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Building the iUtility

Market forces are transforming the IOU business model.

Fortnightly Magazine - August 2008

of the new regulatory compact, then the iUtility must receive offsetting financial incentives. One form of financial benefit will be an energy surcharge added to customer bills to enable iUtilities to recover expenditures in energy-efficiency applications sometimes referred to as negawatts. To the extent a utility can assist with the installation of energy-efficiency products or energy savings from complying with building and appliance codes and the like, the utility can recapture those costs either as expenses or in rate base.

Another offsetting financial benefit in the new regulatory compact will be to allow the iUtility to earn returns based on the number of customers served rather than based on the amount of electricity sold. In this way, the iUtility’s profits are based on sales of energy products and services to a customer at a certain revenue per customer. Rates established on the basis of the number of customers, rather than the amount of electricity sold, will provide the iUtility with incentives to add customers who are attracted by a greater array of more efficient services.

The new regulatory compact simply expands the terms of the old compact while keeping the basic exchange in place, with the intent of protecting both consumer and shareholder interests.

Reinterpreting the Rate Formula

The iUtility, its shareholders and investors must have confidence in revenue stability. Its customers must have confidence in rate stability, and, regulators must have confidence that the rate formula achieves these and other social goals, such as increasing energy efficiency and decreasing carbon emissions. Consequently, the new ratemaking formula looks very much like the old formula: R=O+B (revenue equals operating costs plus return on rate base).

The new rate formula imposes challenges on regulators to determine: 1) whether to treat expenditures as expenses; 2) whether to place expenditures into the rate base so the utility can earn a return; 3) how to clearly define the nature of the product or the service to be included; 4) the length of time an iUtility can charge for the product or service; and, 5) the proper balance among the iUtility’s interests in revenue, the customers’ interests in reasonable rates, and the social interests in a cleaner environment. Most important, regulators must determine how to account for technology investments iUtilities need to make—such as smart grid, reliability and efficiency technologies.

In particular, investments in energy-saving technologies are growing as part of the utility’s budget. In California, for example, PG&E plans on spending $116 million subsidizing compact fluorescent light bulbs. 4 Bulbs that cost between $5 and $10 are available in California for between 50 cents and $1 because of the subsidy. California regulators have ordered the state’s utilities to realize specific conservation goals and are allowing utilities to spend $2 billion ratepayer dollars toward those goals. Utilities that meet targets can earn 12 percent on the amount of conservation savings realized, with total savings estimated at $324 million to $450 million. PG&E anticipates increasing sales from 7.6 million light bulbs in 2007 to 20 million in 2008, which accounts for 10 percent of the homes in Northern California.