The National Regulatory Research Institute

1. THE “GREAT” DEBATE OVER REVENUE DECOUPLING The National Regulatory Research Institute Ken Costello Senior Institute Economist prepared for 2006 MARC Conference Columbus, Ohio. June 20, 2006

2. Introductory Remarks • Much discussion and activity over new ratemaking methods for gas utilities • Major motivating factors include emphasis on gas utilities promoting energy efficiency and the structural change in gas consumption over the last several years • Revenue decoupling (RD) represents one new ratemaking method being seriously considered for an increasing number of gas utilities June 20, 2006

3. Introductory Remarks -- continued • In regulatory proceedings, groups have presented several arguments on both sides of the RD debate • Applying longstanding ratemaking principles and regulatory objectives, RD scores well in some aspects while not so well in others • Based on past state commission actions, a true-up or “tracker” mechanism,” such as RD, requires that it passes a 3-prong threshold test June 20, 2006

4. The advantages of RD to gas utilities (namely, reduced risk) come across as more direct and certain than the benefits to consumers Benefits to consumers hinge largely on cost- effective, utility-initiated energy efficiency programs Alternatives to RD in achieving the same objectives should be, and have been, considered The defense for RD depends importantly on the state commission’s desire to have a gas utility promoting energy efficiency in addition to its core function of selling and delivering natural gas Introductory Remarks -- continued June 20, 2006

5. Basic Structure and Operation of RD Mechanisms • Characterization of mechanism: tracker or attrition allowance • Historically, state commissions have supported trackers when they met certain conditions, namely • The designated activity lies largely outside the control of a utility • Variations in the actual outcome more than minimally affect utility earnings • The actual outcome is likely to deviate from a baseline level June 20, 2006

6. Basic Structure and Operation of RD Mechanisms-- continued • How RD typically works: true-up mechanism for authorized per customer margins • One objective is to create neutral incentives for the utility in terms of varying sales, either upward or downward, from baseline levels • Distinctive features relative to traditional ratemaking: at least from the revenue side, RD guarantees actual earnings at the level of authorized earnings June 20, 2006

7. Conservation margin tracker Conservation-enabling tariff Conservation tariff Conservation rider Conservation and usage adjustment tariff Innovative ratemaking Conservation tracker allowance Incentive equalizer Delivery margin normalization Usage per customer tracker Customer utilization tracker RD under Different Labels June 20, 2006

8. Underlying Rationale for Revenue Decoupling

9. Expected Outcomes from Revenue Decoupling

10. Arguments for Revenue Decoupling

11. Arguments against Revenue Decoupling

12. The Big Issues Being Fought in the Trenches • Specification of the objectives of new ratemaking methods • The merits of RD relative to other ratemaking methods in satisfying the same objectives • The appropriateness of RD as a tracker • Utility commitment to promoting energy efficiency June 20, 2006

13. The Big Issues-- continued • The risk effect of RD on consumers and the utility • The need for RD to promote utility-initiated energy efficiency • The financial effect of declining usage per customer on a utility • “Revenue assurance” effect versus conservation enhancement” effect of RD June 20, 2006

14. The Big Issues-- continued • Assessing RD outside the context of a rate case • RD structure and implementation • Overall effect on consumers June 20, 2006