How Utility Customers Will Pay for the Pandemic
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.
Keep up with Energy Institute blogs, research, and events on Twitter @energyathaas.
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 G Campbell View All
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.
This is a relevant discussion but it presents a one-sided view of decoupling, which has received more promotion than critical analysis by economic and financial analysts* generally and now in the context of this morphing. Among other things, decoupling alters performance incentives and risks, which calls for revisiting authorized returns.
*For a thoughtful treatment, see Steve Kihm’s analysis: http://www.seventhwave.org/sites/default/files/kihmdecouplingarticle2009.pdf).
Yes, I agree. Decoupling has greatly reduced the risk of these investments, probably to the level of low grade corporate debt. In California’s I prepared an analysis that showed that the allowed ROE should be closer to 7% than 10% based on how the market now views risks for utilities with decoupled revenue requirements.
Actually, there is no need for losses at all. Just stop trying to force the change before it makes economic sense – only about 6-8 years out. Then utilities will be self financing to SAVE costs.
Tax increases slow recovery – that’s why it took Obama 8 years just to get back to where things were 8 months before he took office.
Taxpayers are not obligated to keep government workers employed, nor should their benefits (both pre- and post-retirement) automatically include raises when the economy suffers. Government caused this problem, they should share at least equally.
This isn’t the time to talk about rewarding government for an economic slowdown they caused through lock downs (no matter their good intentions, they CAUSED it). This is the time to gut the fish and restructure promises once made which are clearly too generous.
“Tax increases slow recovery – that’s why it took Obama 8 years just to get back to where things were 8 months before he took office.”
No, lots of academic research showing that this is not true, and that tax cuts are typically not stimulative beyond a short period. This is a myth perpetuated by supply siders that has now been long discredited.
“Tax increases slow recovery – that’s why it took Obama 8 years just to get back to where things were 8 months before he took office.”
“No, lots of academic research showing that this is not true, and that tax cuts are typically not stimulative beyond a short period. This is a myth perpetuated by supply siders that has now been long discredited.”
Enjoy your fantasies. Facts are not myths, nor can they be discredited no matter how many times you “say so.” Taxes slow the economy, period. You may argue the VALUE received from that slowing is “worthwhile,” which would be a political opinion, but you cannot successfully argue that it doesn’t exist. That theory would be tantamount to perpetual motion.
I’ll consider taking your theory seriously when you can successfully demonstrate the specific value ADDED to American goods and services RESULTING from higher taxes that results in INCREASED sales at home and abroad. I’ve got my popcorn ready.
This study shows that an increasing share of taxes had no appreciable impact on U.S. economic growth.
Here’s another study on how higher marginal tax rates have no effect on growth rates.
And changes in corporate taxes have little impact:
The problem is that you’re ignoring the productive services that governments provide (such as infrastructure and regulation), and the economic boost from redistributing wealth to those who are more likely to spend the funds so that there is an acceleration in monetary velocity.
“This study shows that an increasing share of taxes had no appreciable impact on U.S. economic growth.”
No, it simply shows that their THEORY says it didn’t. I can write papers like that too, that show how my airplane must be capable of flight without a motor. I can even be convincing. I once stayed in the air for 15 minutes straight without any power at all! Of course, I was losing 500′ of altitude per minute the entire time and ultimately and inevitably reached the ground. Fortunately for me, I have millions of taxpayer dollars in training to fly well, and I landed on a runway.
I notice you dodged my question, which was quite simple – tell us how taxes ADD value? If you cannot do that, you are pushing a perpetual motion scam. And of course, it is rhetorical – you cannot do it.
“The problem is that you’re ignoring the productive services that governments provide …”
Not at all. The Federal government provides a few hundred billion in actual services – tops. Here is the breakdown, ignoring Coronavirus:
Federal Revenues this year (estimated): $3.2 trillion
Entitlements, including payments on the debt: $3.5 trillion (approximate) – note the President does not get to veto these, nor in any way affect them.
The budget – about $1.2 trillion including:
– Military – $700 billion
– Running the government – $300 billion
– Everything else – $200 billion
You can’t hide the big numbers. Oh, you can say that people who receive benefits live better lives and I wouldn’t even argue – that is a fact. However, it requires that WORKING PEOPLE cough up the dough, slowing or eliminating their ability to save for retirement, insuring they must work additional decades before retiring – if ever. Meantime, the COUNTRY would be more prosperous if we simply stopped paying that $3.5 trillion every year and let the people who it came from just keep it. Oh, yes, millions would suffer and die – but the COUNTRY would prosper.
These are simple facts, readily available. Your theories cannot refute facts. If the economy is a boat on the ocean, workers rowing make us move forward, taxes slow us down like an anchor. Period.
No, it’s not their “theory”–these are several among many empirical studies using data that refute your assertion.
As to your question, that’s not relevant to your statement–you said that raising taxes always slows economic growth. That’s the point that I’m refuting. I’m not engaging in a discussion with you about the function and value of government. I’m just showing that your initial statement was incorrect.
“As to your question, that’s not relevant to your statement–you said that raising taxes always slows economic growth. That’s the point that I’m refuting. I’m not engaging in a discussion with you about the function and value of government. I’m just showing that your initial statement was incorrect.”
Except, to PROVE that you must prove that taxes do not adversely affect the economy. To do that, you must prove that there is no societal cost to taxation – which you cannot do. To do so would be to “prove perpetual motion.” It is a fiction, a fantasy. Raise taxes, growth slows. Neither taxes nor borrowed money are a “product” of any value-creating process, and thus taxing can only slow growth. The only possible way that a rising economy might be associated with higher taxes is if people, suffering, WORK MORE to make ends meet (punitive taxes; wage slavery).
You might have said, “it is possible for taxes to be raised and for the economy still to grow.” That is possible – but it would be at a slower rate due to the “drag” of taxes or at the expense of people sacrificing to make ends meet to actually produce more. Government does not CREATE value, it only moves it around. At the very best, in a perfect world, it would not incur drag – but that has never happened and likely never will. They can also create the illusion of growth by turning the crank on the “magic money machine” of the Fed. Yet, for all the paper produced not one shred of additional value is created – so it is fictional. There can be a TEMPORARY increase in growth by drawing down from large collections of accumulated wealth (confiscation). That works just a little – and then the market crashes because nobody else has the money available to buy the things which were confiscated, or the money value collapses because someone printed more money to allow someone to HAVE the money to buy it at its former value.
My initial statement was a fact. You may have opinions about the meaning of it, but a fact cannot be “disproved.” Even Keynes agrees with this.
You haven’t PROVEN your initial statement, and cannot if you are applying the same standard to your assertion. While you may provide simplistic reasoning to try to support your assertion, you still haven’t provided empirical analysis. Your initial statement if far from being a “fact”–its speculation on your part. I’ve provided the empirical studies that refute your “fact”. Your turn to provide the opposing empirical evidence.
“Government caused this problem, they should share at least equally. ”
Government is US, not them. We form the government, we decide where it goes, we are the communities that represent its interests. We are the shareholders in government and the customers if you need a corporate comparison. Government is a cooperative.
Utilities are in an interesting situation.
While commercial and industrial sales are down about 7% nationally, residential sales are UP about 5%.
Typical residential margins (average retail rate minus average wholesale market-clearing power cost) are about twice as large as the margins on industrial power sales. This means that a 5% gain in residential sales can offset about 10% of industrial sales decline. Many utilities, particularly those with smaller industrial loads and primarily residential customers, are doing just fine.
This impact varies from utility to utility, and from region to region. In traditionally vertically-integrated utilities, the two factors directly offset one another. In the restructured utilities of Texas and the Northeast, the utility does not supply the electricity, only the delivery, and the margins are very different.
Some decoupling mechanisms operate WITHIN each customer class, so a loss of commercial sales results in a rate increase to commercial customers, and a gain of residential sales results in a rate decrease to residential customers. Other decoupling mechanisms share the effect between customer classes.
Regulators will face a difficult day of reckoning if they have to raise commercial rates to offset reduced commercial sales at a time when national macroeconomic policy is focused on restoring the business environment.
Rutgers University Center for Research in Regulated Industries has a webinar series going on addressing the specific issues of Covid-19 on the electric utility industry. View at: https://www.business.rutgers.edu/regulated-industries-center
“For example, 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.” I would point out that for a national audience this statement may not be true in all cases. Generally public utility rate making is prospective and not retroactive. Utility regulation does not “guarantee” a profit level so in most cases profits below the previously authorized ROE are not made up by surcharges in the future nor are profits above authorized ROE subject to refund. Decoupling can be designed without any true-up mechanism. Campbell offers that up in the form of “increasing fixed charges”. That would be the method chosen by the FERC for interstate gas pipelines in order 636 – a straight-fixed variable (SFV) rate design. If the California PUC has chosen an annual weatherization or other “true-up” mechanism in the past it can eliminate those provisions, after proper procedures in the future. Going to SFV would eliminate that problem
Overall Campbell’s suggestions as to the Pandemic establishes a need to convene policymakers and the public makes sense in any state.
SFV rate making destroys the principle purpose of utility regulation: to prevent the exercise of monopoly pricing power.
A key way that regulators can implement their responsibility is to ensure that utility pricing is comparable to what would occur under competition. Safeway, Kroger, Wal-Mart (and others) compete for our grocery dollars. None charges a fixed charge. Home Depot, Lowes, Ace, and TrueValue compete for our hardware dollars. None charges a fixed charge. In a competitive market, there is no place for fixed charges.
Yes, Costco charges a membership fee. Their goal is to eliminate “shoppers” from their stores, as contrasted to “buyers.” You never see anybody exiting a Costco with an empty cart. And the fees that they do charge amount to less than 2% of their revenues — no one would be very concerned about a $2/month fixed charge
It is when these charges get above the relevant customer-related costs that smart rate design principles are challenged: the final service drop from the shared grid to the premises, plus billing and collection costs. Network charges should never be reflected in fixed charges.
Shared system costs should all be reflected in time-varying usage rates. Demand charges are archaic rate forms from an era where sophisticated metering was not available.
For more on rate design principles, see:
Smart Rate Design for a Smart Future
For more on why demand charges are inappropriate, see:
Charge Without A Cause
ANOTHER case of privatized profits and socialized costs/ losses. Even if they ‘return’ excess profits in ‘the future’. When PG&E asks for additional funds to ‘upgrade safety’ by replacing ‘old pipes snd poles’ I wonder what happened to the depreciation ‘charge/allowance’. After all any well-managed/ responsible business would put funds aside for replacements.