The purpose of this report by The Brattle Group (“Brattle”) is to describe the research the authors have done on the effect, if any, on the cost of capital (“COC”) of ratemaking mechanisms that significantly relax the linkage between the collection of base revenue and the amount of kWh sales. The two ratemaking mechanisms we analyze are revenue decoupling and fixed-variable rates, which are alternatives to the standard ratemaking in general rate cases. The linkage comes particularly from the common use of volumetric rates ($ per kWh) for residential and small commercial customer classes that collect significant amounts of fixed costs in the volumetric charge. Revenue decoupling is separate from the somewhat similar trackers (using balancing accounts and riders) that true-up forecast to actual variable costs, like fuel and purchased power, EE program expenditures, and certain kinds of capital expenditures.
We have reviewed the relevant finance theory and conclude that the issue cannot be answered definitively on a theoretical basis. While there are theoretical arguments why adoption of linkage-relaxing ratemaking could decrease the COC, there are also valid theoretical reasons why it would not and could even be associated with an increase in the COC. An empirical test is required to answer the question of whether the COC is affected upon adoption of decoupling. To conduct the test, we develop a sample of fifteen electric holding companies with thirty-seven regulated subsidiaries that were central to the rapid growth in revenue decoupling in the U.S. during the period 2005 through 2015.