California’s revenue adjustment mechanisms were designed to protect investor-owned utilities from the negative effects of conservation laws and tiered rates, but some say ratepayers are bearing the burden
It’s been four years since California began implementing decoupling mechanisms to allow investor-owned water utilities to recover costs in light of state-mandated conservation. Although there hasn’t been a comprehensive review by the California Public Utilities Commission (CPUC) to evaluate decoupling’s effectiveness, there is some concern that the benefits have been too heavily weighted toward investor-owned utilities at the expense of ratepayers.
Decoupling reconciles a utility’s actual sales and revenues with adopted sales and revenues previously agreed upon with the public utilities commission during rate cases. It was first introduced in California’s energy sector in the 1970s as a way to reduce consumption without negatively impacting the financial health of utility companies. The concept was carried over to the water sector in 2008 via pilot programs and has been implemented by California Water Service Group, California American Water and Golden State Water. Revenues at California’s municipally owned water utilities are not decoupled; instead, the utilities have rate stabilization plans based on special financial reserves that can be tapped when sales decline.
Some in the commission’s Division of Ratepayer Advocates (DRA) believe ratepayers have suffered because the program did not anticipate the economic downturn that began late last decade. According to the U.S. Department of Commerce’s Bureau of Economic Analysis, California’s GDP dropped 1.79 percent from 2008 to 2009.
The DRA’s Diana Brooks told AWI that under-collections since the start of decoupling have been higher than expected – as high as 28 percent in some cases. In addition, some of those under-collections have pancaked year-over-year, resulting in unusually high surcharges to customers.
“Our opinion in general is that these mechanisms give the investor-owned utilities too much protection,” Brooks said. “They go beyond removing the disincentive to conserve, but they are also shielding the utilities from declining revenues due to other factors like the economy or the weather.”
Sales have indeed been down in California, and not just as a result of the Water Conservation Act of 2009, which set a goal of a 20-percent reduction in per capita urban water use by 2020. California Water Association Executive Director Jack Hawks told AWI that virtually every water utility in the state experienced double-digit sales declines between 2008 and 2011. Much of that was attributable to the drought of 2007-2010 and to a lack of new housing starts.
Exactly how much was attributable to each factor is harder to quantify. For this reason, it’s not clear how a program designed to protect utilities from lower demand from conservation can be expected to account for economic and hydrologic factors. Tom Smegal, vice president for regulatory matters at California Water Service Group, told AWI that his company has seen sales drops in areas that were heavily affected by the recession as well as those that were relatively insulated. If the state’s economy improved drastically, Cal Water would be in the position of giving back a portion of money that it collects due to higher sales, Smegal said.
“One thing that is a concern to some companies about this kind of a mechanism is you really give up the potential for any upside,” Smegal said. “You lock yourself in to a certain sales number, and there’s never going to be an opportunity to have a great sales year.”
Stephen St. Marie, who serves as an adviser to public utilities commissioner Catherine Sandoval, admits there has been some difficulty implementing decoupling due to the distribution of rate increases over a smaller sales volume.
“You end up with a situation where as soon as the customer starts conserving, the rates have to go up,” said St. Marie. “It’s an artifact of the algebra, and you can’t avoid it.”
One of the primary objectives of decoupling is to eliminate a utility’s economic disincentive to encourage conservation. When a customer makes a considerable effort to conserve, however, and his water bills still rise, there is understandable confusion. Brooks said when the pilot programs were first proposed, a number of them provided for further review if any asymmetry between ratepayers and utilities was discovered.
It seems as though that kind of due diligence will be necessary in order to prevent decoupling from becoming a political liability. On top of that, there are concerns about the program’s effect on the utilities’ management of costs. St. Marie, however, believes those fears are rooted in misconceptions.
“Some people think we’re indemnifying the companies and they’re going to become fat and lazy and not do the kinds of research or good management that are required,” St. Marie said. “In fact, that’s a separate issue that has nothing do with decoupling, but somehow it’s gotten caught up with the decoupling issue. We like to think that the companies subject to our jurisdiction are always looking for ways to cut costs.”
Smegal said Cal Water’s revenue adjustment mechanism has a built-in reporting requirement that forces the company to justify increases in production costs. He conceded, however, that the program contains no real incentives to improve efficiency.
“Decoupling has given us a neutral incentive, and so it’s up to individual companies to come in and say, ‘I want to make investments or process changes that are going to improve my production costs,’” said Smegal. “I don’t think there’s a danger with the way it’s currently set up that we would let things slide.”
Smegal said decoupling has worked well for Cal Water because much of the company’s revenues are tied to quantity rates charged to high-volume users. Cal Water’s stock price fell by 2 percent in 2011, a less precipitous drop than non-decoupled SJW Corp. (down 10 percent), although decoupling is only part of the picture.
It isn’t hard to see why investor-owned utilities operating in California support revenue adjustment mechanisms, particularly with the prevalence of tiered rate designs. St. Marie, however, said that opinions vary on the mechanics of decoupling.
“Some of our companies believe they would rather take the risk of selling too much or too little if they’re allowed to over-collect during times when they sell more,” said St. Marie. “They would rather take their chances if they can keep the money. If they can’t keep the money, and this becomes a one-way street where you lose if you sell less and we claw it back when you sell more, obviously those companies are not going to be happy.”
Decoupling seems effective but in need of modifications to ensure the best outcomes for everyone. Because of its unique set of circumstances, California seems to stand alone as the test case for decoupling, even though New York practices it in water as well. Any state that has ambitious conservation laws coming down the pike or a prevalence of tiered rate designs, however, might do well to follow California’s example, albeit with caution.