Revenue decoupling for electric utilities: impacts on prices and welfare

Produced as part of the Competitiveness in the low-carbon economy CCCEP research programme theme

Particularly in electricity markets, revenue decoupling has started to be used as a price adjustment mechanism that disentangles the effect of increased sales volume to a utility’s ability to recover the fixed costs of providing the service to customers. Because of its design, some regard this strategy as win-win both for the utility company and for its customers, because it removes the incentive for companies to increase sales as a means of increasing revenue and profits, and it reduces the volatility of customer bills. Because of this, revenue decoupling is viewed as an effective way to remove the disincentive for electricity companies to promote energy efficiency programmes and allow for distributed generation (the deployment of small-scale technologies, including renewables, to produce electricity close to the end user).

However, the recent adoption of revenue decoupling by American states has been controversial due to a perception that there have been significant impacts on customer prices, and that risks to do with uncertainty of power supply have been transferred from utilities to consumers. To provide analysis that could give guidance on the effects of decoupling, the authors of this paper developed a simple model that allows them to assess the welfare implications of revenue decoupling. They investigated the impacts of decoupling on electricity prices and on welfare in each American state.

Recent technological and economic changes, such as the falling costs of energy-efficient products and distributed generation, are seen to diminish the ability of electric utilities to survive. The authors of this paper find, however, that implementing revenue decoupling in the United States has benefited utility companies at the expense of consumers, particularly those who are failing to improve their energy efficiency or adopt off-grid energy.

Key points for decision-makers

Revenue decoupling could maintain a utility’s profits at the expense of households or end-users by inducing higher electricity rates.
The risks associated with the uncertainty of power supply from small-scale, distributed generation are passed on to the consumers.
While revenue decoupling can provide welfare gains to high-income earners who can afford to have distributed generation or more efficient appliances, it implies losses to low-income earners and renters, who cannot access these technologies as easily.
The inefficiency associated with subsidies for distributed generation (such as solar panels) is greater with decoupling than without.
The study finds that revenue decoupling tends to increase electricity prices substantially over a period of months upon implementation (by about 19% over two years).
Contrary to how revenue decoupling is viewed in many American states, decoupling adjustments have not been implemented ‘symmetrically’: that is, prices do not go down even in times when the sales increase beyond the projected level.
Revenue decoupling has generated negative effects in most states in the US. This is because retail electricity prices tend to exceed the social marginal costs of electricity generation (i.e. the total cost consumers pay for its generation, including the external damages associated with greenhouse gas emissions) in all states where decoupling was already in place in 2011. This implies that further price increases due to decoupling would amplify the inefficiency due to gaps between the price and the social marginal costs.

ISSN 2515-5717 (Online) – Grantham Research Institute Working Paper series

ISSN 2515-5709 (Online) – CCCEP Working Paper series