Utility 2.0: NY Utility Regulators Should Consider Change to “Formula for Success”

Source: Daniel Schwen, Wikimedia Commons

Source: Daniel Schwen, Wikimedia Commons

Acquire more customers, sell more electricity. This primary formula has fueled the runaway success of utility companies in America, as well as the rest of the world, for well over a hundred years.

But today, in an era when customers are technologically savvy, price conscious, and environmentally aware, more families are pursuing opportunities that will cut electricity bills and carbon emissions. Options once considered fringe, like installing rooftop solar panels and driving electric cars, are now becoming so mainstream that utilities everywhere are seeing their bottom lines crunched and even fear for their survival. The electricity sector needs a new formula that can account for these changes, while still providing reliable, safe, and affordable electricity for all.

As a result of increased energy efficiency and heavier reliance on local, distributed energy resources, it’s clear our country is moving toward a reality in which less electricity will come from centralized, fossil fuel power plants. At the same time, customers want utilities to continue providing basic electricity services while allowing them to benefit from new energy-efficient solutions and clean technologies in order to waste less electricity and generate our own power.

How will this be possible? A key first step is moving away from the existing regulatory paradigm, which rewards utilities for investing in more power stations and equipment, to a model that rewards utilities for the performance we seek today.

The New York Public Service Commission (Commission) recognizes that the traditional utility business model – which rewards utilities with investment returns – leaves little opportunity for utilities to innovate, stating in its “Reforming the Energy Vision” (REV) Staff Report: “Current ratemaking provides few incentives for utilities to innovate or to support third-party innovation, to address the current challenges in ways that promote a more efficient system and benefit consumers.”

Utilities will be evaluated on clean energy, customer engagement

In EDF’s recommendations to the Commission, we propose an enhanced version of performance-based regulation, or what we refer to as PBR+, that removes the link between utility earnings and their investments in infrastructure. With PBR+, a utility will be evaluated not just on how well it provides standard electricity service, but also on whether it delivers benefits to the customer and to the environment. Today, the Commission uses metrics such as reliability, safety, and quality of service to regulate utilities, all of which provide a strong foundation for evaluating performance and will still be used. But the Commission plans to establish new metrics that will also take into account the availability of clean energy solutions as well as how much flexibility a customer has to adopt them. It will be necessary for the Commission to establish these new performance metrics and also devise a standard method for evaluating a utility’s performance against them linked to the utility’s compensation.

In establishing these new metrics, the Commission must answer a number of questions, most notably: What outcomes does New York’s REV proceeding seek to achieve? From the start of the landmark proceeding, the state identified four categories of potential outcomes to come from the effort to reform the utility business model:

  1. Advanced clean energy,
  2. Customer engagement,
  3. Reliable and resilient system, and
  4. Operational efficiency.

Metrics might be applied differently

While the same metrics will apply to all utilities within New York State, they might be applied differently to utilities based on individual circumstances. Factors such as the number of homeowners versus renters, population density, and types of customers (e.g. industrial, commercial, residential) could influence the solutions utilities are able to pursue, allowing some utilities to perform better under certain metrics than others.

In defining these metrics, it will be important to understand what value customers will place on the outcomes, and some metrics may by their very nature be exceedingly difficult to accurately value. Three metrics that align with the state’s policy direction, as well as customers’ needs, are greenhouse gas emissions reductions, better resiliency, and improvements to customer service. Such metrics would help put New York on a pathway to achieve its goal of an 80% reduction in total carbon emissions by 2050.

Executed properly, a utility’s earnings would no longer be considered an entitlement, but would be based entirely on its performance according to the Commission’s new metrics. It is our belief that PBR+ is the best way to motivate utilities to achieve the outcomes New Yorkers desire, while still meeting today’s challenges.

 

Last month, EDF filed comments (Track 1 and Track 2) in New York State’s historic ‘Reforming the Energy Vision’ (REV) proceeding to re-evaluate the longstanding utility business model in light of a rapidly changing energy sector. We recommend: 1) transitioning from traditional rate of return regulation to performance-based regulation; 2) fully valuing all costs and benefits associated with distributed energy resources; 3) removing barriers to non-utility entities participating in energy service markets; and 4) requiring the utility to optimize the load it serves.

Over the coming weeks, we will devote a blog post to examining each of these recommendations in depth. This blog post, the first in the Utility 2.0 series, discusses the merits of performance-based regulation. 

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4 Comments

  1. Donovan Allen
    Posted August 21, 2014 at 8:15 am | Permalink

    Interesting perspective on how utilities should be compensated. without the ability to get a good return on investments made in equipment, how will utilities be encouraged to invest in newer, cleaner power plants? Could they obtain a proper rate of return on the reduction in greenhouse gases?

    • Rory Christian
      Posted August 22, 2014 at 10:56 am | Permalink

      Thank you for your comment. This is a very good question and one of the issues we sought to address with our recommendation to the New York Public Service Commission. Opportunities to obtain a rate of return could be achieved through performance based ratemaking when all the costs and benefits of distributed energy resources are fully valued. In fact, this is the recommendation we will examine in our next blog post in the series, scheduled to run on Monday, Aug. 25.

  2. Posted August 26, 2014 at 4:37 pm | Permalink

    An important perspective to consider is that the "regulated utility" is not the same as "utility shareholders." Shareholders are the true stakeholders in the discussion about the new utility business model. (Utility managers may hijack that role but that probably is not a sustainable position.) So we should be looking outside the box of standard regulatory tools, even PBRs (which don't have a great track record), and ask how else can utility shareholders see value from the electricity industry outside of their regulated utility affiliate? There are potential models for alternative approaches that might ease the political and economic transition to the new energy future.

    • Rory Christian
      Posted August 29, 2014 at 8:39 am | Permalink

      The needs of stakeholders are an important perspective to consider, which is why performance-based regulation needs to be properly designed from the start to avoid any problems that may have developed in past deployments. The role of distribution platform provider, as envisioned by the NYS PSC, is certainly outside the box. As we continue our series, you'll see how this new role can be an opportunity for regulated utilities (and as you've pointed out, utility shareholders) to benefit outside the standard regulatory tools.

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