Tuesday, February 27, 2007

Noncompetitive utilities 

My SCBA buddy Leo asks for help on his Xcel Energy bill. The gas and electric utility in Minnesota is asking for the ability to "decouple" demand and rates so that the utility could continue to earn adequate revenues. Leo writes,
For years now, Xcel energy has been harping on its customers to buy more energy efficient appliances, better insulate our homes, turn down thermostats, all in the name of not only saving energy, but of saving money. So we buy their line. We buy more efficient appliances. We insulate our homes and buy expensive energy-efficient windows. We do a helluva job conserving energy to the point where their natural gas sales are down, and their revenue is decreased. So they're going to reward their customers for helping them, by inflating the rates that they charge for using less gas?

Correct me if I'm wrong, but if demand for a product goes down, shouldn't prices go down along with demand? Not only that, but if they're selling and producing less product, wouldn't their overhead to extract and transport same decrease, as well? One would think that the next step in the progression would be to lay off workers that aren't needed due to the decrease in demand.
That would be true of a competitive firm, but Xcel is a regulated monopoly supplier of gas and electricity. It has been a leader in encouraging people to conserve energy, but that's not the model under which Xcel (or NSP, its predecessor) were built.

Those utilities were encouraged to expand energy production. An unregulated monopolist makes money by lowering the amount of goods and services it provides and thus pushing up the price of its product (for instance, newer sports facilities often have fewer seats than those they replace.) That is what maximizes profits -- lower quantity, higher prices. Regulators hold prices down and encourage the monopolist to provide more. But because of environmental concerns, we've pushed energy distributors in the opposite direction.

In return for submitting to regulation, energy producers are guaranteed that the physical plant they build will receive a normal rate of return. Again, when the goal was to get them to produce more energy, we would do this by permitting some small passthrough of the costs of construction to rates. But not too much, because we want access to electricity and heat for all. But now because of conservation measures the access problem can be solved with less physical plant than was there before. "So shut the inefficient, dirty producing facilities down!" you might say. But the regulator promised them a fair return on the investment, and that may mean the old plant has to stay open longer.

The way to handle this problem, says the industry, is to allow the industry to target a smooth revenue stream to pay for those plants so that, when demand falls, they can increase prices back towards the profit-maximizing rate. The regulator would only agree to this if the utility could be brought back to the regulated rate when demand rises (so that they don't make too much.) Thus the proposal Leo reads Xcel to offer.

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