10 Nov 2011

Marriage or decoupling?

"Utility revenue decoupling" refers to a regulatory program in which a utility selling fewer units of water (or energy) is allowed to raise prices, to collect the same revenue.

Decoupling is meant to overcome the "more consumption more revenue" incentive that utilities face by making it easier for the utility to encourage (or allow) conservation.*

Regulators like it because it allows them to pursue two goals: financial stability at the utility and a reduction in demand for scarce resources.

That said, decoupling suffers from a number of design flaws:
  • We don't see any such system in free markets, i.e., companies that make the same money when customers use less of their services. Some may argue that mobile phone plans -- where you pay the same price for a block of fixed minutes, regardless of how many you use -- use a form of decoupling, but not when you consider that customers can switch to a cheaper plan with fewer minutes.
  • Utilities have a performance incentive problem with decoupling. If they make the same revenue when customers use less, then they have no reason to reduce their costs. Companies selling fewer widgets in a market need to find ways to be more efficient.
  • Regulators, likewise, can get lazy with decoupling. Why bother to watch over costs and operations when the company is going to make the same money anyway? Why try to save money for customers who are going to pay the same bill anyway?
  • Customers also face weak incentives. Why use less if they are going to pay the same?
As a thought experiment, consider what happens if customers use ZERO water. They still pay the same bill. Well, that's not a very good idea.

As an alternative to decoupling, I suggest that:
  1. Bills are based on actual fixed and variable costs, so customers who use less pay less but the reduction in revenue is the same as the reduction in costs.
  2. If conservation (water scarcity) is indeed a goal, then add a surcharge on that variable price to customers that will raise its price. Excess revenue can then be rebated to customers.
  3. This system gives regulators, customers and utilities a reason to reduce costs and conserve water without putting the utility's financial stability at risk.
Bottom Line: Everyone loves to get paid without having to work, but such systems encourage waste and inefficiency. Better to pay for performance.
* Note that decoupling is a regulatory "solution" to a problem that the regulators created: a heavy reliance on variable revenues for a business that has heavy fixed costs; see this post for more.