Advanced Energy Perspectives

Fitch Report Sends Utilities Barking Up the Wrong Tree

Posted by Ryan Katofsky and Bob Keough

Aug 4, 2016 11:53:12 AM



Fitch Ratings released a report last month analyzing the impact of rooftop solar and net metering on the creditworthiness of Investor Owned Utilities (IOUs), and the takeaway seems geared to raise alarm. In short, Fitch states that distributed solar, and especially net metering for solar owners, pose a risk to utilities’ financial stability and thus their ability to borrow at low interest rates. As discussed in a USA Today column, the Fitch report suggests that the best way for utilities to solve this problem is to recover more revenue through fixed charges and compensate rooftop solar owners for their excess generation at the lower avoided cost rate instead of retail, as is typically done under net metering.

While this may make a pithy message for investors, as guidance for utilities the Fitch advice is dubious. It seems to say the only way utilities can remain financially viable, and hold onto their rock-solid credit ratings, is to limit the options of their customers, ramp up charges that don’t correlate with usage, and discount the value of power contributed to the grid by customers. Instead, we would suggest that there are better ways for utilities and their regulators to look at the impacts of distributed generation on the electric power system. Utilities are responsible for maintaining a reliable, affordable electricity system, but this should not include punishing their customers who are availing themselves of new options for meeting their energy needs. It would make more sense for Fitch to point utilities, and their investors, toward more forward-looking solutions that make rooftop solar customers (and customers who invest in other forms of distributed energy resources) their partners, instead of their adversaries.

First, let’s acknowledge the obvious: Rooftop solar cuts into utility revenue. That’s because it reduces the amount of electricity customers buy from the utility. Energy efficiency does the same thing, but nobody says we should stop making lighting, appliances, and machinery more efficient, or charging customers more for using more efficient devices, just because it deprives utilities of money they would make if our electricity use were more wasteful. Net energy metering (NEM) cuts into revenue more, because solar owners get credit for the electricity they export to the grid at the same rate they pay for power from the grid. Since those rates include not only the cost of electricity but the cost of maintaining the transmission and distribution network that gets the electricity to customers, utilities lose revenue coming and going (they lose that grid-support revenue from efficiency too, but only on reduced consumption, not generation.) So, under current ratemaking systems, there is a problem to be addressed. Where Fitch goes wrong is in suggesting that there’s only one way to fix rates - with higher fixed charges and reduced credits for solar-owning customers, who are not likely to take them lying down.

But Fitch’s is not the only way.

Broadly speaking, ratemaking goes like this: Regulators set rates for most customers by compiling all of a utility’s costs, undepreciated assets, and a rate of return for their investments into a “revenue requirement.” Regulators divide that revenue requirement across all of a utility’s expected sales (kWh) to set a rate. If the utility experiences an unexpected decrease in sales from net-metering or energy efficiency (or mild weather, for that matter), it can experience a revenue shortfall.

To compensate for this - especially the policy-driven shortfall coming from state energy efficiency requirements - many states employ what is called revenue “decoupling.” This is a process that automatically adjusts rates upward as sales decrease so that the utility receives the revenue it requires for maintaining the grid (decoupling can also adjust rates downward if harsh weather gives utilities bonus sales revenue not justified by costs).

The Brattle Group has found that revenue decoupling lowers risk to bondholders. Even Fitch has called decoupling “credit positive” in its own bond rating outlooks, such as this one on DTE. In a press release on the current report, Fitch makes a passing reference to decoupling, but does not acknowledge how much it could relieve a utility’s NEM-induced revenue crunch.

But the ratemaking adjustments needed to make distributed energy resources (DER) like rooftop solar and energy efficiency integral parts of a viable electric power system don’t stop with decoupling. The interplay between utilities and DER is more complicated - and more beneficial to customers - than Fitch suggests.

Fitch says that NEM customers avoid paying the “fixed” costs of maintaining the grid while non-participating customers have to pick up the tab through higher rates. This ignores the fact that many of the benefits of DER accrue to utility customers generally rather than the utility. For example, distributed renewables typically reduce load overall, which reduces prices in the wholesale market across the board and drives down energy costs for all customers. Energy efficiency does the same thing. DER can also avoid or defer future investments in distribution and transmission infrastructure, further reducing bills for all customers.  

So, while it is true that, under current rate designs, revenue collection does shift from net-metered customers to non-participating customers, that “revenue shift” does not necessarily equal a “cost shift.” A cost shift only occurs when the the extra revenue collected from non-participating customers due to net metering exceeds the value provided to non-participating customers.  Questions of value and cost shift to non-participating customers are valid discussions to have, but those discussions should not start with the conclusion that revenue collection shifted onto non-participating customers directly equals additional net costs to those customers. A fixed charge does rough justice, at best, in terms of cost recovery because it makes no attempt to account for value provided by a solar customer. Smarter rates attempt to value and compensate the benefits from solar and other forms of DER, which in turn will evolve to maximize the benefits they provide to the grid.

In our view, there is a future for utilities to coexist with growing adoption of DER like solar, energy efficiency, and (entering the scene) energy storage, and still maintain their AAA credit ratings, without sharply curtailing customer options.

In New York, where revenue decoupling is already in place, utilities and a number of solar companies proposed an option to the commission where solar developers would begin to pay a per-kWh fee for certain types of community and remote solar projects, which would decrease the amount of revenue shift that takes place between net-metered and non-participating customers. That proposal was filed in a proceeding specifically addressing the wide range of issues associated with net metering, in which New York is seeking to proactively develop successor tariffs that can more fairly and accurately value the benefits of DER. California has also recently adopted a policy that made net metered customers subject to charges that pay for public benefit programs, shouldering their public responsibility without diluting the benefits of their investment beyond recognition.

The process of truly integrating DER into an electric power system that works for all is not over; it has barely begun. Which is why Fitch’s analysis points the wrong direction, and its misguided solution for dealing with utility revenue lost from customers who avail themselves of DER is premature, at best. For the sake of an electric infrastructure needed by all customers - including those with a two-way relationship with the grid - the goal should be rates that move the U.S. toward a dynamic electric power system that takes full advantage of the advanced energy technologies that are now disrupting electricity markets, but will one day be the core.

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Topics: State Policy Update, Energy Finance


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