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Revenue Decoupling Quickview

By Lewis Verduyn

What is revenue decoupling?Revenue decoupling is a regulatory mechanism that removes critical barriers toinvestment in energy efficiency, new renewables and distributed generation. Whenimplemented as part of an efficiency strategy, it turns power companies intoproviders of energy services and vanguards of sustainable energy.

Why is decoupling needed?

Under conventional regulations, the more electricity a power company sells, themore 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 loadand revenue. This means that power companies trying to maximize sales areworking 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 thehighest rate. The decoupling mechanism ensures that revenues are stableregardless of sales volume. Now, power companies can invest in energy efficiency,smart grid technologies, and all demand-side-management, and continue to makea profit.

How does the decoupling mechanism work?

In its essential form, an approved revenue target is set by the regulator over afixed period usually a year, to provide a safe and reliable service, with a fairreturn for investors, and at a fair cost to customers. The power company thencollects revenue regardless of sales volume. Regularly usually monthly, therevenue return is reviewed to see if the predetermined revenue requirement isbeing 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 targetrevenue, and profits increase. If energy sales are higher than expected, rates andprofits diminish.

The revenue target is calculated on a per-customer basis, and moves up or downaccordingly, protecting customers from risk. Power companies are motivated toadd customers, because approved revenues then increase, and saved energy canbe sold to new customers without the cost of adding equivalent generatingcapacity.

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 mechanismcan be designed for both traditional and restructured markets.

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What does decoupling mean for power companies and investors?

A compelling benefit of decoupling for power companies is that it provides reliablefixed-cost recovery and therefore revenue certainty, by eliminating the financialrisks associated with reduced sales; when consumers become more energyefficient with new appliances or habits, when weather limits supply (hydroreservoir dry years), and when economic conditions depress the market.

Revenue certainty reduces investor risk, and is favoured by financial institutionsand credit agencies, making low-cost capital more accessible, and investmentprogrammes easier to plan and more sustainable. If power companies also supportdiversification and distributed generation, they take risk reduction a step further.

Future-oriented power companies can transform from being the providers of acommodity to the providers of complete energy services, able to take advantageof the rapidly expanding demand for smart grid technologies. Such end-to-endconnectivity has enormous operational benefits in respect of demand response,load profile flexibility, and access to distributed power and storage flowing backinto the grid. Real-time information allows for optimization of electricity in thenetwork, and for the maximum utilization of assets.As energy advisors who understand the particular requirements of their custom-ers, power companies can work with architects, engineers and developers onbuilding design, advising on load reduction, micro-generation, storage, andregulatory incentives, for domestic, commercial and industrial customers. Thisdiversification not only improves efficiency, it adds profitable revenue streams andfurther lessens financial risks.

What does decoupling mean for consumers and power prices?

Power companies run savings programmes to help their customers lower theirelectricity bills. Such programmes can cover replacement of selected applianceswith energy-efficient models, rebates on building retrofits, or interest free loans.Consumers may have no up-front costs, simply paying a little extra assessed ontheir monthly bills over a fixed period, which is made affordable because they aresaving electricity and have lower usage costs. Government subsidies and taxcredits may also add financial benefits for consumers.

Meanwhile, the decoupling mechanism itself is often unnoticed by customers. Atypical rate adjustment is only 2-3 percent (capped), equating to less than 1percent of a customers power bill in most cases, which is usually imperceptible,

especially to those with lower power bills because of less consumption. And sincethe rate adjustments are always opposite the direction of changes in overallconsumption, decoupling has a stabilizing effect on customer bills. In the longerterm, consumers often pay much less than they would have done under theprevious growth-based system. For example, after three decades of decoupling inCalifornia, 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 beforeefficiency and environmental protection. Decoupling does the reverse.

By investing in energy efficiency, power companies can meet demand growth atless than half the cost of new generation, and deploy it much faster, whilereducing transmission capacity issues. Under decoupling, building new power

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stations without first investing in all cost-effective energy efficiency is a hugemisallocation of capital. Efficiency becomes the supply option of first choice. Andsince fewer new power stations are needed, all the negative environmentalimpacts of unnecessary generation and transmission capacity are avoided,including emissions. Landscapes need not be carved up and rivers need not bedestroyed.

While energy efficiency alone is not the ultimate solution to growth-drivenecological destruction and climate change, it is the largest single first-aid option.In tandem, decoupling sets the agenda for the necessary transition to cleanenergy 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 conventionalenergy business model, based on profits that are tied to increasing sales, is notbeneficial to society. Economic and environmental imperatives demand that weevolve our energy systems toward maximum efficiency, new renewables anddistributed generation. The result is more sustainable economic activity, more

green collar jobs, more energy security, more environmental protection, and theshortest route to reducing climate change impacts.

Crucially, our society is locked into unsustainable growth in a finite world, and theenergy sector is a fundamental driver of growth in every country. But decouplingstops quantitative growth by default, putting the brakes on expansion and thefocus on efficiency and sustainability. Since energy underpins our society,decoupling represents an essential paradigm shift away from our impossiblegrowth-based economy towards a sustainable future.

Given the positive attributes of decoupling for power companies, consumers, andsociety, it is reasonable to expect that it will continue to gain in popularity andbecome the regulatory method of choice for the 21st century.