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The future of rate design: Why the utility industry may shift away from fixed charges

The animosity over fixed charges is giving way to a debate over comprehensive rate reform

Less than three years after the utility industry first introduced fixed charges into its playbook, state regulators and utilities across the country appear to be looking for a new approach to growing concerns over load defection.

In January 2013, the Edison Electric Institute, the national trade group for investor-owned utilities, released its landmark “Disruptive Challenges” report. The report's most notable recommendation was to advise utilities to increase fixed charges to make up for stagnant load growth and customers installing their own distributed generation.

Utilities across the nation took to the recommendation. Last November, Utility Dive reported that there were at least 23 separate fixed charge proposals being considered by state regulators across the country, and the trend has continued through 2015. A recent report from the NC Clean Energy Technology Center found that there were 26 open dockets in 18 states relating to fixed charge increases in the third quarter of this year.

But as quickly as fixed charges came into vogue, they now appear to be on the way out. 

After two years of contentious battles between utilities and solar advocates, the blowback against the wave of fixed charge proposals has led regulators and stakeholders to seek a new approach. Recently, even the author of the original “Disruptive Challenges” paper reversed his original position on fixed charges in a recent paper for Ceres, plotting out a new approach for utility business models that doesn’t include high fixed charges.

Regulators call for balanced approach at NARUC

The new approach to rate design was on display last week at the annual meeting of the National Association of Utility Regulatory Commissioners (NARUC) in Austin, Texas.

At a panel on the future of rates, Samantha Williams, attorney and energy policy advocate at the Natural Resources Defense Council (NRDC), explained that most regulators have not viewed the fixed charge trend kindly.

“Approving these proposals does appear to be the outlier,” she said. “Nearly three quarters of the decisions that have been put out so far in 2015 on this issue have either denied the fixed charge outright or commissioners have scaled it back considerably.”

EEI Executive Vice President David Owens stressed to the audience that utilities must create a rate design that will enable the transition to a networked grid where bidirectional power flows are the norm.

The utility sector is in a “significant state of transition to a 21st century distribution system,” he said. “The rate design has got to anticipate that we’re moving to a network, and the rate design has got to anticipate that we need to modernize the grid in order to achieve that.”

Because many of the regulators in the audience are currently overseeing open proceedings on rate design issues, Owens and the rest of the panelists could not discuss specific examples, and the EEI executive was careful not to openly endorse any specific rate design. But he stressed that rate design issues should be approached from the standpoint of enabling more integration of DERs onto the grid, while preventing cost shifts and keeping price impacts to a minimum.

“There’s an array of approaches for dealing with this,” he said. “You can have a grid access fee. You can have a minimum bill, which looks at whether you’re supplying your own needs or making excess for the grid. You can create a special category for distributed generation, look at standby charges, or a three-part rate.”

“I know that’s very controversial,” he added, “but there’s an array of approaches that need to be discussed that seek to achieve this outcome and acknowledge that we’re all about grid modernization.”

So what is good rate design, anyway?

David Owens' stated goal — designing rates to boost integration of distributed resources while keeping costs down  is a relatively uncontroversial one for utility sector stakeholders. The debate, as always, is about how to get there.

Jim Lazar, senior advisor at the Regulatory Assistance Project (RAP), thinks his organization has a solution. In a recent report, he and his colleagues laid out a residential rate design they think is broadly applicable throughout the nation and that can help resolve some of the lingering disputes in the sector.

Much like the recent rate design reform in California, RAP envisions a three-part residential rate: A low fixed charge, time-of-use pricing, and inclining block rates.

Time-of-use rates will encourage customers to shift their usage to non-peak hours, Lazar told the NARUC audience, while the inclining block rates — which increase the cost of electricity per kWh as usage increases — incentivize them to use electricity frugally.

The fixed charge, he said, should only apply to the customer-specific costs of connecting to the grid, while shared infrastructure costs “should be recovered through some measure of usage,” rather than fixed charges.

Lazar compared that rate design to a less desirable construction — a rate with high fixed charges and a flat volumetric rate.

That rate structure, he said, “encourages customers to use more and creates a continued need for operation of marginal resources.”

In addition to the three-part rate design, Lazar would include a residential demand charge and a critical peak pricing component “for the 10 or so times a year when the grid is really stressed.”

The difference between a good and a bad rate design can be significant for utilities. When taking into account expected increases in electricity consumption from poorly designed rates, the RAP team estimates that “the difference between good and bad rate design can mean a 15% difference in customer usage.”

“15% is a lot,” Lazar said. “It translates into about half the Clean Power Plan emission reduction [requirements] for our nation. That’s big.”

See Also: Rate design roundup: demand charges vs. time-based rates

The future: Residential demand charges and more

Demand charges for residential customers are a relatively recent approach for electric utilities, and RAP’s recommendation for their inclusion sparked discussion on the NARUC panel.

Lazar stressed to the audience that his organization’s design for residential demand charges is a limited one, and the price should reflect the scale of customer usage.

“We actually have a demand charge, but only from a customer-specific capacity  the line, transformer, and secondaries to connect to the grid,” he said. “The apartment will pay $2 or $3; the large mega-house will pay more like $15 or $20 to connect to the grid.”

NRDC's Williams largely endorsed the RAP proposal, agreeing that the “lion’s share of the customer’s bill should be volumetric.” However, she said the team at NRDC is still evaluating the concept of residential demand charges. Central to the considerations should be the charges’ impacts on distributed generation.

Already, Arizona utilities Tucson Electric Power and Salt River Project have proposed demand charges for rooftop solar customers in response to burgeoning distributed generation in their state, a move that solar advocates say will hurt the resource’s value. However, analysts told Utility Dive earlier this year that such charges could have the unintended consequence of promoting the installation of more distributed storage, since the customer-sited batteries could allow users to cut their peak usage, avoiding high charges.

Stopping short of openly endorsing a specific rate design, EEI’s Owens seemed to support the rate design approach undertaken by RAP.

“A three-part rate with a demand charge gives customers ability to say, ‘Let me adjust my demand to when my utility has its highest demand,’” he said.

During an exchange with Lazar, the EEI executive pointed out that the conversation was based on the assumption “that the way we traditionally designed rates is wrong, so we need to redesign rates so they tie into cost causation and all those other elements.”

“I don’t disagree with that,” he said, “but we’re not going to revolutionize ratemaking overnight. I do agree with time differentiated rates, but I also know that many are pushing back.”

“All I’m trying to suggest to you,” Owens said, “is with these changing techs, we need to sit down and have a serious conversation about a whole array of ratemaking approaches … There’s a whole array of approaches, but let’s get the conversations started. We have to roll up our sleeves and begin to have a collaboration on these issues [that are] very important to consumers.”