Revenue Decoupling Quickview

By Lewis Verduyn

What is revenue decoupling? Revenue decoupling is a regulatory mechanism that removes critical barriers to investment in energy efficiency, new renewables and distributed generation. When implemented as part of an efficiency strategy, it turns power companies into providers of energy services and vanguards of sustainable energy. Why is decoupling needed? Under conventional regulations, the more electricity a power company sells, the more money it makes, so there is a financial incentive to increase throughput, raise prices, and build load. As such, there is a corresponding disincentive to invest in energy efficiency, and any demand-side-management that reduces load and revenue. This means that power companies trying to maximize sales are working against public policies aimed at reducing consumption. However, under decoupling, the link between sales and profits is separated, or 'decoupled', removing the incentive to sell as much power as possible at the highest rate. The decoupling mechanism ensures that revenues are stable regardless of sales volume. Now, power companies can invest in energy efficiency, smart grid technologies, and all demand-side-management, and continue to make a profit. How does the decoupling mechanism work? 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 the target a true up rate adjustment is made. 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. 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, without decoupling, inefficiency can be offset by sales. Decoupling is ideologically neutral with broad political appeal, and the mechanism can be designed for both traditional and restructured markets.

What does decoupling mean for power companies and investors? 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. Revenue certainty reduces investor risk, and is favoured by financial institutions and credit agencies, making low-cost capital more accessible, and investment programmes easier to plan and more sustainable. If power companies also support diversification and distributed generation, they take risk reduction a step further. Future-oriented power companies can transform from being the providers of a commodity to the providers of complete energy services, able to take advantage of the rapidly expanding demand for smart grid technologies. Such end-to-end connectivity has enormous operational benefits in respect of demand response, load profile flexibility, and access to distributed power and storage flowing back into the grid. Real-time information allows for optimization of electricity in the network, and for the maximum utilization of assets. As energy advisors who understand the particular requirements of their customers, power companies can work with architects, engineers and developers on building design, advising on load reduction, micro-generation, storage, and regulatory incentives, for domestic, commercial and industrial customers. This diversification not only improves efficiency, it adds profitable revenue streams and further lessens financial risks. What does decoupling mean for consumers and power prices? Power companies run savings programmes to help their customers lower their electricity bills. Such programmes can cover replacement of selected appliances with energy-efficient models, rebates on building retrofits, or interest free loans. Consumers may have no up-front costs, simply paying a little extra assessed on their monthly bills over a fixed period, which is made affordable because they are saving electricity and have lower usage costs. Government subsidies and tax credits may also add financial benefits for consumers. Meanwhile, the decoupling mechanism itself is often unnoticed by customers. A typical rate adjustment is only 2-3 percent (capped), equating to less than 1 percent of a customers power bill in most cases, which is usually imperceptible, especially to those with lower power bills because of less consumption. And since the rate adjustments are always opposite the direction of changes in overall consumption, decoupling has a stabilizing effect on customer bills. 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 around 20 percent below the US national average. What does decoupling mean for the environment? Conventional energy sector regulation promotes infrastructure growth before efficiency and environmental protection. Decoupling does the reverse. By investing in energy efficiency, power companies can meet demand growth at less than half the cost of new generation, and deploy it much faster, while reducing transmission capacity issues. Under decoupling, building new power

stations without first investing in all cost-effective energy efficiency is a huge misallocation of capital. Efficiency becomes the supply option of first choice. And since fewer new power stations are needed, all the negative environmental impacts of unnecessary generation and transmission capacity are avoided, including emissions. Landscapes need not be carved up and rivers need not be destroyed. While energy efficiency alone is not the ultimate solution to growth-driven ecological destruction and climate change, it is the largest single first-aid option. In tandem, decoupling sets the agenda for the necessary transition to clean energy by promoting investment in new renewables and distributed generation, with numerous environmental benefits. Why is decoupling so important for society? Decoupling better aligns power company incentives with societal interests. More and more, policy-makers and regulators are realizing that the conventional energy business model, based on profits that are tied to increasing sales, is not beneficial to society. Economic and environmental imperatives demand that we evolve our energy systems toward maximum efficiency, new renewables and distributed generation. The result is more sustainable economic activity, more green collar jobs, more energy security, more environmental protection, and the shortest route to reducing climate change impacts. Crucially, our society is locked into unsustainable growth in a finite world, and the energy sector is a fundamental driver of growth in every country. But decoupling stops quantitative growth by default, putting the brakes on expansion and the focus on efficiency and sustainability. Since energy underpins our society, decoupling represents an essential paradigm shift away from our impossible growth-based economy towards a sustainable future. Given the positive attributes of decoupling for power companies, consumers, and society, it is reasonable to expect that it will continue to gain in popularity and become the regulatory method of choice for the 21st century.