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.


Emily Green said...

Interesting. Yesterday in Carson, there was a long exchange in the Vegas water hearings over computer models developed to set rate structures. Who (besides you) knew it was so interesting?

Jan Beecher said...

I share many of your concerns about decoupling, and then some. However, the problem with straight fixed-variable pricing (considered a form of decoupling), especially with water, is that it sends a lousy price signal about long-run marginal capacity costs. This is part of the rationale for including some fixed costs in variable charges for water.

Fixed Carbon said...

The real power of decoupling and its twin feed-in-tariffs is in energy. It is a powerful tool for reducing fossil fuel use and encouraging renewable energy.

DW said...

You ignore the fact that "normal" businesses don't have a state sanctioned vertical monopoly over generation, transmission and distribution of their product to their captive customers. Comparing free market businesses with monopoly utilities isn't very convincing.

The good side of decoupling:

It ended ratepayers having to fund endless marketing wars between the electric and gas utilities who built expensive customer technology centers not to help customers use energy less efficiently, but to convince customers to switch to their product to meet their energy needs, taking market share away from their opponents. Adding shareholder incentives for successful energy efficiency efforts helped keep California's per capita energy demand level over the last thirty years, while the per capita energy demand of the other states more than doubled during the same period.

The down side of decoupling:

Since the utilities couldn't make more money by more aggressively marketing their products, they had to look for other ways to make profits to keep their executives in huge bonuses and stock option plans. They found them via new capital projects. Instead of having to deal with more sophisticated state regulatory agencies, they got to deal with the Federal Energy Regulatory Commission (FERC) which is basically ineffectual and goes along with whatever the utilities national lobbying associations want. This is reflected in utility reports to Wall St stock and bond analysts, which always start off with a list of the new expensive capital projects they are planning to build. FERC allows the utlities it controls to make (by today's standards) very high profits on these projects. For example, SDG&E plans to spend $1.8 billion dollars constructing the Sunrise Powerlink transmission project, and FERC is going to allow them to roll the entire cost, plus an 8%+ annual ROI, into customer rates over the life of the project. The company's total return on the project, when you include the interest it gets to collect in rates on its investment is over $3 billion. Spend $1.8 billion, get back more than $3 billion. And your ratepayers pay it all. Not a bad business.

Since there are effectively no federal or state regulators over regional water agencies, they find other ways to spend their customers money.

David Zetland said...

@Jan -- I address conservation in the post (add a variable surcharge)

@FC -- feed in tariffs are TERRIBLE policy; they result in terrible games.

@DW -- your missed my point -- "free market" pricing is robust wrt incentives; that's why we should try to use those models. As you said, decoupling just leads to more games.

Fixed Carbon said...

Feed in tariffs are a wonderful policy tool. They reduce the use of fossil fuels. The games policy plays in promoting the use of fossil fuels are why we need such as feed in tariffs. You go feed in tariffs!

David Zetland said...

@FC -- you must work for the solar industry in Germany (Italy and Spain)... Congrats on earning far more than your technology is worth! at taxpayer expense!

Mac said...

David- I like the concept, but not sure if I understand fully. Assuming the bulk of costs are fixed, how would your thought experiment (what would bill be for zero usage) play out, even with variable conservation surcharges?

It seems to me that any rate structure based on cost structure would fail your thought experiment, because significant fixed costs remain.

I still like your concept- just not sure the thought experiment is relevant. Perhaps the better question (and one your structure PASSES) is 'would a rate structure motivate conservation where scarcity is an issue?'.

David Zetland said...

@Mac -- zero use pays only FC -- same as a standby fee. That's not a fail. That's the same as not driving a car :)

Scarcity or not, need to pay for system capacity/potential to take service!

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