In the traditional model for establishing rates for customers of regulated electric and natural gas utilities, higher sales of energy lead to higher utility revenues (and, in turn, utility profits). This is a strong financial disincentive for utilities to engage in customer energy efficiency programs, since these programs reduce energy sales through improving efficiency. Reduction of energy sales reduces revenues and associated utility profits.
When state regulators introduce “decoupling,” they separate utilities’ sales from their revenues and profits. There are a number of regulatory mechanisms that achieve this result. A commonly used approach is to establish a "revenue per customer" formula and use periodic true-ups based on actual energy sales.
Although decoupling can neutralize the disincentive to support energy efficiency programs, it doesn’t create a financial incentive to save energy through investing in energy efficiency that is comparable to the financial incentives that exist for utilities to invest in capital assets such as new power plants and facilities. Consequently, states that wish to establish energy efficiency as a comparable alternative to supply-side investments also need to establish a performance reward mechanism that allows utilities to earn a positive return on their energy efficiency investments.