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March 08, 2011
Rate Decoupling Does Not Lower Cost of Capital According to Empirical Study by Brattle Economists

As revenue decoupling continues to grow in importance with the implementation of enhanced energy efficiency programs, utility management and commission staff will increasingly need to address the extent to which decoupling affects business risk and a utility’s cost of capital. Economists at The Brattle Group released a discussion paper today with the results from an empirical investigation that tests the hypothesis that decoupling lowers the cost of capital. The authors examined a sample of exchange-traded companies in the natural gas distribution sector for which estimates of the cost of capital were available during the five-year study period (October 2005 to June 2010). For these holding companies, the authors examined each of their regulated gas local distribution companies (LDC) subsidiaries and identified whether and when each LDC had decoupled versus traditional volumetric rates. They then compared the estimated cost of capital across two mutually exclusive groups: regulated utilities with all or a large share of revenues collected under decoupled ratemaking versus regulated utilities with all or a large share of traditional volumetric rates. Their findings do not support the position that the cost of capital is reduced by the adoption of decoupling. To the contrary, they found that the estimated cost of capital for decoupled utilities was higher by a small but statistically significant amount. If decoupling decreases the cost of capital, the statistical tests they performed strongly suggest that the effect must be minimal because it is not detectable statistically. The discussion paper, “The Impact of Decoupling on the Cost of Capital: An Empirical Investigation,” was authored by Brattle economists Joseph Wharton, Michael Vilbert, Richard Goldberg, and Toby Brown.