change impacts.2

Energy efficiency component in policy scenarios

But New Zealand is far from being energy efficient. Despite decades of campaigns urging us to reduce electricity consumption, we continue to rank among the least energy efficient countries in the OECD,3 while paying ever higher electricity prices. Why are we struggling? Working against us is an electricity industry driven by consumption, not by energy efficiency. Thats no surprise, given that we have a 20th century grow-and-build4 market model based on production, consumption and construction. As a supply strategy, the traditional grow-and-build model worked well during much of last century, when supply networks were developed, and when improving technology and economies of scale kept electricity prices relatively affordable and stable. It delivered major networks and inestimable benefits. But the imperatives have changed in todays capital and carbon-constrained world. The costs of new generation, both financially and environmentally, are enormous.
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We need a market that promotes efficiency, and clean energy. We need a smart market that works in the 21st century. Decoupling is a regulatory mechanism that decouples the link between increased sales and increased profits. It is a proven strategy that stimulates investment in energy efficiency, new renewables and distributed generation.5 How decoupling works In the grow-and-build market, the more electricity a power company sells, the more money it makes. When there is enough demand for more electricity, it can justify a new power station, funded by customers and with profits returned to shareholders. More consumption equals more profits. More demand equals more power stations and more profits. In short, there is a throughput incentive. Traditional regulated markets, typically found in the US, have a strong throughput incentive. Restructured markets, such as that of New Zealand, also encourage electricity generators to sell as much electricity to consumers as they can at the highest attainable rate. It follows that power companies are not seriously interested in lowering electricity consumption through energy efficiency, in spite of the positive impacts on supply, customer bills, and the environment. However, the decoupling mechanism removes the throughput incentive by ensuring that power companies have stable revenues regardless of sales volume. In its essential form, an approved revenue target is set by the regulator over a fixed period usually a year, to provide a safe and reliable service, with a fair return for investors, and at a fair cost to customers. The power company then collects revenue regardless of sales volume. Regularly usually monthly, the revenue return is reviewed to see if the predetermined revenue requirement is being met, and if it is under or over a true-up rate adjustment is made.6 If energy sales are less than expected, rates rise slightly to reach the target revenue, and profits increase. If energy sales are higher than expected, rates and profits diminish. A typical rate adjustment is only be 2-3 percent (capped), equating to less than 1 percent of a customers power bill in most cases,7 which is usually imperceptible to consumers, especially those with lower power bills because of less consumption. Since the rate adjustments are always opposite the direction of changes in overall consumption, decoupling has a stabilizing effect on customer bills. The revenue target is calculated on a per-customer basis, and moves up or down accordingly, protecting customers from risk. Power companies are motivated to add customers, because approved revenues then increase, and saved energy can be sold to new customers without the cost of adding equivalent generating capacity. Performance incentives are a key component of the mechanism. At the same time, any efficiency measures that reduce the fixed costs of supply will increase profits, whereas previously inefficiency could be offset by sales. Decision-making then refocuses on cost-effective investments to deliver more efficient energy to customers, even when such investments reduce sales.

Shareholder and customer interests aligned Electricity prices under the grow-and-build model face continuous upward pressure.8 Power companies are motivated not only to achieve fixed-cost recovery and profits for shareholders, they are also intent on financing new generation and passing on those costs to the consumer. But with decoupling, the pressure to raise prices is eliminated because company profits are maintained or improved while energy consumption and projected demand is reduced. Power companies run savings programmes to help their customers lower their electricity bills.9 In the longer term, consumers often pay much less than they would have done under the previous growth-based system. For example, after three decades of decoupling in California, electricity bills are about 20 percent below the US national average.10 A compelling benefit of decoupling for power companies is that it provides reliable fixed-cost recovery and therefore revenue certainty, by eliminating the financial risks associated with reduced sales; when consumers become more energy efficient with new appliances or habits, when weather limits supply (hydro reservoir dry years), and when economic conditions depress the market. By investing in energy efficiency, power companies can meet demand growth at less than half the cost of new generation,11 and deploy it much faster, while reducing transmission capacity problems. And since fewer new power stations are needed, everyone benefits by avoiding the economic and environmental costs of unnecessary generation. Power company investments in energy efficiency also yield faster returns than investments in new generation. Importantly, as the cost of new generation continues to climb and the cost of energy efficiency continues to fall, the returns on efficiency investments are outpacing the returns from new generation. Under decoupling, building new power stations without first investing in all costeffective energy efficiency is a huge misallocation of capital. Efficiency becomes the supply option of first choice. The bottom line is that decoupling results in a positive alignment between shareholder and customer interests. With decoupling, power companies can make money when their customers save money. The decoupling success story Decoupling electricity began in 1982, when California adopted an Electric Revenue Adjustment Mechanism to decouple power company revenue from sales.12 The mechanism successfully removed disincentives for energy efficiency and reduced rate volatility. In 1996, however, the state regulator decided that deregulating power companies would be more effective. Deregulation was a disaster as rates spiralled out of control, impacting heavily on consumers. Energy resources were squandered and after electricity shortages in 2000 and 2001, decoupling was re-adopted in a landmark programme that resulted in two billion dollars of investments in energy efficiency measures from 2006 to 2008.13
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The cost has averaged 2 to 3 cents per avoided kilowatt hour, which is about one-fifth the cost of electricity generated from new sources. Every dollar invested by the power companies in efficiency has reaped more than two dollars in savings for customers. The average saving per family has been about US$1000 per year.14 In the past three decades, electricity consumption per capita grew 50 percent in the rest of the US, while it stayed relatively flat in high-tech, fast-growing California, which has cut electricity consumption by a massive 40%.15 Efficiency measures saved California households US$56 billion from 1972-2006, enabling households to redirect expenditure toward other goods and services, creating about 1.5 million jobs with a total payroll of US$45 billion. Reduced demand has resulted in slower growth in energy supply chains, but for every new job foregone in the supply sector, more than 50 new jobs have been created across the economy.16 In total, California saves over 40,000GWh annually17 through a combination of utility efficiency programs and building and appliance standards, compared to the aggregate of other US states.

California energy consumption compared to US energy consumption

Californias success story has prompted decoupling roll-outs across the US. Full or partial decoupling has been enacted in 17 states and is under consideration in 11 more and the District of Columbia.18 In many cases, decoupling has been supported by the large power companies. Even with Californias impressive achievement so far, the state still thinks that with further effort, it can achieve as much additional electricity savings by 2020 as it has in the past three decades.
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Last year, California adopted a revised scheme called decoupling plus, which aims to make investments in energy efficiency more profitable for power companies than new power stations would be.19 The winning recipe is not a secret Governments around the world are realizing that specific incentives and regulations must be in place to achieve progress in energy efficiency, and that the markets and the providers, will have to change in order to make it happen. Obvious, is the need to integrate a three-part policy including utility incentives, government standards, and technology innovation. Policy-makers and regulators have a number of market and standards-focused options. While various market mechanisms may stimulate certain energy efficiency measures, only revenue decoupling removes the throughput incentive, while being flexible enough to meet the needs of utilities and customers alike.20 To decouple successfully, it is vital that the regulator treats the return on energy efficiency expenditure in the same way as new plant, as this provides the necessary incentive for utilities to actively pursue efficiency for profit. Regulators can opt for lesser degrees of decoupling, but the full true-up approach is considered best practice because it encourages, at a reasonable cost, the full range of measures to promote efficiency and clean energy.21 When designing the mechanism, regulators must be sure that utilities have ready access to project finance, and ensure that investment risk is not passed on to the consumer. Progress and outcomes need reliable monitoring and verification programmes, and the revenue true-up process requires robust fairness tools. Power companies should be able to design and administer programmes that involve all stakeholders regulators, lines utilities and customers. Decoupling is only part of the recipe. It is also essential to set standards and targets that create forward momentum, and to leverage innovation by providing financial incentives for research and development, and deployment. Improvements in standards are particularly important. Half of Californias savings are due to building and appliance standards, which are revised upward every three years. Building codes should move toward the goal of zero net energy, in line with the success of passive design.22 When the energy market is driven by efficiency, the result is an ever-expanding efficiency industry, with energy companies taking a leading role if theyre smart. Much of Californias success can be credited to Art Rosenfeld, the former Commissioner of the California Electricity Commission from 2000 to 2010, who designed aggressive and visionary energy policies. The winning recipe is not a secret, and can be adapted to any market:23 1. 2. 3. 4. RD&D and Standards Integrate energy efficiency into resource procurement Motivate utilities by decoupling revenues from sales Set energy saving targets
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5. Well-designed programmes 6. Independent evaluation of savings 7. Performance-based incentives Well-planned and implemented, this formula turns the market, stimulating investment in efficiency and cleantech energy - the ultimate climate-friendly energy strategy. But there are barriers to success, and they are not financial or technological. Researchers talk about policy-makers with knowledge gaps,24 and energy companies with habitual behaviour.25 Success factor is the strength of political will A commitment to energy efficiency is one thing, achieving it is another. Regardless of government policy and efficiency targets, progress will be slow unless power companies are provided with incentives to invest as much in efficiency as they do in generation. If our government and our power companies were as committed to efficiency as they are to generation, we would be winning already. Without a favourable regulatory environment, the motivations of power companies and policy-makers will remain at cross purposes. Efficiency technologies and new renewables are rapidly expanding and will influence every aspect of our lives in the 21st century. Efficiency will soften the transition to a clean energy economy, and both will enable more sustainable economic activity, more competitive businesses, more green collar jobs, more energy security, more environmental protection, and the shortest route to reducing climate change impacts. To that end, decoupling removes critical barriers to investment in energy efficiency and cleantech, simply and effectively eliminating a power companys throughput incentive, while stabilizing consumer power bills, and reducing the overall level of business and financial risk that power companies and their customers face. If thats not enough, the decoupling mechanism represents an essential paradigm shift from quantitative economics (volume-based) to qualitative economics (qualitybased) the fundamental antidote to unsustainable 'growth at any cost' in our finite world. Given the positive attributes of revenue decoupling, it is reasonable to expect that it will continue to gain in popularity and become the regulatory method of choice for the 21st century electricity sector.26 Energy - clean and efficient, and decoupled, is not only the opportunity of the 21st century, it is our top survival strategy. What is missing is a long-term vision for New Zealand, and the strength of political will to achieve it.

Rob Bishop (2001). New Zealands Energy Efficiency Potential A Top Down Analysis, Energy Solutions Ltd. http://www.energysolutions.co.nz/pdf/New%20Zealand's%20Energy%20Efficiency%20Potential.pdf Very large savings from energy efficiency are possible in New Zealand. This study, using assumptions believed to be realistic and conservative, shows that, for fast implementation of efficiency, a cumulative benefit of up to $75 billion dollars could be achieved by 2020, at a cost of only $12 billion.
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Expert Report (2007). Realizing the Potential of Energy Efficiency, Targets, Policies and Measures for G8 Countries, United Nations Foundation. http://www.globalproblems-globalsolutionsfiles.org/unf_website/PDF/realizing_potential_energy_efficiency.pdf Based on extensive consultations with senior energy experts from around the world, this report proposes that G8 countries pledge to double their historical rate of energy efficiency improvement. This translates roughly to a 2.5 percent annual improvement. Accomplishing a 2.5 percent efficiency improvement on a worldwide basis would save 97 EJ and return energy consumption to 2004 levels. Importantly, doubling the rate of energy efficiency would make it possible to keep carbon dioxide (CO2) concentrations in the atmosphere below 550 parts per million (ppm) through the end of the century if the goal were expanded worldwide. This calculation is based on the assumption that the 2.5 percent improvement through 2030 then linearly falls to 1 percent by 2100.
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Massimo Filippini, Lester C. Hunt (October 2009). Energy Demand and Energy Efficiency in the OECD Countries: A Stochastic Demand Frontier Approach, Centre for Energy Policy and Economics, Swiss Federal Institutes of Technology. http://www.cepe.ethz.ch/publications/workingPapers/CEPE_WP68.pdf Figure 4 gives the ordered data for the latter period only, 1998-2006. This shows that the ordering does change, with the five least efficient countries being Finland, Belgium, the Slovak Republic, Canada and New Zealand and the five most efficient countries being Germany, Switzerland, Denmark, Italy and Ireland.
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Michael Valocchi, John Juliano and Allan Schurr (2010, March). Switching Perspectives, Creating New Business Models for a Changing World of Energy, IBM Institute for Business Value. http://www.fuqua.duke.edu/edge/documents/IBM_-_New_energy_biz_models-optional.PDF From the early days of the integrated monopoly utility until the mid-to-late 1960s, electric utilities aggressively pursued a grow-and-build strategy as core to their operating model. ...Because each succeeding class of turbine generator units had greater output, higher thermal efficiency and lower cost-perunit output, the cost of generating electricity declined as production rose. To escalate production and achieve these economies of scale, utilities actively encouraged more and more usage of electricity. Economies of scale eventually plateaued, as generating units reached a practical optimum size by the early 1970s. But there has been significant stagnation in business models as well. In reality, todays business models in many places differ little from the business models of the grow-and-build era, even though the imperatives are vastly different.
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Stephen Heins and Joel Sandersen. (2007). Decoupling: Divorcing Electricity Sales from Revenues Creates Win-Win for Utilities and Customers. Summer Study on Energy Efficiency in Industry. Orion Energy Systems. European Council for an Energy Efficient Economy (eceee), c/o Borg & Co, Sveavgen 98, IVS113 50, Stockholm, Sweden. http://www.eceee.org/conference_proceedings/ACEEE_industry/2007/Panel_5/p5_4/Paper/ Breaking the linkage between utility sales and utility revenues will remove the disincentives and stimulate utility investment in energy efficiency, renewable energy and distributed generation.
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United Nations Foundation. (2010, September). International Energy Efficiency Initiative. - Changing the Utility Business Model (abridged by European Institute). http://www.europeaninstitute.org/Documents/international-energy-efficiency-initiative.html Actual deviations from this formula are discovered through monitoring and verification programs and reconciled through credits to consumers (in the case of excess utility revenue) or recoveries from consumers (in the case of a revenue shortfall). This is often referred to as a true-up process.
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National Renewable Energy Laboratory. (2009, December). Decoupling Policies: Options to Encourage Energy Efficiency Policies for Utilities. U.S. Department of Energy, Office of Energy Efficiency and Renewable Energy. http://www.nrel.gov/docs/fy10osti/46606.pdf The decoupling adjustments, positive or negative, tend to be small, resulting in less than a $2.00 difference in a customers average monthly electric bill (less than a 1% change in the total bill in the majority of cases).
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Ministry of Economic Development. (2008). Schedule of Domestic Electricity Prices: Updated to 15 November 2008. http://www.med.govt.nz/templates/MultipageDocumentTOC____39087.aspx The price of electricity increased 7.5% in the year between 2007 and 2008, and 41% in the five years between 2003 and 2008.
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Cassie Zinzow, e4energy, Economy-Environment-Energy-Efficiency, Decoupling, Making Energy Efficiency a Reality. http://www.stateinnovation.org/Research/Energy-and-Environment/Utility-Decoupling/Decoupling20Brochure(2).aspx As utilities begin to implement efficiency programs more enthusiastically, energy demand should stabilize and eventually decline. Decoupling will not impose any new or additional costs on customers and initially rates will only oscillate up or down very modestly. However, residential electric consumers will now have more opportunities to use energy efficient practices in their own home through their utilitys support, which will result in lower utility bills. As energy efficiency becomes a more prevalent practice, the residential sector will also benefit from overall declining utility rates.
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United Nations Foundation. (2010, September). International Energy Efficiency Initiative. - Changing the Utility Business Model (abridged by European Institute). http://www.europeaninstitute.org/Documents/international-energy-efficiency-initiative.html Under decoupling, Californias per capita energy has remained relatively flat over the last thirty years. To put this in perspective, energy use per capita in the rest of the country has increased by 50 percent. As a result, Californians enjoy electricity bills that are approximately 20 percent below the national average.
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United Nations Foundation. (2010, September). International Energy Efficiency Initiative. - Changing the Utility Business Model (abridged by European Institute). http://www.europeaninstitute.org/Documents/international-energy-efficiency-initiative.html Recent improvements in technology and practice have brought the cost of freeing up a kilowatt-hour of electricity through energy efficiency down to less than half of the cost of building new generation.
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Brian C. Prusnek (2005, May 18). Promoting Energy Efficiency in California. http://www.epa.gov/statelocalclimate/documents/pdf/PrusnekPresentation.pdf
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John Bacino (2007, September 10). Utility Decoupling: Giving Utilities Incentives to Promote Energy Efficiency.http://www.progressivestates.org/blog/672/utility-decoupling-giving-utilities-incentives-to-promoteenergy-efficiency California is just one of many states to have disastrous experiences with deregulation. Deregulation has not delivered energy savings and has often undermined state programs, as in California, that were promoting energy conservation. After the mass electricity shortages in 2000 and 2001, California re-adopted decoupling in a groundbreaking energy-efficiency campaign that includes two billion dollars of approved investments in efficiency from 2006 to 2008.
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International Rivers. (2009, January).The Power of Negawatts. Efficiency: The Greenest Electricity Source. http://www.internationalrivers.org/files/EnergyFactSheet.pdf Weve saved $16 billion a year in electricity, with a net savings of about $1,000 per family per year, notes John Wilson, formerly of the California Energy Commission. Put another way, every dollar invested by Californias utilities in efficiency measures has generated more than two dollars in savings for customers.
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David Roland-Holst (2008, October). Energy Efficiency, Innovation, and Job Creation in California http://areweb.berkeley.edu/~dwrh/CERES_Web/Docs/UCB%20Energy%20Innovation%20and%20Job %20Creation%2010-20-08.pdf Over the last thirty-five years, as a result of landmark energy efficiency policies, California has de-coupled from national trends of electricity demand, reducing its per capita requirements to 40 percent below the national average.
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David Roland-Holst (2008, October). Energy Efficiency, Innovation, and Job Creation in California http://areweb.berkeley.edu/~dwrh/CERES_Web/Docs/UCB%20Energy%20Innovation%20and%20Job %20Creation%2010-20-08.pdf Energy efficiency measures have, enabled California households to redirect their expenditures toward other goods and services, creating about 1.5 million FTE jobs with a total payroll of $45 billion, driven by welldocumented household energy savings of $56 billion from 1972-2006. The same efficiency measures resulted in slower (but still positive) growth in energy supply chains, including oil, gas, and electric power. For
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every new job foregone in these sectors, however, more than 50 new jobs have been created across the states diverse economy. EPA State Clean Energy-Environment Technical Forum. (2005, November 10). Call #10: State and Regional Clean Energy Planning. http://www.epa.gov/statelocalclimate/documents/pdf/Clean_Energy_Planning_11_09_05.pdf The EAP II notes that Californias energy efficiency efforts, particularly efficiency requirements for appliances and new buildings, have already reduced peak capacity needs by more than 12,000 MW and continue to save about 40,000 GWh of electricity annually.
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United Nations Foundation. (2010, September). International Energy Efficiency Initiative. - Changing the Utility Business Model (abridged by European Institute). http://www.europeaninstitute.org/Documents/international-energy-efficiency-initiative.html
18

California Public Utilities Commission, Californias Decoupling Policy. http://www.fypower.org/pdf/Decoupling.pdf

19

PEW Center on Global Climate Change. (2011, February 10). Revenue Decoupling Detail. - Other Mechanisms to Encourage Efficiency. http://www.pewclimate.org/docUploads/Revenue_Decoupling_detail_0.pdf
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Pacific Economics Group. (2011, July). What's New. Pacific Economics Group (PEG), 414 Mission, Santa Fe, CIR, chico, CA 95926, USA. http://www.pacificeconomicsgroup.com/whats-new.html 'Dr. Lowry discussed basic approaches to decoupling, decoupling precedents, and criteria for choosing between alternative decoupling methods such as decoupling trueup plans and straight fixed variable ("SFV") pricing. He commented that "the trueup approach to decoupling is the best practice approach because it encourages, at a reasonable administrative cost, the full range of measures that can promote clean energy. These advantages help to explain why decoupling trueup plans are spreading rapidly in the gas and electric power industry and are used or scheduled for use in most states that have a strong commitment to clean energy'.
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International Rivers. (2009, January).The Power of Negawatts. Efficiency: The Greenest Electricity Source. International Rivers, 1847 Berkeley Way, Berkeley CA 94703, USA. http://www.internationalrivers.org/files/EnergyFactSheet.pdf Half the states savings are due to building and appliance standards, which are revised upward every three years. We were told the 1993 standards couldnt be done, and today were meeting a standard that is 20% more efficient than that one, Wilson says. I think well get to zero-net-energy buildings in 10 years.
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Sheryl Carter, Devra Wang and Audrey Chang. The Rosenfeld Effect in California: The Art of Energy Efficiency. Natural Resources Defense Council. http://www.energy.ca.gov/commissioners/rosenfeld_docs/rosenfeld_effect/presentations/NRDC.pdf
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Prof. Don Cleland (2006, July). Energy Efficiency Potential. Institute of Technology and Engineering. Massey University. http://ips.ac.nz/events/completed-activities/breaking_pdfs/Don%20Cleland.pdf
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Akaash Sachdeva and Philip Wallis (2010, August). Our demand: reducing electricity use in Victoria through demand management. Monash University. Monash Sustainability Institute. The University of Melbourne. http://www.monash.edu.au/research/sustainability-institute/assets/documents/dm-electricity-report.pdf Strategies that address the financial barriers to DM (demand management) should be complemented by conclusions from behaviour change literature to address barriers related to bounded rationality and habitual behaviour among management.
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Navigant Consulting, A Ceres Report. (2010, July). The 21st Century Electric Utility: Positioning for a LowCarbon Future, Ceres, Boston, MA, USA. http://www.ceres.org/resources/reports/the-21st-century-electric-utility-positioning-for-a-low-carbon-future-1 Given decouplings positive attributes especially its effectiveness in removing utilities inherent conflict of interest and given concerns about alternatives to decoupling, it is reasonable to expect that decoupling will continue to gain in popularity and become the regulatory method of choice for maintaining utilities financial health while capturing EE as the key resource for the 21st century power sector. Utility targets and performance incentives, combined with the right rate model, will help ensure that utilities become drivers for
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EE (Energy Efficiency) and DER (Distributed Energy Resource) in a manner that wont harm the utilitys credit ratings or other financial metrics.