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NorthWestern Energy – Decoupling – The Need to Break The Link Between Sales And Revenue
Q. WHY IS IT IMPORTANT TO BREAK THE LINK BETWEEN A UTILITY’S
SALES AND FINANCIAL HEALTH?
The following is an excerpt from: IN THE MATTER OF NorthWestern Energy’s ) Application for Authority to Increase Retail Electric )
Utility Service Rates and for Approval of Electric ) Docket No. D2018.2.12
Service Schedules and Rules and Allocated
Cost of Service and Rate Design
DIRECT TESTIMONY OF
AMANDA LEVIN
FOR THE NATURAL RESOURCES DEFENSE COUNCIL AND HUMAN RESOURCE COUNCIL, DISTRICT XI
(The full Testimony follows this excerpt.)
THE NEED TO BREAK THE LINK BETWEEN SALES AND REVENUE
Q. WHY IS IT IMPORTANT TO BREAK THE LINK BETWEEN A UTILITY’S
SALES AND FINANCIAL HEALTH?
A. The electricity sector has undergone a rapid change over the last few decades. The traditional cost-of-service regime came to be more than a century ago, with the establishment of the first centralized electric utility in New York City. Over the 20th century, the electric industry became a vast system of poles, wires, and large power plants. State regulators and utilities built upon the economies of scale from large fossil fired plants to offer lower-cost electricity to a broad population and bring new, labor saving electric appliances to every corner of the country. In response, or in tandem, electricity demand grew quickly: seven percent a year, resulting in a doubling of electricity demand every ten years. Demand was projected to continue to see strong growth in the future, as well. To meet this growing electric demand (and expected future growth) at reasonable cost, utilities needed to constantly build large, lower-cost power generators.
Traditional cost-of-service regulation fit well within this energy environment: investor-owned utilities were able to more effectively pool money from shareholders to build these large power plants, utilities were then able to set rates based on their “cost-of- service” with approval from regulators, recover these prudent expenses through sales (which were growing strongly) over decades, and provide shareholders with a low-risk, profitable return.
In this environment it made perfect sense to tie utility revenue recovery to energy sales. Ever increasing energy use was tantamount to national economic growth. It was not a coincidence that in a period of our nation’s history when the imperative was economic growth – to build the nation, to fight world wars, to urbanize cities and mechanize the countryside, and to accommodate a burgeoning middle class – that a core element of the
system that evolved to regulate utilities promoted the sales of energy.
However, things have changed. Electricity sales have been flat – or even declining – due to new efficiency standards and codes, structural shifts in the economy, and new information technology options for consumers. An influx of low-cost, domestic natural gas has helped natural gas displace coal-fired power as the main source of electricity across the country. At the same time, the costs of renewable technologies, such as wind and solar, have declined sharply. Unlike conventional resources, like coal and nuclear power, these renewable energy sources can be built either very small or to utility scale, providing households and businesses with the opportunity to self-supply portions of their demand and allowing independent power producers to offer generation at comparable or lower cost than regulated utilities.
Of perhaps even greater importance when considering whether it still makes sense to tie a utility’s economic performance to sales is that it is no longer necessary for society to promote energy consumption in order to have economic growth. During the last couple of decades, the correlation between economic productivity and energy use has weakened significantly. As was reported by Bloomberg New Energy Finance, “Energy productivity and GDP growth both accelerated, demonstrating that the U.S. economy can grow at a reasonable rate even as total energy consumption actually declines.”
Part of what is enabling this transition is that technological progress has also extended well beyond the generation site. Advanced metering technology, coupled with the development of “smart” or grid-enabled, internet-connected appliances, provide customers with the ability to see their electricity use in real-time and even adjust their use whether at home or away to respond to grid changes in demand or supply. These “smart”appliances and the ubiquity of internet technologies has also changed customers’ expectations from their utilities. Selling electricity and providing reliable service is no longer enough; customers want good customer-centric service and control of their usage, bills, and electricity supply.
The changing energy sector has irrevocably changed the nature of electric utilities. New technologies, both in front of and behind the meter, have given customers much greater control of their consumption and the energy source of their consumption. Utilities must change to meet this new reality. This will require shifting away from the traditional cost-of-service regime that has dominated the electric utility sector for more than a century.
Breaking the link between sales and a utility’s profit is a small, but vital, first step towards modernizing our electric utilities. Doing so will allow NorthWestern Energy to move beyond the business of selling kWhs to a business model based on providing energy products and services tailored to meet customer needs while maintaining a reliable grid.
Q. HOW DOES TRADITIONAL COST-OF-SERVICE REGULATION CREATE A DISINCENTIVE FOR UTILITIES TO PROMOTING COST-EFFECTIVE ENERGY EFFICIENCY?
A. Under the current rate structure, NorthWestern Energy sees a reduction in both the Company’s recovery of authorized fixed costs and shareholder welfare if it were to pursue all cost-effective energy savings. It is called the “throughput incentive,” where traditional “cost-of-service” regulation motivates a utility to increase sales and resist efforts that would decrease sales. This is because a utility currently recovers much of its authorized costs, including those that are fixed in the shorter period – like capital investments, through the energy (kWh) charge.
This means that if sales decrease, a utility’s actual profit and return on equity (ROE) decreases, and if sales increase, profit and ROE increases.
Energy efficiency has significant documented societal and customer benefits, such as avoided pollution and avoided generation and grid infrastructure investment costs. However, because every additional kilowatt-hour saved currently directly reduces the costs recovered by NorthWestern Energy, the utility does not want to promote or achieve all cost-effective efficiency measures. This can and should be addressed through established ratemaking and regulatory policies that remove or break the link between sales and profit, making the utility indifferent to changes in sales volumes – and any measures that drive these changes.
Q. ARE THESE DISINCENTIVES LIMITED TO ENERGY EFFICIENCY?
A. No. In the last few years, a number of customer-sided technologies have become more affordable and widespread. Like energy efficiency investments, a utility also has a disincentive to promote or help customers invest in these newer, “behind-the-meter” technologies because they also decrease utility sales or opportunities for profit. These other technologies were not nearly as prevalent or widely available when the Commission last reviewed and considered the disincentives utilities face due to this “throughput incentive.”
Much like energy efficiency investments, distributed generation (DG) – most notably rooftop solar – can also significantly reduce a utility’s sales. DG has become a much more common and desirable customer option over the last few years, thanks to technology cost declines and utility, state, and federal incentives to boost local renewable development. Under a cost-of-service regime, each kWh of distributed solar that is used by a home is a kWh sale lost. And with additional state and commission policies, such as net-metering, the utility may face an even more significant financial penalty and disincentive from increasing DG deployment within their territory. Mechanisms that address the “throughput incentive” historically associated with energy efficiency can also address a utility’s disincentive to promote or help customers invest in DG. In fact, several decoupled utilities have explicitly noted that decoupling mechanisms have allowed them to be more amenable to and accepting of the growing number of DG applications and installations in their territories.
Q. WHY IS IT NOT PREFERABLE TO REMOVE THE LINKAGE BETWEEN NWE’S FINANCIAL HEALTH AND RETAIL SALES BY RECOVERING ITS FIXED COSTS IN HIGHER FIXED CHARGES TO CUSTOMERS?
A. First, I note that Dr. Power also addresses this issue at more length in his testimony. But because of its relevance and to be comprehensive I will also briefly discuss the subject.
While utilities may see fixed charge increases – or Straight Fixed Variable (SFV) pricing – as a quick and simple fix to address revenue deficiency, increasing the fixed charge presents numerous problems for consumers, the utility, and energy efficiency and other clean energy programs.
Evidence from other states support the conclusion that increasing fixed charges has a disproportionate impact on low-volume, lower income customers. High fixed charges also reduce all consumers’ incentive to control their energy usage and ability to take measures to reduce their bills. Higher fixed charges send the wrong price signal to customers, discouraging individuals from investing in energy efficiency measures or conservation. This undermines customer incentive to change usage patterns and reduce energy waste that would help consumers and the utility avoid increased investments in high cost generation and grid investments over the long-term.
Thus, while increasing the fixed charge may help NorthWestern Energy address revenue deficiency from reductions in consumer energy consumption in the short-term, it results in undesirable impacts on consumers and creates perverse consumer incentives that hinder the adoption and implementation of customer-sided technologies and actions that promote smart energy conservation. Over the long-term, these perverse incentives result in increased capital and variable expenses to meet the higher load, resulting in higher energy rates and bills for consumers.
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