Energy Efficiency and the Future of Utility Business Models

After reading Steve’s post and seeing I chose a related topic to discuss, I kind of feel like Kenny Bania following Jerry Seinfeld. Honestly, that was gold, Steve. Gold.

Anyway, during our class discussion regarding business models for utilities, the use of “decoupling” was mentioned and I realized that I have a somewhat limited understanding of how it actually works. What I do know is that decoupling is considered one of the best ways to promote energy efficiency. Like many, I believe the first step towards meeting our growing energy needs is by grabbing the low hanging fruit by pursuing energy efficiency. Therefore understanding the framework behind decoupling is important. More importantly, given the energy challenges we face today, it seems that any future utility model has to include something that promotes energy efficiency. The argument for this position can be made simply by looking at the success of decoupling in California.

California has the lowest per capita energy consumption of any state in the country despite being the second highest energy consumer overall (behind Texas, of course). Part of the low per capita consumption is likely due to the moderate weather that occurs throughout most of the state, however much of it must also be attributed to the success of California’s energy efficiency programs stimulated by decoupling. There is a great illustration of this in the California Energy Commission’s 2007 Integrated Energy Policy Report. The graph shows California’s per capita energy consumption compared to the rest of the U.S. from 1960 through 2004. What is interesting is that while the rest of the nation’s per capita consumption has steadily increased, California’s has stayed flat since the late 70’s. This timeframe roughly corresponds to the same period when decoupling was introduced (1979 for gas and 1982 for electric). Meanwhile, the utilities have enjoyed steady profits and have succeeded in working within the system.

If you are anything like me, decoupling is a challenging concept to get your head around because it runs counter to traditional capitalism. In the case of decoupling, governments break the link between sales and profits with the intent of creating an incentive for utilities to focus on efficiency rather than selling more energy. According the California Public Utilities Commission (CPUC), the mechanics of the initial decoupling legislation were as follows:

• Utilities submit their revenue requirements and estimated sales to regulators.
  
• The CPUC sets the rates by regularly applying adjustments to ensure that utilities collect no more and no less than is necessary to run the business and provide a fair return to investors.
  
• Any excess revenue gets credited back to customers.
  
• Any shortfall gets recovered later from customers (CPUC, 2007).
  

This system works because it aligns the incentives of the shareholder and the customer, and encourages energy efficiency. It is this framework that can be given the credit for the flat per capita consumption mentioned before.

In 2007, California took the system a step further by implementing “decoupling plus” which not only provides the set profits as before, but also pays utilities based on how much energy they actually conserve. At the same time, the new system provides an estimated return to rate payers of greater than 100% (CPUC, 2007). By economically benefitting both the consumers and utilities, and by helping governments meet energy demands while reducing CO2 emissions, the system is designed to be a win-win-win.

The long-term effects of “decoupling plus” remain to be seen. I am unaware of any preliminary findings on the overall per capita energy consumption of California since 2007, but given the success of the original decoupling initiative, I expect this plan to further the cause. The biggest pitfall of the system will of course be if the efficiency programs don’t save enough energy to reach the milestones that allow the utility to realize extra profits from the program. Along these lines, I would suspect that the primary challenges of implementing “decoupling plus” are: benchmarking initial energy usage; and determining how much energy efficiency measures have actually reduced consumption when accounting for confounding variables like consumer behavior and changes in weather patterns. I have no doubt this is very difficult and therefore it’s important for state and local governments to allocate adequate resources to ensure accurate measurements are obtained. Likewise, it’s imperative that a third party be responsible for conducting the studies as any participation by the utility or government would create a conflict of interest.

Regardless, it is programs like these that other states are starting to consider as they face increasing energy and climate challenges. As was mentioned in class and in Steve’s post, Duke Energy is proposing an even more aggressive form of decoupling plus called Save-a-Watt in which they would be paid 90% of the cost of each watt saved. Although opponents feel this figure is too high, I think it is this kind of compensation that will lead to innovation and accelerate the move towards energy efficiency.

In class Professor Webber mentioned that an issue he has with business models of this type is that they may not be sustainable. That very well may be true, but given the success of California utilities over the last 25 years, and the forecast of a 1/3 increase in energy consumption over the next 20 years (EIA, AEO 2008), the model has to be considered. If the utility business model must again adapt in the future, then so be it. The costs to society of not increasing our energy efficiency are too great to worry about that now.