Hawaiian Electric Co. is hoping to convince its customers that an overhaul of the way electrical rates are set for most Hawaii households and businesses will bring benefits that outweigh any potential short-term increase in their bills.

Following the lead of about a dozen other states HECO and the Public Utilities Commission are implementing a new rate-setting mechanism designed to encourage the development of renewable energy and energy conservation by eliminating the economic incentive on the part of the utility to sell more electricity.

Often referred to as "decoupling," the scheme essentially guarantees utilities enough revenue to cover their fixed costs if their electricity sales decline. Having to pay fixed costs, such as capital improvements, while revenues are declining can put a strain on a utility’s finances. Proponents say that by decoupling sales from earnings a utility is free to pursue alternative energy sources or increased efficiency without worrying about hurting its bottom line.

Decoupling, which was pioneered by California in the early 1980s, has gathered steam in recent years as more states have embraced alternative energy sources.

The concept is not without its critics, however, including one member of the Hawaii Public Utilities Commission who voted against the proposal saying it would result in higher electricity rates and would not produce the benefits that warrant "such a transformational change" in the current regulatory structure.

The PUC itself acknowledged that the new revenue adjustment mechanism at the heart of the decoupling initiative "will put upward pressure on rates."

On balance, though, the commission determined that the possible short-term rate increase will be outweighed by a reduction in the frequency of rate cases, "the costs of which are borne by ratepayers." Under the old system, HECO had to apply for a rate increase every few years.

The new system should also improve HECO’s access to capital and accelerate the state’s transition to clean energy, the PUC said last month in approving the decoupling plan.

HECO and its sister companies on Maui and the Big Island are assembling a multi-pronged campaign to prepare customers for the change, which could take effect as soon as next year. HECO currently has two rate cases pending on Oahu, two at Hawaii Electric Light Co. on the Big Island and one at Maui Electric Co.

"We are working on a plan with the state Consumer Advocate to help explain the new ratemaking method to customers, including steps for training customer service reps, bill inserts, website explanations, briefings and many other steps," said Lynne Unemori, HECO’s vice president for corporate relations.

"We know that decoupling is a very complex regulatory methodology and that most customers are less interested in the mechanics and really just want to understand how this will impact their bills and what the benefit of the change is," she said.

In Idaho, officials at the state’s major electrical utility said preparing their customers for a decoupling pilot program launched in 2007 was a top priority.

"The subject of decoupling is one of the more complex we’ve had to deal with in talking to the public," said Ric Gale, Idaho Power’s senior vice president for corporate responsibility. Gale also was the utility’s vice present of regulatory affairs for 19 years and oversaw the launch of it decoupling project.

One of the biggest challenges was explaining to customers that although the utility would be compensated for lost revenue when electricity consumption fell, individual rate payers could still lower their bills by reducing electricity usage. Idaho Power uses a tiered rate scale that charges customers more per kilowatt hour as their electricity usage goes up. HECO is planning a similar system, Unemori said.

The revenue adjustment mechanism around which the decoupling program is built ensures that HECO is able to collect the amount of money needed to recover its fixed costs, notwithstanding the effect on revenues from alternative energy programs or conservation efforts.

Differences between what the PUC authorizes in allowable revenues and HECO’s actual revenues will be tracked in a "revenue balancing account." The authorized revenues will be adjusted annually to reflect changes in HECO’s capital expenditures, its costs of capital and interest rates, and inflation.

Under- or over-collection of revenues will be recovered or refunded.

In the case of Idaho Power, the utility overshot its revenue target in 2008, the first year of the program, and its nearly 500,000 customers shared in a $2.4 million refund. In 2009 increased energy efficiency resulted in Idaho Power having to collect an additional $6.3 million from customers in excess of its revenue target.

Although the three-year pilot program was deemed a success by the Idaho Public Utilities Commission, the agency this year declined to make it permanent, instead opting to extend its pilot status for an other two years.

"There is no doubt the utility has ramped up its conservation efforts, both with energy efficiency and demand-side management. The reason the PUC is continuing it as pilot is that there were a lot of questions as to whether people were saving because of the weak economy or weather-related reasons," said Gene Fadness, assistant to the commissioner for the Idaho PUC.

The three-member Hawaii PUC approved HECO’s decoupling plant by a vote of 2-1 last month. In his dissent, Commissioner Leslie Kondo said the plan unfairly shifted HECO’s business and economic risks to its customers.

"That transformational change in the current regulatory framework will guarantee the HECO companies increased revenue and profits, will guarantee higher customer bills, and will essentially make the HECO companies recession proof," he wrote.

One of the critics of decoupling on the national level is Robert Michaels, professor of economics at California State University, and a Senior Fellow at the Institute for Energy Research.

Michaels said there are ways to achieve the same results with market-based approaches, rather than having regulators step in. By giving utilities an implicit guarantee for revenues regulators are removing the incentive for them to monitor their costs, he said.

"You don’t want utilities to have a guaranteed revenue stream unless they can prove they can do it prudently," Michaels said.

By eliminating more downside risk the government is rewarding shareholders and leaving consumers with even higher electricity bills, he said.