Rate and Revenue Considerations When Starting an Energy Efficiency Program

APPA’s National ConferenceJune 13th, 2009Salt Lake City, Utah

Mark Beauchamp, CPA, CMA, MBAPresidentUtility Financial SolutionsPhone: 616-393-9722

Objectives

How will rates be impacted if an energy efficiency program is implemented

How is industry responding to the changes What impacts on contributions to City What types of cost structures place the

utility most at Risk How rates may need to change What rate structures should be considered

Utilities Incentive is to grow

Improved profitability for IOU’s If sales were above projected amount between rate

cases- Profitability improved Increasing return to shareholders

IOU’s had incentive to construct new power plants New investment increased the rate of return (in

dollars) More investment the greater the allowable rate of

return in dollars Public Power Systems

Growth helped to keep rates low Added to reserve levels Funded capital programs to improve reliability

Movement Toward Energy Conservation

Pressure started in the early 90’s to promote energy conservation Started experimenting with decoupling rates to

reduce the utilities incentive to promote usage Focus changed to energy restructuring

Many Regulatory Commissions promoted the use of inclining block rate structures Social reasons to help low income customers

Low use does not relate to low income Promote energy conservation

Little residential conservation occurred

Inclining Block Rates

Inclining Block Rate Structures created additional incentive for Utilities to not promote energy efficiency Most profitable usage was at higher

blocks Inclining Block Rate Structure

Customer Charge: $5.00 First 500 kWh’s 0.065/kWh Excess 0.105/kWh

Assessment of Risk of Under Recovery

Power Supply Costs – Limited Risk

Due to Off system sales Fixed cost of generation may be recovered

through sales to others

Purchased Power If the utility purchases power, energy portion of

purchased power rates will decline Some of the demand portion of the rate will

decline

Power Supply Costs – Limited Risk

Power Supply Cost Adjustments If structured properly will protect utility

Marginal generation costs may exceed average costs Marginal costs may be impacted by cost

related to carbon Any risk related to power supply is

short term risk All costs are variable in the long term

Sample Utility Cost Breakdown

Functional Breakdown of Costs

Power Supply73%

Distribution22%

Customer Services5%

Recovery of Delivery Costs

Fixed Costs related to distribution investments: Utility Basis

Depreciation Expense Operation and Maintenance Rate of Return Contribution to City

Cost of Service Breakdown of Costs

Service Total

Recovered in Monthly Customer Charges

kWh or kW Recovery

Percent Recovered

in Facilities Charge

Power Supply 33,656,162$ 33,656,162$ 0%Distribution 2,834,033 674,489 2,159,544 24%Transmission 2,677,347 2,677,347 0%Transformer 1,539,122 675,289 863,833 44%Substation 2,163,669 440,515 1,723,154 20%Meter O&M 1,043,975 1,043,975 - 100%Meter Reading 423,082 423,082 - 100%Billing 74,139 74,139 - 100%Services 34,919 34,919 - 100%Customer Service 458,238 458,238 - 100%

Direct 420,510 420,510 - 100%Contribution to City 3,136,611 267,153 2,869,457 9%Totals 48,461,806$ 4,512,309$ 43,949,497$ 9%

Distribution Recovery 14,805,644$ 4,512,309$ 10,293,335$ 30%

Customer Charges

Recovers cost that do not vary based on usage Meter Costs Meter Reading Costs Billing Costs Customer Service Service Drop Portion of Distribution System

Sample Utility 5% Reduction in Usage Assumed Utility Charged Cost Based Rates

Dollar Short Fall

Impact on Rates

Distribution Under Recovery 514,667$ 1.06%

Reduction in Payment

Percent Reduction

Contribution to City 156,831$ 5.0%

Rate Structures that Place Utilities Most At Risk

Rate Design

Types of Residential Rate Structures: Flat Rates – Typically contain a customer charge

and flat energy charge (Often these are cost based charges)

Inclining Block Rates – Rates increase with increased usage. Promoted by many state public utility commissions to send price signal to reduce usage

Declining Block Rates – Rates decrease with usage. Illegal in some states. Used often by rural utilities to help recover distribution investments as quickly as possible

Cost of Service Rates, 5% Reduction, 1,000 kWh’s

Customer Charge All kWh's

Cost Based Rates 10.00$ 0.080$ Distribution Charges 0.015 Distribution Recovery 25.00

Distribution Recovery at 5% reduction 24.25$ Short Fall 0.75$ Percent Short Fall in Distribution Recovery 3.0%Rate Increase to meet revenue requirements 0.8%

Residential Rate Structures

Inverted Block rates Inverted block rates may result in

largest under recovery of distribution costs

Distribution recovery tend to occur in end blocks

Inclining Block Rate Impacts of 5% reduction in usage

Customer Charge First 500 Excess

Inclining Block 5.00$ 0.065 0.105 Distribution Recovery - 0.040 Distribution Dollar Recovery 25.00$

Distribution Recovery at 5% reduction 23.00$ Short Fall 2.00$ Percent Short Fall in Distribution Recovery 8.0%Rate Increase to meet revenue requirements 2.2%

Residential Rate Structures

Flat Rates Tend to be cost based rates Cost of service does not differentiate on

how much energy is used but on usage patterns

Distribution recovery tends to occur in all kWh blocks

Flat Rate Impacts of 5% reduction in usage

Customer Charge All kWh's

Flat 5.00$ 0.085 Distribution Recovery 0.020 Distribution Dollar Recovery 25.00$

Distribution Recovery at 5% reduction 24.00$ Short Fall 1.00$ Percent Short Fall in Distribution Recovery 4.0%Rate Increase to meet revenue requirements 1.1%

Residential

Declining Block Rate Structures Recovers distribution costs as quickly

as possible Tends to be used by rural systems due

to substantial distribution investments Many states have discouraged declining

block rate structures

Declining Block Rate StructureImpacts of 5% reduction in usage

Customer Charge First 500 Excess

Declining Block Rate Structures 5.00$ 0.100 0.070 Distribution Recovery 0.040 Distribution Dollar Recovery 25.00$

Distribution Recovery at 5% reduction 25.00$ Short Fall -$ Percent Short Fall in Distribution Recovery 0.0%Rate Increase to meet revenue requirements 0.0%

Rate Structure

Summary

Percent Increase in

Overall Rates

Inclining Block Rates 2.2%Flat Rates 1.1%Declining Block Rates 0.0%

Industry Responses

Some utilities have promoted high customer charges to recover 100% of the distribution costs Highly controversial

Contrary to Energy Conservation Is not supported by Cost of Service Potential social impact on low use

customers (perceived as low income)

Industry Responses

Push toward declining block rates to recover fixed delivery charges as quickly as possible Social concern over impact on low use

customers Rate does not promote energy efficiency Reduces the savings to customers by

implementing energy efficiency programs

Decoupling Rates

Breaks the cycle of linking revenue to sales of electricity

Reduces Utilities disincentive and opposition to energy conservation programs

Reduces the risk to utilities to help ensure recovery for the delivery service

Issues around decoupling

Should true up be applied to all customer classes equally or classes where under recovery is

occurring Should weather be considered Frequency of occurrence of True–Ups Utilities could reduce some of the

issues by moving to cost of service rates

Change of Rate Forms

Implementation of demand charges for all customer classes Many utilities recover distribution costs

through the kWh charge In-line water heaters

Reduces kWh consumption of electricity Creates demands on system between 15kW and

28 kW Typical residential is around 5 kW

Rate Impact based on Density of System with a 5% reduction in Usage

Under recovery using 5%

reduction in Usage

Rate Impact on Total System

Case Study Utility

Rate Impact on Rural System or Municipal with

Low Power Supply Costs

Rate Impact on Municipal

with High Power Costs

Based on Current Rates 623,827 1.29%Based on Cost of Service Customer Charges 514,667 1.06% 1.24% 0.92%

If Fixed Power Supply was un-recovered 1,021,299 2.1%Total Potential Impact 3.4%

Impacts on Contribution to City

Energy efficiency may have a greater impact on City than Utility

Five percent reduction in usage may have a direct 5% reduction in City Contribution

Can City sustain revenue loss

Summary

Rates reviewed more frequently implementation of Decoupling?

Movement toward distribution charges recovered in demand charges rather than energy component

Movement toward cost based customer charges

Power Cost Adjustments