Time to reexamine how utility losses will be shared among customers.
The coronavirus pandemic has thrown public finances into turmoil. Legislators and city councils are wrestling with what services to cut—health care, education, public safety. They’re also starting to look at what taxes to increase. Universities and many private sector industries are facing similar fiscal crises. Meanwhile, regulated electric utilities are in pretty good financial shape, but this isn’t because their businesses have been insulated from the pandemic.
Utilities have had to adopt more expensive operational practices to keep workers safe, more customers aren’t able to pay their bills, and electricity sales have dropped. The Energy Information Administration projects that electricity consumption will drop by 4% from 2019 to 2020. That would be the biggest annual percentage drop in electricity sales in over 20 years. The commercial sector demand is forecasted to drop 7%.
In the face of such significant challenges, you might expect public utilities commissions and utility corporate board rooms to mirror legislatures with tough decisions being made that trade off customer costs, reliability, safety and company profits. But that’s not the case. Utilities can continue spending in the face of lost revenues with confidence that they’ll be able to charge customers for the losses in the near-future.
This is due to several decades of regulatory rulemaking that allow utilities to make up for unexpected losses today by automatically adjusting the prices they charge customers in the future. For example, in the California version, if sales drop due to an economic slowdown, rates are increased in the future to make up the difference. Conversely, when weather is hotter than expected and air conditioning use jumps, utilities bring in more revenue from electricity sales, but are required to return the extra profits to customers in the future.
The most well-known of these adjustment mechanisms is “decoupling”, given this name because, from a utility perspective, the profits earned over time are decoupled from electricity sales. Decoupling has been adopted by many states so that utility profitability does not suffer when households and businesses increase their energy efficiency.
Similar mechanisms allow utilities to increase rates when costs rise in response to an emergency that is beyond a utility’s control. The details of these mechanisms vary by state. The Regulatory Assistance Project has produced the go-to resource to help regulators understand these choices.
Taken together, these policies mean that utilities and their regulators aren’t wrestling with the sorts of trade-offs that face legislators and city councils. Utilities just let the cost recovery mechanisms do their thing.
Keeping Utilities Healthy
There’s lots to like about decoupling. In the current pandemic, instead of slashing costs and fighting big dollar regulatory battles, the utilities can focus on running their businesses and maintaining the reliability of a service that is more essential than ever, especially in our homes. They’ve also been able to take actions to help customers navigate the pandemic, such as more generous deferred payment plans. Not many other essential service providers are offering this kind of payment flexibility.
Wall Street loves these mechanisms too. Lenders and equity investors are still happy to fund utilities. Utility access to capital markets creates the potential for utility-enabled stimulus programs such as the bill moratorium proposed by Catherine Wolfram in a recent blog post.
How to Pay the Bills
Decoupling is reducing utility stress through the crisis, but soon the bill will come due, for customers, that is. The rate increases could be significant, especially for customers of utilities that serve a lot of commercial load. How customers pay those costs will impact consumer behavior and raise equity implications.
Severin Borenstein and Jim Bushnell have shown how residential rates in many states, including California, are already way higher than the underlying costs, even after accounting for pollution. This is discouraging use of electricity, one of our cleanest energy sources. Loading the pandemic costs into rates will make matters worse and discourage consumers from electrifying buildings and transportation, steps that would reduce greenhouse gas emissions, at least in regions with clean electric grids.
The equity issues have multiple dimensions. There’s the question of which class of customers pay—residential or business. Some states keep the shortfall in the customer class in which sales dropped. This would mean the commercial sector would see the biggest rate increases, and many of these, such as small, retail businesses, are already struggling. In other states, including California, the shortfall is shared across all customer classes, so residential rates will increase too, raising other issues. For example, rate increases will add to the racial and income disparities embedded in electricity burdens today. People living in large households, poorly insulated homes, hot climates and without rooftop solar will bear much of the cost.
Economic theory doesn’t provide easy answers for what to do about equity, but the economic analysis toolkit can shine light on the trade-offs. Utilities and their regulators should take this opportunity to analyze how the existing mechanisms will distribute the cost burdens and consider alternative approaches. They should convene public discussions at public utilities commissions and legislatures to figure out the best course. Spreading out cost recovery over longer periods, increasing fixed charges, reducing utility spending and funding the shortfall through general government budgets could all be part of the answer.
Given how slow the regulatory machinery operates, now is the time for regulators to begin taking a closer look at how utilities will pay the pandemic bills and how they will do it in a way that does not reinforce inefficiencies and inequities built into the current revenue models.
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Suggested citation: Campbell, Andrew. “How Utility Customers Will Pay for the Pandemic” Energy Institute Blog, UC Berkeley, July 27, 2020, https://energyathaas.wordpress.com/2020/07/27/how-utility-customers-will-pay-for-the-pandemic/
Andrew Campbell is the Executive Director of the Energy Institute at Haas. Andy has worked in the energy industry for his entire professional career. Prior to coming to the University of California, Andy worked for energy efficiency and demand response company, Tendril, and grid management technology provider, Sentient Energy. He helped both companies navigate the complex energy regulatory environment and tailor their sales and marketing approaches to meet the utility industry’s needs. Previously, he was Senior Energy Advisor to Commissioner Rachelle Chong and Commissioner Nancy Ryan at the California Public Utilities Commission (CPUC). While at the CPUC Andy was the lead advisor in areas including demand response, rate design, grid modernization, and electric vehicles. Andy led successful efforts to develop and adopt policies on Smart Grid investment and data access, regulatory authority over electric vehicle charging, demand response, dynamic pricing for utilities and natural gas quality standards for liquefied natural gas. Andy has also worked in Citigroup’s Global Energy Group and as a reservoir engineer with ExxonMobil. Andy earned a Master in Public Policy from the Kennedy School of Government at Harvard University and bachelors degrees in chemical engineering and economics from Rice University.