Rate And Regulatory Barriers To Innovation In The Energy Sector

Chuck Harder

Senior Director, Regulatory Policy & External Relations

CenterPoint Energy, Inc.

Overview

Restructuring the energy industry (both electricity and natural gas) and a national global focus on introducing competition and modernizing infrastructure has opened the market to new players, products and services.

The traditional process for setting rates in the United States – the rate case – poses a significant barrier to market transformation.

Traditional rate design misaligns the interests of the utility and its customers … and the public interest.

Regulatory regimes that can quickly adapt to the changing market and which better align stakeholder interests will succeed in promoting growth and innovation.

Texas’ regulatory regime is making progress, and there are some things that work well …

But much remains to be done.

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CenterPoint Energy

CenterPoint Energy, Inc., headquartered in Houston, Texas, is a domestic energy delivery company that includes electric transmission & distribution, natural gas distribution and competitive natural gas sales and services operations. The company serves more than five million metered customers primarily in Arkansas, Louisiana, Minnesota, Mississippi, Oklahoma, and Texas. The company also owns a 58.3% limited partner interest in a midstream partnership it jointly controls with OGE Energy Corp. with operations in major natural gas and liquids-rich producing areas of Oklahoma, Texas, Arkansas and Louisiana. With more than 8,700 employees, CenterPoint and its predecessor companies have been in business for more than 135 years. For more information, visit the website at www.CenterPointEnergy.com.

Electric Transmission & Distribution

Natural Gas Distribution

Competitive Natural Gas Sales & Services

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Regulation During The Energy Sector’s First Hundred-Plus Years

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Electric And Natural Gas Systems

Electricity Natural Gas

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Historically …

Public utilities were vertically integrated monopolies that were first regulated by the cities where they were located.

Systems expanded to connect more cities and rural areas, and rate regulation in other states shifted from cities to state agencies.

Growth in customers and load created enough growth in revenues to offset increases in normal operating costs.

The need to raise rates typically arose when significant improvements were made to the infrastructure and the growth in revenues wasn’t sufficient to cover the normal operating costs and the additional capital investment.

Rates were designed to encourage growth in usage.

Regulatory oversight occurred mostly through rate cases where the determination of prudency of public utility investments and the setting of rates resembled complex commercial litigation.

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Innovation In The Energy Sector

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Innovation

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Drivers

Changing Market

Customer Expectations (Self Reliance, Reliability, Value)

Technology

Environmental Stewardship

Products

Distributed Generation

Micro-Grids

Energy Storage

Smart Products and Applications

Providers

Transmission and Distribution Utilities

Retail Electric Providers

Non-Traditional Players (like Microsoft and Google)

Funding

Tax Incentives

Traditional Financing

Other Incentives and Innovative Financing

Consumers

Innovation is driving decentralization in the electric industry, including the development of distributed generation, micro grids, electricity storage (including, for example, electric cars), and other alternatives to traditional delivery of electric services, and creating new opportunities at the intersection of gas and electric markets.

Transmission and distribution utilities sit at the center of all this change.

Introducing Competition Changes The Market

Since the late 1970s the Congress and the Federal Energy Regulatory Commission (FERC) have taken a number of steps to lessen federal regulation of natural gas markets and to make the industry more competitive. FERC Order 636 allowed pipelines in 1993 to offer unbundled firm and

interruptible sales services at market-based rates, and required that cost-based rates follow the straight fixed variable (SFV) method of cost classification, allocation, and rate design.

For the past two decades, natural gas utilities have incorporated much of the Federal model into their state-regulated rates, terms and conditions of service to local distribution customers.

Similarly, in the Texas electric industry, Senate Bill 7 passed in 1999 caused ERCOT to launch the competitive retail electric market in 2002 allowing individuals and corporations in most cities to choose power suppliers. SB 7 applied specifically to investor-owned utilities, enabling customer choice for

6.5 million.

SB 7 allowed municipal utilities and electric cooperatives to decide if they wanted to opt to participate in competition.

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ERCOT’s Market Structure

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Affiliated Utility

Generation

Distribution

Services

Unregulated

Wholesale Generation

REGULATED UTILITY

Customer

Transmission

Services

( ISO)

Qualified Scheduling

Entity

Retail Electric

Provider

Modernizing The Grid …

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Source: Edison Foundation, Utility-Scale Smart Meter Deployments: A Foundation for Expanded Grid Benefits (August 2013)

… Provides Significant Operational Benefits

Improved outage response through automatic notification of customer outage. Enhanced ability to reroute power around an outage, thus improving restoration time and minimizing the number of customers affected.

Reduced vehicle emissions by eliminating need to send crews to execute such routine orders as turning electric service on and off.

Environmental benefits as less power may have to be generated

Automated meter reading

Remote connect and disconnect

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… Facilitates Products/Services From REPs

In-home energy monitors – smart meters can interact with these devices, such as thermostats or other electric appliances, so users can better manage electricity

Special pricing plans like – Free nights and weekends

Peak and non-peak pricing

Pre-pay service

“Green Power” – 100% renewable products

Pricing options for charging electric vehicles

Bundled products including appliance maintenance and repair

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Source: Association of Electric Companies of Texas (AECT), Update on the Texas Electric Industry (January 23, 2014)

Technology Drives A New Kind Of Customer Engagement

Redefined customer service value proposition

Use of advanced customer service channels to deliver customer benefits based on their preferences

Shift from issue resolution to relationship building

Utilities will form new partnerships between electric and gas merchants and with companies like Google, Microsoft, etc.

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Traditional Regulation Is Ready For Overhaul

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Rate And Regulatory Barriers To Innovation

19TH Century Rate Design Costs recovered based on energy consumption rather than on distribution

cost of service

Discourages energy efficiency (conservation)

1960’s Rate Setting Process Designed for determining prudency of major investments before rates could

be increased

Slow to respond to changes in the industry

Contentious

Expensive

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Rate Cases Are Time-Consuming And Expensive

Rate Case Timeline

Typical Issues in a Rate Case

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4-12 Mos

•Plan the rate case

•Close the books

•Prepare the rate filing package

6-12 Mos

•Filing

•Discovery

•Hearing

•Briefing

•Final Order

1-2 Mos

•Compliance tariffs

•Implement new rates

On average, a rate case takes 9⅓ months to process – from filing to final order.

(Source: Regulatory Research Associates)

Differences of Opinion Return on equity

Depreciation of capital investment

Lead/lag study – working capital needs

Pro forma adjustments and other estimated costs

Establishing or challenging regulatory policy

Cost allocation and rate design

Audit Findings Below-the-line disallowances

Out-of-period adjustments

Unusual and non-recurring items

Established regulatory policy misapplied

In Texas and other jurisdictions, the cost to process rate filings is a reasonable and necessary utility expense, and customers ultimately bear the cost of rate cases.

Controversy In Setting Distribution Rates

Cost Classification Fixed

Demand Commodity (Usage)

Rates

Cost Allocation to Rate Classes Residential Commercial

Industrial

Billing Determinants

Significant Differences of Opinion

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Gross Plant

Working

Capital

Accumulated

Depreciation

Rate Base

(Investment)

Depreciation

Rate

Rate of Return

(ROR)

Depreciation

Expense

O&M and G&A

Taxes

Return on

Investment

Cost of Service

+

–

=

x

x

=

=

+

+

+

=

The utility’s

cost of service

is based on a

past or future

“test year.”

Modernizing Rate Setting Processes

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Innovative Regulatory Mechanisms

Formula Rate Plans A formula rate plan (FRP) is a comprehensive cost tracker designed to help a

utility’s revenue track its cost of service.

Infrastructure Mechanisms Infrastructure mechanisms provide cost-based rate recovery between rate cases to

encourage broad-based investment in infrastructure or to address specific programs and concerns.

Energy Efficiency Energy efficiency rate adjustment mechanisms are designed to allow the utility to

recover its cost of funding energy efficiency programs and in most instances provide performance incentives.

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Innovative Formula Rate Plans

Sources: American Gas Association, Innovative Rates, Non-Volumetric Rates, and Tracking Mechanisms: Current List (February 2014) Edison Electric Institute, Alternative Regulation for Evolving Utility Challenges: An Updated Survey (January 2013)

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Trend Toward Accounting/Auditing-Driven Processes

Faced with having to deal with frequent, time-consuming and costly rate cases, regulators in many states have worked with public utilities, consumer advocates and other interested parties to develop alternatives to rate cases.

Innovative rate setting processes more closely resemble an external audit of a company’s financial statements than complex commercial litigation.

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Innovative Infrastructure Mechanisms

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Source: Edison Electric Institute, Alternative Regulation for Evolving Utility Challenges: An Updated Survey (January 2013)

Energy Efficiency

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Sources: American Gas Association, Innovative Rates, Non-Volumetric Rates, and Tracking Mechanisms: Current List (February 2014) Edison Foundation, State Electric Efficiency Regulatory Frameworks (July 2013)

New Rate Designs

Straight Fixed Variable Straight fixed variable (SFV) rate design imposes a fixed charge to customers that is

designed to recover all of a utility's fixed costs.

Revenue Decoupling Revenue decoupling (RD) is generally defined as a ratemaking mechanism designed

to eliminate or reduce the dependence of a utility’s revenues on sales.

Revenue decoupling works by adjusting the actual sales volumes to the weather-normalized sales volumes approved during the utility’s last rate case.

Lost Revenue Adjustment Mechanism Akin to RD, a lost revenue adjustment mechanism (LRAM) compensates a utility for

base rate revenues that are estimated to be lost due to its energy efficiency or demand-side management (DSM) programs, distributed generation (DG), or other specific causes.

Weather Normalization Adjustment Weather normalization adjustment (WNA) clauses adjust rates on a regular basis

with the goal of normalizing revenue or throughput by adjusting bills to correct for abnormal weather.

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Non-Volumetric Rate Designs (Natural Gas)

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Source: American Gas Association, Innovative Rates, Non-Volumetric Rates, and Tracking Mechanisms: Current List (February 2014)

Weather Normalization Adjustment Mechanisms

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Source: American Gas Association, Innovative Rates, Non-Volumetric Rates, and Tracking Mechanisms: Current List (February 2014)

Non-Volumetric Rate Designs (Electricity)

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Source: Edison Foundation, State Electric Efficiency Regulatory Frameworks (July 2013)

Here in Texas

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Regulatory Scorecard

Works Well Permanent infrastructure cost

recovery mechanisms for – Advanced meters

Transmission

Natural gas pipelines

Energy efficiency

Needs Improvement Rate case process City original jurisdiction is an

anachronism

Incentivizes controversy and causes high rate case expenses

Infrastructure cost recovery mechanisms for electric distribution set to expire

Rate design that aligns utility investor and consumer interests

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Questions? Chuck Harder Senior Director of Regulatory Policy and External Relations CenterPoint Energy, Inc. 1111 Louisiana Street, Suite 1960 Houston, Texas 77002 Tel 713.207.7273 Chuck.Harder@CenterPointEnergy.com

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