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September 08, 2015
Brattle Economists Co-Author Article on Decoupling for The Electricity Journal

Brattle principals Michael Vilbert and Joseph Wharton recently co-authored an article on decoupling in August/September 2015 issue of The Electricity Journal. Decoupling is a set of important regulatory policies for ratemaking that “disconnects” dollar revenues for collecting fixed costs from kWh sales. In situations where it is appropriate, decoupling enables utilities to pursue energy efficiency more aggressively and to avoid serial rate cases as revenues falls with declining sales.

The article, “Decoupling and the Cost of Capital,” addresses the debate over the effect of decoupling on the cost of capital. The authors look behind what they agree is a clear stabilizing effect of decoupling on revenues alone. They empirically investigate whether decoupling results in lower systematic risk and thus a measurable decrease in the cost of capital.

Although there is no empirical evidence provided for the assumption that reduced revenue volatility is related to systematic risk, a minority of regulatory decisions over the past 10 years have reduced the companies’ allowed returns on equity in conjunction with approving decoupling. The issue is raised in every proceeding on decoupling. Unjustifiably reducing the allowed return on equity is likely to have a dampening effect on the expansion of this policy.

Drs. Vilbert and Wharton assemble a detailed 10 year database of the market returns of 14 utility holding companies and a corresponding index to measure the precise level of decoupling within those companies. The authors find that statistical evidence does not support the hypothesis that the adoption of decoupling results in a statistically significant reduction in the cost of capital.

To view the full article, please click here.