Common Tragedies

Thoughts on Environmental Economics

Decoupling + Energy Efficiency Programs = Corporate Welfare?

Posted by Rich Sweeney on January 28, 2008

N-dot’s assertion that “Cap-and-trade = Carbon tax + Corporate welfare” seems to have resonated with policymakers in DC . It’s been mentioned at just about every cap-and-trade talk I’ve attended in the past few months. While I sense that the tide is turning towards a full (or at least close to full) auctioning of permits, listening to people talk about what we should do with all this revenue raises some new concerns about corporate welfare. In particular, as the title indicates, I’m a little concerned that we may overcompensate utilities in our quest for energy conservation.

Decoupling refers to severing the link between increased electricity sales and utilities’ profits. Since a large portion of electricity costs are fixed, a producer’s profitability increases with output. This, in turn, creates a disincentive for utilities to invest in energy conservation/ efficiency. If electricity revenue is set independent of output, many groups believe that utilities will invest in programs to help their customers reduce consumption.

At the same time, many groups, such as the environmental departments of the RGGI states, are calling for the government to literally go out and buy energy efficiency. The idea is that there is some supply curve out there of mega-watts to be saved, and the government could subsidize or actively substitute consumers’ purchases of the necessary efficient capital (Imagine the DOE literally coming to your house and swapping out all of your incandescent light bulbs).

Which brings me to the corporate welfare part. Decoupling works by projecting what energy consumption would have been and then compensating utilities for the difference between that projection and the actual amount. This makes sense as long as the projections are accurate and the utility actually plays an important role in reducing consumption. Yet if a government sponsored efficiency initiative was going on at the same time, it would be difficult to identify how much of the decline in electricity use the utility should really get credit for. Seems like both over and under compensation are possible, with the former being much much more likely. Either way these programs appear to have quite a bit of overlap, which suggests that the policymakers should either pick one or find a way to merge the two.

4 Responses to “Decoupling + Energy Efficiency Programs = Corporate Welfare?”

  1. You know what’s good at making fine-grained, iterative judgments like this? Markets. Curious what you folk think about utility deregulation.

  2. […] is a hot-button topic. Common Tragedies breaks down auctions versus free giveaways in a pair of posts, while Grist finds that power companies will charge the same whether they get free permits or buy […]

  3. Plus, of course, lots of energy utilities are aggressively pursuing conversation/DSM programs so that they can either sell power from DSM savings or avoid larger supply expansions (or get paid some performance target from regulators as in Ontario). And if they are then compensated for energy efficiency, freeridership is further intensified and cost-effectiveness tanks. Also, governments would likely buy efficiency at prices that would crowd out utility efforts, (because of information asymmetry on avoided cost I suspect) which then could lead to questions of additionality.

    Seems to me government revenue is better placed on tax shifting, or to address market failures (R&D spillover) and the under supply of technology such as CCS (CCS pipelines returns are well below private sector levels but from a longer view make sense).


  4. Jeff said

    Your description of how decoupling works in the 4th paragraph seems a little off. Although decoupling mechanisms vary across states in their details, they are generally set up to allow utilities to collect their “revenue requirement” (i.e., variable + fixed costs), not their projected sales, irrespective of what happens to sales. The point of decoupling is to make utilities agnostic to energy efficiency programs generally (including programs they run and other ones, like federal or state building codes and appliance standards) by allowing them to recover all of their fixed costs even if sales are lower than projected, not to dole out “credit” for EE programs run by the utility (although there is a competing mechanism, called “lost revenue adjustment mechanism”, which attempts to identify and allow recovery for the lost margin caused only by the utility’s programs). Allowing utilities to recover their fixed costs hardly seems like corporate welfare.

    There are other issues associated with decoupling that, depending upon how it’s implemented, could result in excess profits for utilities. For example, rate-payer advocates often suggest the decoupling significantly reduces a utilities risk, and therefore, they should get a lower rate of return once decoupling is in place.

    Also, many of the states trying to push energy efficiency programs are (or envision) relying on utility-administered programs to do so; hence their interest in removing the throughput incentive, as utilities without some form of decoupling (or other lost margin recovery) are unlikely to have any motivation to implement effective EE programs.

    For more:

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