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History of Colorado Energy Industry Regulatory Incentives

History of Colorado Energy Industry Regulatory Incentives. Presented to: Colorado Public Utilities Commission June 10, 2008 Gary Schmitz Schmitz Consulting LLC. Project Goals. Provide a history of energy industry incentives approved by the Colorado PUC.

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History of Colorado Energy Industry Regulatory Incentives

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  1. History of Colorado Energy Industry Regulatory Incentives Presented to: Colorado Public Utilities Commission June 10, 2008 Gary Schmitz Schmitz Consulting LLC

  2. Project Goals Provide a history of energy industry incentives approved by the Colorado PUC. • Develop an index of decision numbers and docket numbers for energy industry incentives. • Provide a context for the decision to adopt or modify incentives. Schmitz Consulting LLC

  3. Incentive Regulation • Traditional regulation – incentives; • Incentive regulation – earnings sharing; • Automatic adjustment mechanisms; • Price volatility management & trading; • Resource acquisition incentives: DSM, renewables, supply side resources. • Quality of service. “All regulation is incentive regulation.” Alfred E. Kahn Schmitz Consulting LLC

  4. Incentive Regulation History • 1855 English manufactured gas utilities. • Base dividend set at 10%: • If gas prices increased above a base level the dividend rate was reduced according to a sharing formula. • However, if gas prices fell below the base level the dividend rate did not increase. • The mechanism was made symmetric in 1867. Source: Hammond, Johnes, and Robinson, 2002 Journal of Regulatory Economics , 22:3 p. 255). Schmitz Consulting LLC

  5. 1. Traditional Regulation • “Traditional” utility regulation contains incentives for utility to reduce costs between rate cases (prices, not earnings set by the Commission). • If a utility reduces costs below the rate case level – shareholders see higher earnings. • Prices change at next rate case. • Benefit of lower costs passed on to customers in the next rate case. Schmitz Consulting LLC

  6. 2. Electric Incentive Regulation • “Performance-based regulation” alters traditional regulatory incentives: • Rate case moratorium provides some level of certainty about utility retention of costs savings; • Sharing of the benefits from cost savings between shareholders and ratepayers. Schmitz Consulting LLC

  7. Electric Incentive Regulation • 1996: Commission approved PBR in merger that created New Century Energy; continued in Xcel merger. • Ratepayers and shareholders annually share earnings in excess of authorized return on equity. • Commission approved reverse taper. • PBR recently expired. Schmitz Consulting LLC

  8. 3. Automatic Adjustment Mechanisms • Purpose; • Criteria for approval; • Impact on utilities incentives and risks; • Specific mechanisms. Schmitz Consulting LLC

  9. Automatic Adjustment Mechanisms • Allow utility to recover changes in costs outside of a rate case. • Commission criteria for automatic adjustment mechanisms: • Cost must be significant; • Cost must be beyond the control of the utility; • Cost must be volatile. Schmitz Consulting LLC

  10. Automatic Adjustment Mechanisms • Advantages: • Avoid frequent rate cases; • Provide better price signals (increases and decreases). • Disadvantages: • Incentive problem: management has no direct financial incentive to expend resources to reduce expenses for items subject to an adjustment mechanism that recovers 100% of costs in timely manner. Schmitz Consulting LLC

  11. Automatic Adjustment Mechanisms • Fuel costs (electric); • Gas cost adjustment (natural gas); • Purchased capacity costs (electric); • Demand side management (electric and gas); • Air quality improvement (electric); • Renewable energy standard (electric); • Transmission costs (electric). Schmitz Consulting LLC

  12. Electric Fuel Costs • PSCo reportedly had a fuel adjustment clause as early as 1923. • 1970s: recovery of 100% of fuel costs. • 1993 Commission statement: historical justification for electric fuel adjustment mechanism may no longer exist. • 1996: “Incentive” costs adjustment - 50% of the difference between the base cost and the actual cost of energy passed on to customers. Schmitz Consulting LLC

  13. Electric Fuel Costs • 2003: PSCo proposed targeted incentive mechanism. Incentives: reduce heat rate, increase coal plant availability, acquire fuel at lower cost. • Current PSCo ECA: • Incentive for production from coal plants; • Incentive to purchase capacity at a rate less than PSCo system cost. • Current Aquila ECA: Full pass-through of fuel costs. Schmitz Consulting LLC

  14. Gas Cost Adjustment • Purpose: allow LDCs to reflect increases or decreases in gas costs (gas commodity costs and upstream services costs) in rates on an expedited basis. • Reflects the cost of gas commodity and upstream service projected to be incurred by the utility during the GCA effective period plus recovery of the deferred account. Schmitz Consulting LLC

  15. Purchased Capacity Costs • 1978: Commission authorized recovery of 100% of costs of firm power purchases in fuel adjustment mechanism. • Early 1990s: Purchased power removed from fuel adjustment mechanism. • 1993: Capacity costs of qualifying facilities recovered through QFCCA. • 2004: PCCA recovers incremental capacity costs for contracts approved in the 1999 IRP. • 2006: Current PCCA allows recovery of all projected capacity costs. Schmitz Consulting LLC

  16. Demand Side Management • 1990: Commission approved DSMCA for PSCo electric programs. • Early 1990s: DSMCA extended to PSCo gas and Aquila electric. • “Incentives” beyond actual cost recovery occasionally allowed. • HB07-1037 requires incentives: • Electric: Opportunity of cost-effective DSM to be more profitable than other investments; • Gas: Reward cost-effective gas DSM beyond cost recovery. Schmitz Consulting LLC

  17. Air Quality Improvement Costs • 1998: legislation allowing full cost recovery of costs associated with voluntary environmental improvements. • Cap of $211 million (1998$). • Rate cap of one and one-half mills per kilowatt hour. • PSCo placed environmental controls on metro plants, retired small Arapahoe units. • AQIR became effective 2003. Schmitz Consulting LLC

  18. Renewable Energy Standard • Result of Amendment 37 and HB 07-1281 which established a renewable energy standard of 20% by the year 2020; • Maximum retail rate impact: 2 percent; • HB 07-1281 specifies that utilities can earn extra profit up to 50 percent of the net economic benefit. Schmitz Consulting LLC

  19. Transmission Costs • SB07-100: Utilities entitled to recover prudent costs of planning, developing, and completing transmission facilities through a separate rate adjustment clause. • Current recovery of construction work in progress (CWIP) through the rider. Schmitz Consulting LLC

  20. 4. Price Volatility and Trading • Natural gas price volatility management; • Electricity price volatility management; • Electricity Trading. Schmitz Consulting LLC

  21. Natural Gas Price Volatility • Natural gas prices determined in competitive market. Price determined by weather, economic growth, supply trends, storage levels, and random shocks. • Gas commodity prices are volatile and lead to associated customer price risk. • Natural gas commodity costs make up 70–80% of customer’s total bill. Schmitz Consulting LLC

  22. Natural Gas Price Volatility • GCA rules modified on emergency basis in late 2001 - made permanent in 2002. • Requires utility’s Gas Purchase Plan to describe the options and steps that the utility has taken or will take to “reduce customers’ risk of gas price volatility.” • Costs related to gas price volatility risk management may be recovered through GCA, if allowed by tariffs. Schmitz Consulting LLC

  23. PSCo Monthly GCA • 2004 Settlement allows PSCo to adjust GCA monthly. • Provides better price signals. • Prevents build up of large under-recovered balances. • As part of monthly GCA, PSCo agreed to undertake an expanded Gas Price Volatility Mitigation (GPVM) program (filed annually). Schmitz Consulting LLC

  24. Electric Fuel Volatility 2002 PSCo rate case – authorized hedging gas supply for electric generation: Required annual filing for approval of gas hedging plan. 2004 Trading case - Commission modified settlement allowing Public Service to hedge natural gas for the forward purchase of energy for native load.

  25. Electricity Trading 2000: Short term trading authorized. 2002 rate case: Continue trading, modify margin-sharing percentages. 2004: Trading docket established business rules, audit plan, reporting requirements. 2006: Margin-sharing percentages again modified.

  26. 5. Resource Incentives • HB07-1037 - DSM mandate; • HB07-1281 - Renewables mandate; • IGCC option; • Natural gas partial decoupling; • Treatment of CWIP: current earnings on CWIP for Comanche 3, depending on Company’s bond rating. Schmitz Consulting LLC

  27. Demand Side Management • 1990: PSCo 100 MW DSM bidding program – approved DSMCA; • 1992: PSCo gas DSM program for low income customers • 2007: HB07-1037: • Electric IOU’s: peak and energy saving of 5% of 2006 retail sales by 2018; • Natural Gas: IOU’s required to spend .5% of revenue from sales customers on DSM programs. Schmitz Consulting LLC

  28. Renewable Resources • 1999 PSCo IRP: Commission approved 162 MW Lamar wind project. • 2004: Colorado voters approved Amendment 37. • 2007: HB07-1281 expanded renewable energy standard beyond Amendment 37: • IOUs: Twenty percent of retail sales from renewable sources by 2020. Schmitz Consulting LLC

  29. IGCC • HB06-1281: Utilities may propose projects to demonstrate feasibility of IGCC at altitude with western coal and carbon capture; • Commission to grant rate adjustment rider to recover IGCC costs. Schmitz Consulting LLC

  30. Partial Gas Decoupling • PSCo residential 3-year pilot program. • Rate adjustment mechanism reflects non-weather related changes in average actual use per customer. • Decoupling breaks the link between utility sales and earnings. Removes the disincentive for utilities to undertake DSM programs. Schmitz Consulting LLC

  31. 6. Service Quality • 1996: Electric quality of service plan included in original PSCo earnings sharing plan. Bill credits for failure to meet targets. Goals: • maintain historical level of service; • discourage cost savings at the expense of quality of service. • 2001: Gas quality of service plan. • 2005: Aquila electric quality of service plan. Schmitz Consulting LLC

  32. Summary • Existing regulatory structure has evolved over many decades to address emerging issues. • Incentives come from Commission decisions and the Colorado legislature. • Recent increase in the use of adjustment mechanisms. Schmitz Consulting LLC

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