Fact Sheet on Utility Regulatory Reform

Fact Sheet on Util= ity Regulatory Reform

By Geoff Young, member, Sierra Club

August 9, 2005<= /span>

Q1: What is the major problem facing Kentucky’s energy sector?

There is a huge amount of energy inefficiency – waste – in every part= of Kentucky’s economy. We spend about 5 to 6 billion dollars a year on electricity and natural gas. At least a third of that amount &#= 8211; about 2 billion dollars a year – is wasted. No one benefits from waste. Our economy would be much stronger= if we could eliminate that inefficiency over time. There would be major environmental benefits as well.

Q2: What needs to be done to reduce energy waste?

We need a concerted campaign to improve energy efficiency. The campaign to will work best if = all Kentuckians work together. Individuals, corporations, government agencies, environmental groups, and utility companies all have a positive role to play.

Q3. Don’t most utilities have energy efficiency programs in effect now?

Some of the utilities in Kentucky<= /st1:place> operate “demand-side management” (DSM) programs, but they are t= oken in size and save very little energy, compared to what is technically possib= le and economically beneficial.

Q4: Why have utility companies done so little to date?

One reason is inertia. They have = gotten accustomed to doing the same thing – building more power plants ̵= 1; for 70 years. In addition, the regulatory formula that sets the rates for electricity and natural gas rewa= rds utilities for selling more energy and kicks them in the teeth financially f= or helping their customers use energy more efficiently and lowering their bills. Utilities end up worki= ng against the interests of their customers most of the time. This is an unintended side effect = of the traditional ratemaking process, but it can be changed. The key reform is to break the link between utility companies’ sales and their revenues/ profits. This is known as “decoupling.”

Q5: How does decoupling work?

In between rate cases, the utility’s allowed revenues (and thereby indirectly its profits) are made to depend on factors other than the amount= of energy it sells. Different ty= pes of decoupling formulas recouple the revenues to something else, for example, t= he number of customers and/or an automatic escalation factor. If a utility takes in more revenue= than allowed, it must lower the price slightly in the next time period and return the excess revenue to its customers. If it takes in less revenue than allowed, it raises the price slight= ly during the next period.

Q6. Do other states use decoupling?

Yes, but only California and Oregon still use it today. Other states that have experimente= d with decoupling over the past two decades include Washingt= on, New York, Maine, and Kentucky.

Q7. Why did some states move away from decoupling?

Some states such as Maine saw the decoupling formula lead to excessive changes in the price of energy from year to year. The price swings were due to mild weather and an economic recession.

Q8. What is statistical recoupling?

Statistical recoupling is a type of decoupling formula developed by Eric Hirst that sol= ves the problem of price swings resulting from weather and economic activity. It uses historical data to recoupl= e the utility’s revenue to the major determinants of energy use.=

Q9. Is decoupling or statistical recoupling all that needs to be done?

No, decoupling is necessary but not sufficient. Kentucky must also implement positive financial incentives for utilities to help the= ir customers use energy more efficiently, as well as financial penalties if th= ey fail to do so. It will not be= easy to change the utility executives’ anti-consumer corporate culture that has built up over many decades. This pernicious attitude even holds sway in the electric cooperatives. The Public Serv= ice Commission (PSC) should institute policies that provide financial rewards f= or utilities that effectively promote energy efficiency, cogeneration (also kn= own as combined heat and power), and small-scale renewable energy technologies.=

Q10. Does the PSC have the authority to implement the necessary reforms today?

The PSC can implement the necessary regulatory changes on its own authority wit= hout the need for new legislation. It simply needs to state that the present rate structure is not fair, just or reasonable because it provides perverse incentives that penalize utilities = for implementing energy-efficient, least-cost strategies. The reforms could be implemented by holding a series of limited rate cases that change only the rate structure = and do not allow changes in the utility’s total revenue requirement or the allocation of revenue between customer classes.

Q11. What is the role of the Governor?

The most important action that the Governor and the PSC could take is to communicate clearly that Kent= ucky is serious about harvesting the vast potential energy efficiency gains that= can be made throughout the Commonwealth. Part of this message needs to be addressed to utility companies, as follows: “If you get serious about helping your customers use energy = more efficiently, the government will ensure that you are not penalized financia= lly, as has been the case for almost all of the past seven decades.” = The Governor can play a positive role by stressing the importance and urgency of this issue to the PSC and to the utility industry in Kentucky.

Q12. Can’t this wait another 70 years?

No, Kentucky’s environment and economy cannot afford to allow the status quo to continue f= or another 70 years. =