You asked for a brief discussion of electric rate decoupling and the relevant provisions of PA 07-242. You also wanted to know whether the arguments for and against decoupling were raised in the floor debate on this act.

SUMMARY

Under current rate-making practices, the vast majority of an electric company's revenues are tied to its sales. Proponents of decoupling revenues and sales believe that this gives electric companies a disincentive to vigorously promote energy conservation, since this can hurt them financially. They also believe that decoupling could result in lower rates by reducing the risks for electric companies and by reducing the need for rate cases. Finally, they believe that it is inconsistent for the state to promote energy conservation, but use a rate-setting mechanism that can discourage conservation. People who are skeptical of decoupling believe that in fact the electric companies have been very effective in promoting conservation, that decreases in electric sales can be the result of factors unrelated to conservation, and that decoupling is inconsistent with established rate-making principles.

PA 07-242 addresses a wide range of energy issues. Among other things, it requires the Department of Public Utility Control (DPUC) to order electric companies to decouple their distribution revenues from the volume of sales using one or more specified methods. These provisions also apply to natural gas companies.

An amendment was offered in the House that would have narrowed the scope of the decoupling provision. Although there was a lengthy debate on the amendment, which did not pass and would have made many changes in the underlying bill, there was no debate on the decoupling provision itself. There also was no debate on the decoupling provision in the Senate.

ELECTRIC RATE SETTING

Historically, the DPUC set electric rates in periodic rate cases. The rates were primarily set by dividing the company's projected revenue requirements in a future year by its projected sales of electricity in that year. The revenue requirements were the amount DPUC projected the companies would need to recover their prudently incurred capital and operating expenses and to earn a DPUC-set rate of return on their DPUC-approved capital investments. The scope of rate cases was reduced as a result of the electric restructuring law adopted in 1998.

The electric restructuring law effectively required the companies to sell their power plants and as a result the companies buy power on the wholesale market. (PA 07-242 allows the companies to re-enter the generation market under certain circumstances. ) DPUC approves these purchases in proceedings that are separate from the companies' rate cases. The companies recover the cost of the purchased power in rates, but do not earn a return on these costs. The cost of the purchased power is recovered from electric company customers based on their consumption. This cost accounts for the bulk of electric customer rates (more than 60% of the total monthly average bill for a Connecticut Light and Power residential customer. ) Under current DPUC policy, the wholesalers bear the risks for changes in sales volume with regard to this component of electric rates.

DPUC continues to set rates for delivering power to customers and customer services charges in rate cases. In addition, certain charges are imposed under federal and state law. Except for the flat consumer service charge (about 8% of the average residential customer's monthly bill) the various components of residential electric bills are based on the number of kilowatt-hours a consumer uses each month. (Larger commercial customers also pay a demand charge, which based on their historic consumption. ) As a result, most of the electric companies' revenues are directly tied to their sales.

ARGUMENTS FOR AND AGAINST DECOUPLING

Advocates of decoupling argue that this rate design creates a financial disincentive for electric companies to actively promote conservation programs. This is because several of the companies' expenses are fixed and do not decrease with reduced consumption. To the extent that conservation programs reduce sales and this reduction is not offset by growth in the number of customers, the company will not fully recover its expenses. This is particularly true for the part of the bill that covers the companies' cost in delivering power, which accounts for about 16% of the average residential customer's bill. To the extent that the company does not fully recover its expenses, its rate of return on it capital investments may fall below the level authorized by DPUC in the company's last rate case. Proponents of decoupling company sales from revenues believe that reducing the company's risk that it will not fully recover its costs can reduce its cost of capital and thus potentially its rates. They also believe that it is inconsistent for the state to promote energy conservation while at the same time potentially harming the electric companies that implement the conservation programs.

A number of legislators and other participants in the debate on energy policy have expressed skepticism as to the merits of decoupling. They claim that the electric companies have aggressively promoted energy conservation and that the programs they have implemented have been highly successful. They believe that year-to-year reductions in electric sales can be the result of factors other than conservation, notably changes in weather and economic conditions. As a result, adjusting electric rates to make up for reduced sales can shift risks from the companies to ratepayers and provide the companies with a windfall. They also argue that decoupling is contrary to established rate-making principles, which call for DPUC looking at all of the factors affecting electric company revenues simultaneously, rather than on a piecemeal basis, when it sets rates.

PA 07-242 AND DECOUPLING

PA 07-242 requires DPUC, in future rate cases, to order electric companies to decouple their distribution revenues from the volume of sales. It can do this by a sales adjustment clause, rate changes that increase the amount of revenues recovered through fixed distribution charges, a mechanism that adjusts actual distribution revenues to reflect allowed revenues, or a combination of these measures. A sales adjustment clause adjusts distribution rates between rate cases to reflect changes in electric sales. The second option would allow DPUC to establish flat distribution charges, similar to the existing customer service charge, in lieu of the existing distribution rates that are charged on the basis of electric consumption. The third option is similar to the first, but focuses on distribution revenues rather than distribution rates. In making its choice among these options, DPUC must make necessary adjustments to the rate of return the company earns to reflect the impact of decoupling. These provisions also apply to natural gas companies.

On the House floor Representative Fontana asserted that the decoupling provision would cost ratepayers $ 72 million per year and proposed an amendment (House “C”) that would have modified the provision, among many other changes.

The amendment would have required DPUC to design a cost-effective mechanism to make the relationship between an electric company's sales and the recovery of its costs more flexible. The adjustment would have applied to the distribution component of rates, adjusting them annually for changes in company revenues resulting directly from ongoing or new energy efficiency, conservation, demand response or load management initiatives implemented by the company. The amendment would have required the Energy Conservation Management Board to inform DPUC of the amount of revenue changes. DPUC could then implement the mechanism if it determined this was in the best interest of ratepayers under existing rate-making principles. The base level of revenues allowed per customer would be reset in each following DPUC decision modifying the company's distribution rates. By February 1, 2010, DPUC would have been required to report to Energy and Technology Committee regarding the mechanism and its use. Finally, the amendment would have required DPUC to consider the existence of the mechanism in setting the company's authorized rate of return. Fontana asserted that this provision would limit the payments to the companies under the decoupling provisions to costs they had incurred in promoting energy efficiency. Although there was a lengthy debate on the amendment, no other members spoke on this provision and the amendment was defeated.

In the Senate, Senator Fonfara stated that the bill decoupled electricity consumption from electric company profits, and this was a key component in having the companies work with rather than against the state in conserving energy. The issue of decoupling was not otherwise addressed in the debate.

KM: dw