Cleaner, Cheaper, Better Simple changes in rate-making philosophy could encourage Virginia's natural gas utilities to promote conservation of their clean, efficient fuel -- helping consumers and the environment alike.   Regular readers of Bacon’s Rebellion are familiar with the growing conviction that market forces and the conservation ethic are not mutually exclusive. Those of us who work in the energy utility sector are often asked why we don’t “do more” to promote conservation. Actually, we do educate customers about the importance of weatherization and energy efficiency as part of our customer service.   Under the traditional model of natural gas utility rate regulation, however, we have no financial incentive to promote conservation on a large scale. We make our profit by charging what amounts to a delivery fee for the units of gas that the customer uses. If a customer reduces gas consumption, we distribute fewer units and make less money.   Yet reversing the disincentive to conserve is easily accomplished by reforming the rate structure, and a growing number of states are doing so. In fact, both the Virginia Energy Plan released by Gov. Timothy M. Kaine and the national energy bill just signed by President Bush encourage changes in the traditional regulatory model.   Recently, I was invited to discuss natural gas ratemaking with a group of Virginia conservationists. Although natural gas utilities and conservation groups often disagree about the need to boost domestic natural gas production, we have found common ground in many areas. We share a vision of natural gas serving as a non-polluting bridge fuel to renewable energy sources in the climate change solution. We are also in broad agreement that traditional ratemaking creates financial disincentives for conservation, which frustrates a common desire to extend the life of domestic gas supplies.   Our company, AGL Resources, and other utilities want to examine ways to adjust the old ratemaking structure in Virginia to align the interests of utilities, conservationists and individual customers behind energy efficiency and conservation -- goals that are compatible, incidentally, with lower utility bills for consumers.   A brief explanation of gas utility rate making is in order. Roughly 70 percent of the average homeowner’s natural gas bill is based on the cost of the fuel, which utilities acquire from gas producers and pass on at the cost they pay. The remaining 30 percent or so of the bill represents the cost of delivering the gas, plus the utility's regulated, authorized rate of return, usually somewhere between 9 percent and 11 percent (although some states authorize returns in the 12 percent to 14 percent range). The traditional ratemaking model focuses on only a fraction of what the customer pays -- the delivery cost and utility profit (profits account for three percent to four percent of the customer’s bill in our case) -- rather than the total cost of heating the customer's home.   Traditional utility ratemaking was born of necessity decades ago, when fuel was cheap and plentiful but the cost to build a grid to provide universal service was staggering. Economists devised an effective mechanism to create the economies of scale necessary to provide universal service: Tag each molecule of the gas with a piece of the cost of infrastructure. Because utilities earned more money the more gas they sold, they had an incentive to encourage consumption, and that's exactly what they did.   Today, the challenge is quite different. Fuel is neither cheap nor plentiful. Because natural gas is the cleanest, most efficient fossil fuel, it has benefited from clean air requirements. While public policy has increased demand for natural gas, direct caps on production and indirect caps in the form of environmental regulation has constrained the development of new supplies. The result is higher commodity prices. Indeed, cost increases in natural gas fuel have driven the lion’s share of increases in electric rates, and the average natural gas customer has seen his bill increase a few times over in the last decade.   On the other hand, our Virginia utility’s base rates – the cost of delivering the commodity – have remained unchanged since 1996.   The situation for customers would be much worse if our industry and its customers did not have a remarkable story to tell.  The average natural gas home uses 20 percent less fuel today than it did 20 years ago. Thus, despite the fact that the number of homes using natural gas has increased 50 percent since the 1970s, the carbon footprint of residential natural gas has remained stable since then.   Most of the climate change bills pending in Congress aspire to return America to 1970s levels of carbon emissions. Our industry is already there. The dramatic efficiency gains of the last two decades mean that the “carbon footprint” for the natural gas home is 40 percent smaller than a home using electricity for space and water heating. These efficiency gains also have served to accommodate, to some extent, demand growth that otherwise would have been met only through more severe economic curtailments or supply increases.   Ninety-plus percent of the energy at the wellhead reaches the gas customer’s meter. Compare that to system efficiency for electricity of less than 30 percent -- more than 70 percent of the energy input is lost in the generation and transmission of electricity. New generation technology, as opposed to end-user conservation, will drive the biggest environmental gains on the electric side over time. Yet, it will take time for our economy to absorb these individual and utility investments on a scale necessary to produce dramatic results.   To say that natural gas is more efficient than electricity is not to say that there is no room for improvement. More efficient building envelopes, more efficient appliances, and greatly increased direct use of natural gas can help meet our domestic energy and climate change goals.   One way to accelerate conservation is to rapidly deploy a new economic model for natural gas utility regulation. Many states have spurned traditional regulation’s encouragement of consumption by “decoupling” rates for natural gas utilities.  Under a decoupling model, the fixed costs of natural gas utility service are truly separated from the variable component – customer energy use – that depends on the price and customer use of fuel. No longer is each molecule of gas tagged with a slice of the infrastructure. The customer pays one charge based on the cost of building and maintaining the system (the only part of the bill that the utility controls) and another for his consumption (the only part of the bill that he controls). Natural gas utilities in Virginia would continue to pass through commodity prices at cost.    Once these charges are decoupled, the interests of the utility and the customer, as well as society, are better aligned. The utility becomes indifferent to how much gas the customer uses -- or conserves -- and is more focused on making sure the gas can get there every day, safely and reliably, which is our main public service obligation under any regulatory model.   While decoupling removes the economic incentive for utilities to promote consumption, a true conservation ratemaking model would go a step further and reward gas utilities for cost-effective conservation plans. Utilities with a profit motive to encourage conservation can use their access to customers and heft in the marketplace to contract for cost-effective customer energy audits, lower prices on programmable thermostats and obtain good deals and rebates on more efficient appliances, among other things.   The Virginia Energy Plan notes that $1 invested in energy-efficiency programs results in approximately $3 in natural gas savings. Those gains are permanent to the customer, earning an energy savings dividend year after year. Allowing utilities to recover the expense of cost-effective natural gas conservation programs and providing additional economic rewards for meeting or exceeding conservation goals makes complete economic sense, if the goal is to promote efficiency and conservation.   Utilities operating in roughly half the U.S. have already decoupled. There are many successful examples. My company’s Atlanta Gas Light utility, serving 1.5 million customers, decoupled rates nearly ten years ago. Georgia Tech has concluded that informed customers have had the opportunity to save energy and money, compared to the traditional ratemaking model. Atlanta Gas Light actively markets tankless water heaters and other fuel-efficient appliances because it makes economic sense. Likewise, the decoupled environment of Oregon leads the nation in the percentage of efficient appliances per capita.   A true conservationist focuses on the bottom line in a holistic sense. We are committed to a sustainable model of conservation because we believe our product is the cleanest, most efficient fuel nature offers, and that conserving it is simply good business and the bridge to the future. We can deliver gas more efficiently, save customers money, and improve the environment in the process.   Give us the more economically efficient model, better suited to today, and let us go to work.   -- December 27, 2007