You asked for a discussion of electric rate decoupling initiatives in other states. You were particularly interested in learning how the decoupling mechanisms work and whether there have been any evaluations of their effects.

Under current rate-making practices in most states, the vast majority of a utility company's revenues are tied to its sales. Advocates of decoupling argue that this creates a financial disincentive for companies to promote conservation programs and may increase rates by increasing uncertainty that the company will recover its allowed costs. On the other hand, people who are skeptical of decoupling believe that (1) the companies have been effective in promoting conservation without using this approach, (2) decreases in sales can be the result of factors unrelated to conservation, and (3) decoupling is inconsistent with established utility rate-making principles.

California, Idaho, and Maryland currently have decoupling mechanisms for some or all of their electric companies. In each state, the mechanism periodically adjusts electric rates, up or down, to account for differences between revenues the companies have been authorized to recover by the state Public Utility Commission (PUC) and the revenues the company has actually received. The mechanism covers the fixed costs of distributing electricity in all three states; for some companies in California and the affected company in Idaho it also covers fixed costs for generating electricity.

California began its decoupling initiative in 1982, although it was interrupted while the state deregulated the electric industry in the late 1990s. The allowed revenue amount is adjusted each year to reflect inflation, productivity increases, and increases in the number of customers the company serves. It appears that the use of the decoupling mechanism has contributed to the effectiveness of the state's conservation initiatives while having a limited effect on rates.

In 2007, the Idaho PUC approved a three-year decoupling pilot program for Idaho Power, the state's largest electric company. The results in the first year were mixed, with consumption increasing for residential customers notwithstanding increased expenditures for energy conservation. On the other hand, consumption decreased for general service (small business) customers. It appears that consumption is decreasing for all affected customers in the program's second year, which would lead to a rate surcharge to cover the company's fixed costs.

In July 2007, Maryland's commission issued an order allowing two of the electric companies in the state to implement a decoupling mechanism for customers who had not chosen a competitive supplier. We have not found any analysis of the effectiveness of this mechanism to date.

In addition to these states, Vermont has a rate design that is somewhat similar to decoupling. The two largest electric companies (Central Vermont Public Service and Green Mountain Power) have earning sharing adjustment mechanisms that have been approved by the Public Service Board. If a company's rate of return on equity falls significantly below the level authorized by the board, it can raise its rates to make up part of the shortfall. Conversely, if the company's revenues allow it to significantly exceed its authorized rate of return, the company must share the excess earnings between the company's shareholders and its ratepayers. This mechanism does not affect spending on conservation programs, which in Vermont are administered by a non-profit organization rather than the electric companies.

As discussed in OLR memo 2005-R-0702, Maine, New York, and Washington adopted decoupling mechanisms in the 1990s that were subsequently eliminated. Oregon is considering a decoupling proposal from PG&E, a major electric company in the state. In 2001, it turned down a proposal from the company, finding that decoupling would place too much risk on its customers, and that charging a flat distribution rate (one approach to decoupling) was unfair to customers who use less electricity than other ratepayers.

The non-profit Regulatory Assistance Project has several recent documents on decoupling on its website, www. raponline. org.

In most states, the PUC sets electric company rates by dividing the company's projected revenue requirements in a future year by its projected sales in that year. The revenue requirements is the amount the PUC projects the company will need to (1) recover its prudently incurred capital and operating costs and (2) earn a PUC-set rate of return on the company's equity and debt. When the company sells more electricity it earns more revenue; if it sells less electricity it earns less revenue.

Advocates of decoupling argue that this rate design creates a disincentive for companies to promote conservation. This is because several of the company's expenses, notably distribution costs, are fixed and do not decrease with reduced consumption. To the extent that conservation reduces sales and this reduction is not offset by growth in the number of customers, the company will not fully recover its expenses. 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 the PUC. Proponents of decoupling 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.

People who are skeptical of decoupling believe that the companies have been effective in promoting conservation under the existing rate design, that decreases in sales can be the result of factors unrelated to conservation, and that decoupling is inconsistent with established rate-making principles. Historically, rates have been set based on all of a company's costs and revenues and regulators have generally been reluctant to engage in “single-issue ratemaking,” which considers a specific cost in isolation.

California's decoupling approach, initially known as the Electric Rate Adjustment Mechanism (ERAM), was first implemented for Pacific Gas and Electric in 1982 (the PUC had adopted a similar mechanism for gas companies starting in 1978). ERAM applied to all customer classes and was subsequently implemented for the other electric companies in the

state. In 1990, the PUC supplemented this mechanism with a system of performance-based financial incentives for the companies to promote additional cost-effective energy savings.

Electric decoupling was discontinued when the electric industry was deregulated in 1996. This was because decoupling potentially conflicted with the rate freeze adopted as part of the deregulation legislation. The legislation that re-regulated the industry in 2001 (AB 29X) reinstated decoupling. The legislation required that the PUC ensure that errors in sales estimates used in ratemaking not result in material over- or under-collections by the electric companies. The legislation simultaneously assured the companies of cost recovery for authorized revenue requirements.

The PUC determined the companies' initial revenue requirements in subsequent rate cases. The mechanism (now called the company's balancing account) covers fixed costs for transmission and distribution for all of the companies and fixed costs for generation for two of them. The revenue requirements are adjusted annually to reflect inflation (subject to a minimum and maximum inflation rate), increases in productivity, and increases in the number of customers the company serves. The mechanism requires utilities to track the difference between actual and forecasted revenues in the balancing account. Over-collections are refunded to ratepayers while under-collections are recovered from ratepayers.

A 1993 study by Lawrence Berkeley Laboratory found that the ERAM had a negligible effect on rate levels and reduced the risks of rate volatility for customers and profit losses for the utilities. The Environmental Protection Agency believes that the re-instatement of decoupling, combined with other factors, has led to expanded conservation programs. Its 2006 analysis is available on-line at

www. epa. gov/cleanenergy/documents/gta/guide_action_chap6_s2. pdf. The analysis also discusses performance-based ratemaking and other ratemaking approaches to encourage energy conservation.

In 2004, the Idaho PUC began an investigation of financial disincentives to investment in energy efficiency by Idaho Power Company. The final report of the investigation called for: (1) the development of a simulation to track what might have occurred if a decoupling or true-up mechanism had been implemented for the company at its last general rate case, and (2) advocacy for filing a pilot

energy efficiency program that would incorporate both performance incentives for energy efficiency and “lost revenue” adjustments, through which the company would be made whole for revenue reductions directly attributable to conservation.

In January 2006, Idaho Power filed an application requesting authority to implement a Fixed Cost Adjustment (FCA) mechanism for residential and general services (small business) customers. The mechanism was designed to adjust the company's rates up or down to recover its fixed costs independent from the volume of its energy sales. Specifically, under the proposal the fixed cost portion of the company's revenue requirement would be established for these two rate classes as part of a general rate case. Thereafter, the FCA would adjust rates to recover the difference between the fixed costs actually recovered in rates and the fixed costs authorized for recovery in the company's most recent rate case.

In December 2006, the company, PUC staff, and the NW Energy Coalition filed an application with the PUC requesting approval of a negotiated stipulation and implementation of the FCA as a three-year pilot program. (The coalition describes itself as an alliance of more than 100 environmental, civic, and human service organizations; utilities; and businesses in Pacific Northwest. ) The proposal covered the residential and general services rate classes.

Under the proposal, the actual number of customers for each customer class would be multiplied by the fixed cost per customer (calculated as a part of determining the company's allowed revenue requirement). This amount would represent the “allowed fixed cost recovery” amount. This amount would be compared with the amount of fixed costs actually recovered by the company. To determine the “actual fixed-cost recovered amount” the company would take sales for each class, adjusted for weather, and multiply that by the fixed-cost per kilowatt-hour rate. The difference between these two numbers would be the FCA for each class. The FCA could be either positive or negative. The adjustment would be made at the same time that rates are adjusted to reflect changes in wholesale power purchase costs and in seasonal rates. Additionally, the parties proposed that the PUC be allowed to cap rate adjustments to 3%. The company also agreed to provide a detailed annual summary of its conservation activities that demonstrate an enhanced commitment resulting from implementation of the FCA mechanism and removal of the financial disincentive to energy conservation.

The Idaho Community Action Network (ICAN) opposed the proposal. It argued that the proposal favored the company and its shareholders rather than customers and allowed the company to receive additional revenue through the FCA without providing any proof of need. ICAN asked that the PUC address a number of issues in reviewing the proposal, such as the proportion of declining customer use that was due to factors unrelated to conservation programs, including more stringent housing codes, appliance standards, and responses to higher rates. ICAN recommended that if the PUC approve the mechanism, it:

1. establish a mandatory 3% revenue cap on the FCA;

2. create a separate line item for the FCA on customer bills to increase transparency and public education about the program;

3. establish a clear conservation plan with real accountability; and

4. reduce, by at least 0. 5%, the rate of return the company is allowed to earn on its equity.

The PUC approved the application in March 2007. The decision mandated that the FAC revenue be capped at 3%. It required the company to submit annual reports on their conservation efforts and expenditures, but did not change the company's allowed rate of return on equity. The decision is available online at www. puc. idaho. gov.

The decision did not specify what constitutes the company's fixed costs; the program as implemented covers about 64% of the company's total costs, including generation, transmission, and distribution costs.

According to PUC staff, conservation funding has increased since the adoption of the FCA, but it is unclear to what extent the adoption of the mechanism is responsible for this increase. Notwithstanding the funding increase, consumption by residential customers (adjusted for changes in weather) increased in the first year while consumption for general service customers decreased. As a result, the company over-collected revenues from residential customers by $ 3. 5 million, but under-collected general services customers by about $ 1. 2 million. Blending the two classes resulted in a credit to all affected customers of about $ 2. 3 million, effective June 1, 2008. The PUC has not yet reviewed the results of the second year of the program, but has received monthly updates. They indicate consumption appears to have declined in both classes, and thus a surcharge would be in order, effective June 1, 2009.

In July 2007, Maryland's Public Service Commission issued an order allowing Potomac Electric Power Company (Pepco) and Delmarva Power and Light to implement a decoupling mechanism, called a Bill Stabilization Adjustment (BSA) for their ratepayers taking standard offer electric service (i. e. , those who had not chosen a competitive supplier). In issuing the order, the commission chair argued that decoupling would remove the financial disincentives companies face if aggressive conservation efforts are successful and sales of electricity are reduced.

Under the order, each month actual revenues per customer for each rate class are compared to approved revenues. The BSA is adjusted up or down to achieve approved annual revenues. The adjustment rate cannot fluctuate more than plus or minus 10%. In approving the BSA for Pepco, the commission stated that

the BSA serves multiple public policies. First, the BSA reduces the risks faced by the Company, and thus allows us to reduce the return on equity by 50 basis points [one half percent] to 10 per cent and the overall return to 7. 68 percent on its rate base. Second, the BSA disengages the Company's revenue from the sale of kilowatt hours of electricity, which removes a major disincentive to the Company's participation in programs designed to manage demand for electricity. Third, the BSA smoothes out billing variations induced by extremes in weather conditions. This program, which has served customers well in other contexts, promotes energy conservation and stabilizes the revenues per customer of the Company.

(In the matter of the application of Potomac Electric Power Company for authority to revise its rates and charges for electric service and for certain rate design changes, Md. Public Service Commission Order 81517, July 19, 2007, p. 5) case 9092

The decision is available online at http: //webapp. psc. state. md. us/Intranet/Casenum/CaseAction_new. cfm?RequestTimeout=500.

We have found no evaluations of decoupling in Maryland, although the state Energy Administration recommended that decoupling be extended to all energy utilities in the state as part of its 2008 strategic electricity plan. The plan is available online at www. energy. maryland. gov/about/reports/documents/MEASTRATEGICELECTRICITYPLAN. pdf. A June 2008 analysis of Pepco's parent company

by Fitch Ratings stated that the BSA will “help mitigate the volatility of customer bills during colder and warmer than normal weather conditions, as well as to mitigate the financial impact of energy efficiency programs. ”

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