Originally published on RMI Outlet.
By David Labrador
The electric industry is evolving. New technologies are available to make the system more reliable and less costly, improve service quality, and lower carbon emissions. New customer programs, utility business models, and regulations are under development across the U.S. and internationally to harness those technical capabilities and position the industry to achieve higher qualities of service as well as public policy goals.
New York and Minnesota are recognized leaders in reforming the traditional utility business model, but they are not the only states thinking about change. Colorado took up the issue this past spring when the state legislature considered a bill to move towards performance-based regulation (PBR) of investor-owned utilities (IOUs). Though the bill did not make it to a full House vote in the 2015 session, which ended in May, it adds to a gathering momentum around the country to move towards new models for electricity markets, including PBR-based systems.
The Colorado bill, HB 15-1250, directed the state’s Public Utilities Commission (PUC) to “explore alternative utility revenue models,” including rates based on such things as efficiency, resilience, carbon emissions, and customer satisfaction. This was a way to begin “looking at 21st century regulation instead of 20th century regulation for power companies,” says State Representative Max Tyler, who introduced the bill in the Colorado House. “We want to reward utilities for doing the right thing, such as having good reliability, reducing pollution, and giving consumers options—things that don’t fit the old model as much,” says State Senator Matt Jones, who sponsored the bill in the Colorado Senate.
The bottom line for Jones is that the 100-year-old business model that governs America’s regulated, investor-owned utilities “does not necessarily take into account other goals that our society would want.” The current model is simple, he says: “You build plants, you sell electricity, and you take a cut of the costs, and that does not necessarily reward conserving and efficiency, for instance.”
“The electricity industry is based on building stuff, getting a rate of return, and then setting rates to cover that rate of return,” explains Tyler. “It’s not easy to get a rate of return for not building something,” even when not building is what’s best for all stakeholders. “There’s very little benefit to the power companies to save electricity,” says Tyler. “The companies need to get paid for that. How that works is tough and we have to be creative, and that’s where PBR comes in.” The challenge is to remake a utility business model that is inefficient: “It might cost 10 or 15 cents per kilowatt-hour to build a natural gas plant; it costs two-and-a-half cents per kilowatt-hour to do serious, utility-scale energy efficiency projects,” Tyler says.
The Next Step in an Evolution
Under performance-based regulation, utilities—and the investors that own them—are rewarded for achieving goals, such as cutting electric use, that they may not otherwise be incented to pursue. With PBR, measurable benchmarks are set for things like carbon emissions, reliability, customer satisfaction, and integrating distributed resources. Progress is regularly measured and reported to regulators, while the utility’s allowed rate of return is based, in part, on performance, not cost. Each PBR scheme is different, but in general, the idea is to compensate utilities for meeting targets, penalize the utility for missing them, and provide rewards for exceeding them.
Today, Colorado reduces the impact of falling demand caused by energy efficiency and distributed generation, such as rooftop solar, from eroding utility revenue by partially decoupling the rates utilities may charge from their costs. For example, if energy efficiency leads to lost kWh sales, a utility can ask the PUC to adjust its rates to make up the shortfall (in what Colorado calls a general rate schedule adjustment, or GRSA). Utility revenues are still based on an authorized rate of return, with adjustments. PBR, in contrast, ties a portion of returns to utility performance on identified policy goals.
The PBR concept has been around for decades, but adoption has been slow. Incremental elements have been applied in a number of jurisdictions, including California, Illinois, and New York, but for the most comprehensive example of PBR in practice we have to look overseas. Since 2013, Great Britain has operated a system called Revenue = Incentives + Innovation + Outputs (RIIO), which adopts a number of reforms to British electricity regulations, including a focus on efficient investments and environmental objectives. PBR in the U.S. could similarly achieve critical industry and policy goals.
“Actors in several states have started to embrace PBR,” says Dan Cross-Call, a senior associate with RMI’s electricity practice. These states include Minnesota, with its e21 initiative, and New York, with its Reforming the Energy Vision (REV) proceeding. “There’s a spectrum with reform,” Cross-Call explains. “There are things like pricing that can be done immediately, and then there are elements that are more ambitious.” PBR provides a toolkit of solutions that can be applied across that spectrum, from incremental ratemaking updates to more sweeping reforms. These issues are discussed in detail in a number of recent reports, including a report by Synapse Energy Economics, and RMI’s eLab report New Business Models for the Distribution Edge.
A Bridge to the Future
A lot of evolution can also happen without wholesale introduction of PBR processes in the style of RIIO, or rather with changes to existing regulations within the existing electricity business model. Regulators could provide space for this kind of experimentation by, for instance, allowing a utility to experiment with a deregulated arm, or to provide distributed generation to low-income customers, where the market is inactive. This is not the approach put forward in the Colorado bill, which calls for an investigation of alternatives to the basic utility-revenue model in the state.
As PBR and other regulatory reform programs are considered, a key question to grapple with is whether these efforts should originate from state legislatures, the executive branch, regulatory agencies, or elsewhere. The Colorado PUC, which the Colorado bill proposed would take the lead on the PBR study, opposed the bill, partly on the grounds that it is already making some of these changes. “The commission doesn’t see a need for legislation to mandate consideration of performance-based legislation,” says Eugene Camp, chief of the PUC’s energy section, “since it’s something that we routinely do at the commission today.” In his testimony against the bill, Camp stated that the PUC recently approved “incentives for meeting and exceeding demand-side management goals… incentives for completing large capital projects below budgets… and plans which provide compensation to customers receiving poor quality of service,” all elements of PBR.
For the bill’s sponsors, however, the PUC’s incremental changes within current law are not enough. “Right now there is some limited direction from the statutes,” says Senator Jones, “but it’s more on a single-issue or pilot-process level.” The legislators would like the PUC to move beyond considering individual regulatory schemes and rate designs and undertake the comprehensive study of PBR called for in their bill, a process that Camp estimates would cost roughly $250,000. “What the bill does is direct the public utility commission in Colorado to explore these options,” says Senator Jones, “and see what makes sense for Colorado.”
Wherever it originates, electricity reform requires buy-in and support from many actors. “Stakeholders can collaborate to develop shared objectives and criteria for an electricity future they can work towards collectively,” says Cross-Call, whether that’s within a regulatory proceeding, as envisioned in the Colorado bill, or without one. In either case, the resulting set of criteria for a new business model must ultimately be codified by a regulator or a legislature, but that’s not always going to be the best forum for evolving a new system.
For Rep. Tyler, who was aware of strong opposition to the bill, a big motivation for introducing it was “to be able to talk about it and get more people understanding the concept.” Now that public debate on PBR has started, “I think there’s momentum. I’m looking forward to some productive conversations with Xcel this year,” he says of the state’s major IOU. “There are some possibilities of finding another way of doing this than through the PUC.” In other states, the kind of collaborative conversations that RMI supports have taken place outside of regulatory forums while including the regulators along with other stakeholders. “I’d like to explore that,” Tyler says. Such dialogue is probably inevitable, wherever it may happen. “There are a lot of pressures to change how utilities are regulated,” says Jones, “and we’re going to keep working to bring that system into the 21st century.”
The bottom line: “Change is on the horizon,” says Tyler, “and the sooner we ask the PUC and all of the stakeholders and utility companies to sit down and take a longer view, the more certain we are to have good outcomes for consumers, and maintain the resiliency and reliability of our grid, and still maintain the profitability of utilities.”
Image courtesy of Shutterstock.
Reprinted with permission.
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