Because of the way utilities are structured, utility companies lack incentives to encourage investment in energy efficiency and to explore innovations that would serve their customers. Traditionally, utilities are authorized to recover their costs and provide a reasonable rate of return for their investors. Based on estimated sales, regulators set a price on electricity for the next several years that allows the utility to recover their revenue requirement. This structure can create problems if energy efficiency or distributed energy generation reduces a utility’s sales. If electricity sales are below estimates, the utility may be unable to recover their expected return on investment. This dynamic can create a disincentive for utilities to establish energy efficiency programs.
Under decoupling, regulators set a target revenue level for utilities. If electricity sales are reduced due to energy efficiency or distributed energy generation, electricity rates automatically adjust without a lengthy or expensive rate case process. This can keep utilities on track to meet their revenue requirement and reduce the volatility in their earnings. It also reduces the disincentive for utilities to implement energy efficiency programs.
Close to half the states have addressed this problem by adopting some form of decoupling regulation for their utilities. Some state natural gas utilities are regulated under a form of decoupling called a “straight fixed variable rate” design. This model differentiates between a utility’s fixed costs and the variable costs (the cost of the gas) on a customer’s monthly bill. The utility imposes a set ratepayer fee on its fixed costs, and recoups a steady stream of revenue each month without regard to the amount of natural gas sold. The variable part of the bill (the gas sold) is thus decoupled from the fixed portion. Similar regulatory reform could be implemented with electric utilities as well.
Recent research highlights the success of revenue decoupling mechanisms across the country. Efforts in Idaho and Wisconsin offer examples of how decoupling can be implemented. By removing the disincentive for energy efficiency, decoupling can open the door for increased energy savings. For example, energy efficiency savings increased in Idaho from 0.5 percent in 2006 before decoupling was implemented to 1.3 percent in 2010. Additionally, by adding more stability to utility earnings, decoupling may lower the future cost of capital that utilities receive from investors. This could provide long-term savings if utilities can access low-cost financing for investing in grid infrastructure.
Decoupling is an important part of aligning financial incentives for energy efficiency and can play a part in driving greater innovation all across the country. The process for implementing some decoupling mechanisms would require formal rulemaking from the public utilities commission. However, governors could issue an executive order requiring their public utilities commission to implement a decoupling rule.