This document discusses rate design pathways for electricity providers to establish fair utility rates for solar PV customers in a distributed energy age. It proposes an integrated cost recovery approach for utilities based on three interrelated pricing approaches: 1) Allowing utilities to recover their minimum necessary customer-related fixed costs through a fixed charge. 2) Classifying utility costs as demand, energy, or customer-related and ensuring solar customers pay their fair share of these costs. 3) Considering utility rate cases like We Energies' proposal to increase fixed charges for solar customers cautiously to avoid over-recovery of costs or discouraging solar adoption.

1. Rate Design Pathways to Fair
Utility Rates for Solar PV in a
Distributed Energy Age
Technological innovation and declining costs in solar PV have
created irreversible momentum. A timely, clear-­‐‑eyed national
conversation concerning how electricity providers and consumers
alike may thrive in such an environment is essential.
By Jim Kennerly
Electricity Policy – the website ElectricityPolicy.com and the newsletter Electricity Daily –
together comprise an essential source of information about the forces driving change in the electric
power industry.

2. Technological innovation and declining costs in solar PV have
created irreversible momentum. A timely, clear-­‐‑eyed national
conversation concerning how electricity providers and consumers
alike may thrive in such an environment is essential.
1
Rate Design Pathways to Fair
Utility Rates for Solar PV in a
Distributed Energy Age
Page / December 2014
By Jim Kennerly
Introduction: The State of Play
After experiencing significant cost
declines over the past decade, 64% of the
cost of rooftop solar photovoltaics (PV) is
now associated not with the cost of the
physical system hardware, but with non-hardware
“soft” costs. Thus, high soft
costs constitute the major remaining
cluster of barriers to cost-effective
rooftop solar PV.
As PV has experienced dramatic cost
declines, however, electric utilities have
Jim Kennerly is the North Carolina
Clean Energy Technology Center's principal
energy policy researcher, and a lead analyst
for the Database of State Incentives for
Renewables and Efficiency (DSIRE) project.
He is the lead author of Rethinking Standby
and Fixed Cost Charges, a technical report
for the Department of Energy's SunShot
Initiative that formed the basis for this
article. He has previous experience as a
utility regulatory analyst with the North
Carolina Sustainable Energy Association.

3. 2
Page / December 2014
concurrently experienced persistent cost
pressure due to a sluggish economy,
offshoring of manufacturing, new
investments in their energy delivery
infrastructure, the increasing commodity
cost of coal and, to an increasing degree,
customer-initiated actions to save energy
and money. Some industry observers
have correctly noted that these factors, if
they persist and spread, could undermine
the basic structure and incentives built
into the regulated utility business model.
This is especially true if a large amount of
utility fixed costs are recovered through
variable “energy” rates.1
hus, regulated utilities in leading
solar PV markets are attempting to
re-evaluate their strategic
approaches. One way utilities have
shifted their strategy is by claiming that
customers’ installation of solar PV panels
to offset some of their energy demands
(and receive compensation through a
mechanism called net energy metering2
(NEM)) causes “cost shifts” that raise
1 P. Kind, Disruptive Challenges: Financial Implications
and Strategic Responses to a Changing Retail Electric
Business. Prepared by Energy Infrastructure
Advocates for the Edison Electric Institute,
January 2013. Available at:
http://www.eei.org/ourissues/finance/documents
/disruptivechallenges.pdf,
2 Net energy metering (NEM or “net metering”) is
the practice by which customers sell their excess
energy back to the utility at the retail rate at which
they pay for electricity from their utility. At the end
of the month, “net metering” customers pay a net
bill that represents the net amount they consumed
from the grid (or receive credit for the net
production of solar energy that exceeded their grid
electricity consumption).
prices for non-solar customers, and
thereby attempting to pay solar
customers less than the retail rate. In
response, solar advocates have argued that
solar provides more benefit than costs, by
partially offsetting peak loads and by
easing the burden of transmission and
distribution facilities. Thus, they argue,
solar owners should be paid more than
the utility’s retail rate for excess solar
energy they provide to the utility.
The dueling utility and solar industry
perspectives have one fundamental flaw in
common: both have long viewed solar PV
in isolation as the key driver of disruptive
change in the electric utility industry.
Thus, neither of these perspectives fully
captures the multi-layered, multi-faceted
fixed cost recovery challenge (driven by
multiple advanced energy technologies)
most utilities face in an age of
fundamental change.
This article describes an integrated cost
recovery approach for utilities, based on
three relatively simple and inter-related
regulated pricing approaches that would
allow them to prepare for a certain, but
radically different, future.
Understanding Utility Costs:
Precursors of Rate Design
Before diving into proposed solutions, it
is important to review the nature of
electric utility costs, and how they are
allocated.
T

4. 3
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Figure
1
Ratemaking for
regulated utilities, as
has been noted time
and again, typically
utilizes cost-of-service
approaches. A cost-of-
service approach
values what are known
as a utility’s
“embedded costs” of
providing service, and passes those costs
on through customer rates.3 These costs
include fixed costs, which do not vary
with usage, as well as variable costs, which
vary based on the quantity of electricity
produced and delivered. Utility costs are
determined to be fixed or variable based
on the results of a cost-of-service study.
head of the rate design process,
the cost-of-service study helps the
utility and its regulators to allocate
costs by:
• Assigning costs by specific functions
(e.g. electricity production,
transmission, distribution, other),
referred to as “cost functionalization”;
• Classifying those costs as demand-related
(intended to meet or reduce peak
demand), energy-related (intended to
meet total kilowatt-hour needs), or
customer-related (costs not varying in any
way with any usage or peak demand),
3 For more on the embedded cost model, see the
National Association of Regulatory Utility
Commissioners (NARUC) Electric Utility Cost
Allocation Manual, Jan. 1992, at 14.
a process referred to as “cost
classification”; and
• Determining which costs of service
are fixed and which are variable, and
allocating them to the different classes
of customers.
Figure 1 is a simplified illustration of this
three-step process.
Rate Design Principles for a
New Era: The New ‘Cost of
Service’
In an age in which a growing number of
customers are likely to supply a significant
portion of their demand- and energy-related
need for electricity with on-site
renewable generation, however, it is
necessary for the ratemaking paradigm to
make a distinct and calculated shift. The
shift utilities and their regulators must
negotiate effectively is toward
“unbundling” of various aspects of utility
service, and toward utility investments in
profit centers that are not dependent
upon sales growth (such as distributed
A

5. 4
Page / December 2014
energy resources and aforementioned
negawatts).4
The foundation of greater unbundling is a
utility’s ability to recover its most basic
customer-related fixed costs, and an
appropriate share of their demand and
energy-related costs, necessary for
providing total or supplementary service
to the large majority of their own
customers. These costs, frequently
estimated using the “minimum system
method,”5 include billing, metering,
customer care, and part of the
aboveground and underground
distribution system that, in essence,
cannot be avoided by customers who use
no net energy. These “minimum system”
customer-related costs can vary
significantly, but generally can be
observed at between $12-$25/month for
residential customers.6 A review of
residential tariffs shows that fixed
monthly charges that appear on a
customer’s bill are often merely a fraction
of these costs.
4 See Rocky Mountain Institute, Rate Design for the
Distribution Edge, 26 Aug. 2014, available at:
http://www.rmi.org/elab_rate_design
5 NARUC, Ibid.
6 See, e.g., Xcel Energy. Direct Testimony and
Schedules of Michael A. Peppin: Class Cost of Service
Study and Selected Rate Design. Before the North
Dakota Public Utilities Commission, 20
December 2010, and Rocky Mountain Power.
Exhibit Accompanying the Direct Testimony of Joelle
R. Steward: Calculation of Net Metering Facilities
Charge. Utah Public Service Commission
Docket No. 13-035-184.
enerally, however, utilities have
tended to favor requesting
permission to impose PV
G
capacity-based or per-customer standby or
fixed charges solely upon solar customers,
reasoning that solar customers fail to bear
their full share of these costs. In certain
more limited cases, where solar PV-specific
charges are prohibited by law
(California, for example), utilities may
choose to apply a fixed charge to all
customers.
There are three general problems with
fixed or “standby” charges, be they
applied to all customers, or merely to solar
customers.
1. Lack of Clarity Regarding Actual
Cost Recovery from Solar Customers.
With the exception of Arizona Public
Service, utilities attempting to apply such
charges generally have applied them by
claiming the need to recover all of their
“minimum system” customer-related costs
being shifted to other customers.7
However, a very cursory analysis suggests
that this approach brings with it a very
high risk of permitting utilities to enjoy a
significant over-recovery of customer-related
costs described above.
7 Examples include Arizona Public Service, We
Energies and Rocky Mountain Power.

6. 5
Page / December 2014
2. Highly Selective Utility Concern
Surrounding Cost Shifting. In addition,
utilities’ idea to apply fixed charges to
customers’ bills to address perceived
inequities betrays a selective approach to
addressing cost shifts. For example,
utilities frequently offer rate discount
programs to
industrial
customers and
the indigent, or
charge the same
rates to rural and
urban customers
in the same class
regardless of the cost of serving them.
Such policies shift substantial costs to
non-participating customers. Moreover,
Instead, they pay the average cost of
energy throughout the year. In California,
imposition of average-cost rates has been
estimated to create cost shifts from
customers with highly variable usage to
those with more consistent usage
estimated at some $400 million annually.8
verall, it is unclear why cost shifts
associated with PV must be
resolved immediately, while these
others can remain untouched.
8 A. Faruqui, Dynamic Pricing: The Bridge to a Smart
Energy Future, presented to the World Smart Grid
Forum (Berlin, DE), 25 Sept. 2013, at 20.
Available at:
http://www.brattle.com/system/publications/pdf
s/000/004/925/original/Dynamic_pricing_-
_the_bridge_to_a_smart_energy_future_Faruqui_
World_Smart_Grid_Forum_092513.pdf?13801186
95
3. Inaccurate Root Cause Analysis
Related to Revenue Under-Recovery.
Perhaps most importantly, focusing solely
on solar customers as the driver of future
declines in utility revenue expectations has
the effect of masking the fact that PV is
not even close to being the most
significant driver of
utility revenue and
fixed cost under-recovery.
For
example, the “base
case” of the US
Energy Information
Administration’s
2014 Annual Energy Outlook (which
assumes no development of future federal
appliance standards as required by law)
forecasts residential electricity usage per
household to decline 4% overall from
2012 to 2040.9 In addition, the
Sacramento Municipal Utility District
(SMUD) made this remarkable disclosure:
75% of its customers did not pay their full
share of fixed cost of service, even though
fewer than 2% of them had installed
rooftop solar PV.10
9 National Appliance Energy Conservation Act
(NAECA). Pub. L., No. 100-12, As Amended.
10 See U.S. Energy Information Administration
(EIA). EIA Form 826 and SMUD General Manager’s
Report on Rates and Service, Vols. 1 and 2, p. 15.
Available at:
https://www.smud.org/en/residential/customer-service/
rate-information/rates-2014-2017.htm
O
Customers
generally
do
not
pay
the
full,
true
cost
of
the
electricity
they
use,
especially
during
peak
or
critical-­‐peak
hours.

7. 6
Page / December 2014
Inherent Risks of Current Rate
Design Approaches for Solar PV
and Utilities
The utilities’ focus on solar PV and NEM
in relation to the future viability of the
utility business model is understandable.
Like any emerging technology with great
disruptive potential, PV draws a great deal
of attention. What’s more, the pairing of
highly modular PV installations with cost-effective
energy storage, when it becomes
available in customer-sized modules,
could lead to increasing “grid defection”
and a growing preponderance of stranded
utility assets.11
If these trends persist, they are quite likely
to undermine the very foundation of the
regulated utility business model. If
utilities continue to press for 100%
recovery of all of their fixed costs,
emerging PV and storage pairings could
cause commercial customers with higher
demand charges to consider partially or
totally exiting the grid, leaving the utility
more dependent upon low load factor
customers, further complicating efforts to
spread fixed costs across its customer
base. Higher rates of grid exit could
accelerate declines in investor confidence,
lead to higher fixed charges and further
heighten customer interest in severing its
relationship with the utility. This is the
dreaded, but perhaps over-hyped, utility
“death spiral.”
11 Rocky Mountain Institute, The Economics of
Grid Defection, Feb. 2014. Available at:
http://www.rmi.org/electricity_grid_defection
Unduly discriminatory charges could also
negatively impact the steady pace of solar
PV cost reduction goals important to
national and regional policy makers. The
US Department of Energy’s SunShot
Initiative, which funded initial research in
into how to reduce solar PV costs, has
initiated efforts to target and reduce non-hardware
“soft” costs. These efforts could
be undone by standby and fixed cost
charges that over-recover customer-related
costs from residential customers.
ronically, utility attempts to cry
“subsidy” could end up backfiring on
future utility plans to own solar PV.
Indeed, utility action to limit payments for
excess generation or apply added fees and
charges to customers on net metering
tariffs could have the effect of delaying the
date by which rooftop PV technology no
longer requires ratepayer and taxpayer
incentives, and thus can be a “least-cost”
investment target for a regulated utility.
For example, Arizona Public Service is
only able to consider owning customer-sited
solar PV (and gaining a toehold in
Arizona’s PV market) because of the
existence of the Arizona’s Renewable
Energy Standard (RES), which allows for
ratepayer recovery of solar PV costs that
exceeds the utility’s PURPA avoided
cost.12
12 Ryan Randazzo, “APS Plan to Offer Free Solar
Faces Critics,” Arizona Republic, 25 Aug. 2014.
Available at:
http://www.azcentral.com/story/money/business
/2014/08/25/aps-plan-offer-free-solar-faces-critics/
14578719/
I

8. 7
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Clearly, both utilities and the solar
industry have a deeply vested interest in
PV soft cost reduction.
Case Study: We Energies
(Wisconsin) 2014 Rate Request
An outstanding example of the problems
with standby and fixed cost charges can
be seen in We Energies’ recently approved
request to add both across-the-board (as
well as solar-specific) fixed charges, which
was recently approved by the Wisconsin
Public Service Commission. We Energies
framed its request to change its net
metering policy, saying that solar PV
customers are paying an insufficient
amount to cover its most basic
infrastructure costs, including those the
utility would incur if the customer used no
net energy.
Thus, We Energies requested recovery of:
§ 100% of its “customer-related” costs
(as described above) through a fixed
charge on all customers (non-solar
and solar alike);
§ A new solar-specific standby “demand
charge” to recover the costs of
supplying solar customers with
standby energy.
Table 1 of page 6 compares the
components of the rates a solar customer
would pay under current rates and the We
Energies proposal.
As justification for these charges, We
Energies’ lead rate case witness explicitly
suggested in pre-filed rebuttal testimony
that across the board, solar PV customers
were not paying their “customer-related”
costs, nor their share of the cost of
“standby” energy, which We Energies
asserts is the cost it must recover from
them.13
owever, it is possible to evaluate
We Energies’ claim by modeling
the bills a customer in Milwaukee
H
would pay using the National Renewable
Energy Laboratory’s System Advisor
Model (SAM). These monthly bills with
solar can be compared to the amount We
Energies claims to require, which is the
total of customer-related charges plus the
solar-specific demand charge. Table 2,
13 We Energies. Direct and Rebuttal Testimony of Eric
A. Rogers. Joint Application of Wisconsin Electric
Power Company and Wisconsin Gas LLC, both
d/b/a We Energies, to Conduct a Biennial Review
of Costs and Rates – Test Year 2015 Rates. Before
the Wisconsin Public Service Commission, Docket
No. 05-UR-107.

9. 8
Page / December 2014
below, represents the results of the SAM
simulation for PV systems of 3 kW, 4 kW,
5 kW and 6 kW in size, installed on an
average-sized residential home in
Milwaukee with an average level of
simulated electricity usage.
Thus, these simulated solar PV customers
at several of the most common system
sizes actually paid, on average, between
$8-$55 more than We Energies claims is
needed to meet bare minimum revenue
requirements for those customers.14
Moving Beyond Risks for Utilities &
for Solar PV Cost Reductions:
Towards a ‘Softer’ Ratemaking Path
It is important for utilities and regulators
to consider carefully a broader, softer,
more holistic strategy for recovering their
fixed customer-related costs, as well as an
appropriate share of the demand-related
14 The model runs that produced this result utilized
simulated system load data from Milwaukee,
Wisconsin, at varying system sizes, and utilizing
above-stated We Energies current and proposed
rates. The System Advisor Model (SAM) is a
publicly available model available at:
http://sam.nrel.gov
and energy-related costs that utilities incur
to serve customers with on-site
generation.
well-designed and equitable
strategy to do so should include:
(1) revenue decoupling, in order
A
to ensure utilities can recover an
appropriate degree of revenue regardless
of sales, (2) a minimum monthly
contribution (or “minimum bill”) all
customers must pay to ensure that utilities
collect the minimum required to serve all
customers, regardless of energy use and
(3) time-differentiated rates to ensure that
solar and non-solar customers pay the true
cost of their electricity, whenever they
might need it.
Implementing these three components
will provide utilities with sufficient tools
to recover their costs in an era of more
distributed generation, and serve as an
equitable substitute for standby and fixed
cost charges on solar PV.

10. 9
Page / December 2014
Figure
2
1. Revenue Decoupling. Recently, the
investment branch of Barclays Bank
advised its clients to reduce their exposure
to securities underwritten by electric
utilities with regulated operations. Indeed,
due to a variety of factors unrelated to
solar PV, Scott Madden & SNL Financial
have found (as illustrated in Figure 2)
that more and more utilities have begun to
under-earn their regulated rates of
return.15
hus, more utilities (and those who
regulate them) have decoupled
their revenues from their sales.
Notably, Consolidated Edison of New
York (ConEd) recently saw an upgrade in
its bond ratings due to adopting
decoupling in the wake of Superstorm
15 Scott Madden, Innovative Ratemaking: Multi-Year
Rate Plans, Feb. 2014. Available at:
http://www.scottmadden.com/insight/683/innov
ative-ratemaking-multiyear-rate-plans.html
Sandy.16 Unlike solar PV-specific
rates and charges,
decoupling mechanisms
assess all utility customers
an added charge—fixed
or volumetric—if the
utility does not recover a
regulator-approved share
of revenue during the
year, or a refund to
customers, with interest,
if it exceeds that revenue
recovery.
Given that, as described
above, residential customers are likely to
use less energy per customer in the future,
decoupling honors the ratemaking
principles of fairness in lost fixed cost
recovery, while also reducing a utility’s
incentive to increase sales. By
implementing it, a utility recognizes that
innovative, behind-the-meter energy-saving
approaches like solar PV (or,
simply, run-of-the-mill energy
conservation approaches) are becoming
more common across its customer base
and are facilitating considerable utility
avoided costs that benefit all customers.
2. Establishing Minimum
Bills/”Minimum Monthly
Contributions” for Low and Lowest-
Usage Customers. However, adopting a
16 Moody’s Investor Service. “Moody’s Changes
Consolidated Edison’s Outlook to Positive”. 30
July 2013. Available at:
https://www.moodys.com/research/Moodys-changes-
Consolidated-Edisons-outlook-to-positive--
PR_278150
T

11. 10
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decoupling approach makes it absolutely
crucial for a utility to adjust what are
known as “minimum bills” or “minimum
monthly contributions,” but only for
customers that use zero net energy, given
that these customers frequently do not
even pay the bare minimum fixed cost
contribution per month. A minimum bill,
which is currently being contemplated in
Massachusetts as a long-term approach to
the Commonwealth’s net metering
program, is assessed on all customers, but
functionally impacts only zero net energy
customers. Indeed, as Figure 3 shows,
using the same $8/month and $0.13/kWh
rates as above, minimum bills ensure that
customers neither over-compensate
utilities for their customer-related costs,
nor impose rate increases, except for
customers that offset 95% of their usage
or more with solar.
Indeed, the minimum bill approach makes
a great deal of sense as a way to ensure
that the decoupling surcharge has
sufficient teeth when dealing with
customers with low (or no) electricity
usage, especially since many revenue
decoupling bill adjustments are assessed
on a per kWh basis.
3. Default Time-Differentiated Rates.
Another approach that can limit
potentially unfair and discriminatory
charges for solar PV customers is a
phased-in or “default” time-of-use pricing

12. 11
Page / December 2014
strategy. Today’s average hourly rates
result in cost shifting from customers who
use energy disproportionately on-peak to
those who use it more regularly. Well-designed
time-differentiated rates would
more accurately reflect the true marginal
costs of supplying all customers. Indeed,
time-differentiated rates could help to
ensure that customers with solar PV
would pay a price closer to the true cost
of the energy they use during periods in
which they experience a need for grid
energy. This is especially true during high-cost
daily system peaks, which can occur
when solar PV output is decreasing in late
afternoon or early evening. In this way,
time-differentiated rates can functionally
substitute for standby or fixed cost
charges without overcompensating the
utility.
Looking Ahead to a Distributed
Energy Future: The Point at
Which ‘If’ Becomes ‘When’
Customer-sited solar PV projects will
continue to be integrated into the grid
nation-wide at increasing rates for the
foreseeable future. However, anticipating
a future energy market with customers
who feel strongly about establishing a
greater degree of control over their own
energy costs and supplies, it is vital for
utilities, their regulators and other key
stakeholders in the solar PV market to
engage in a broader and more candid
conversation regarding their business
models than they have done thus far.
ome stakeholders may believe that
rapid expansion of advanced
customer-sited energy technologies
S
are only temporary, and that the
traditional regulatory system can survive
while avoiding reform. However, the
trend of increasing technological
innovation and declining costs in solar PV
have created irreversible momentum,
rendering the question of whether such
technologies will become commonplace as
irrelevant. A clear-headed national
conversation concerning how electric
energy providers and consumers alike may
thrive in such an environment is one that
cannot be postponed.
Time-­‐differentiated
rates
could
help
ensure
that
customers
with
solar
PV
pay
a
price
closer
to
the
true
cost
of
the
energy
they
use
during
peak
periods.