Business Models: What utilities can learn from Amazon and Netflix about the future of ratemaking
Electricity rates will include time and performance factors, unless subscriptions take over.
Editor's Note: This article is part of a series on the key issues driving the utility sector today. All stories in this series can be found here.
The future of electricity ratemaking will give individual customers more control of their own utility bills. Maybe much more.
Policymakers are already designing and deploying time- and location-based price signals to customers to guide usage. More ambitious plans would incentivize utility performance that meets customer demand. But a cutting-edge proposal offers a complete paradigm shift: Based on communications and entertainment industry subscription packages, it would offer customers subscriptions for electricity services.
The idea of electricity subscriptions elicits mixed reactions. Jim Lazar, senior advisor for the Regulatory Assistance Project (RAP), questions it because it bypasses regulators' ability to impose the pricing discipline of competitive markets. But it "takes seriously the idea of electricity as a service and gets the economics of the value proposition right," according to Purdue University Associate Professor of Economics and rate design authority Lynne Kiesling.
"As technology evolves, we will learn what customers will do, embrace, tolerate and eschew," Lazar told Utility Dive. "As the green power revolution unfolds, we'll need a lot of rate design innovation."
For more than a century, a customer's only choice was buying power from utility power plants at a price determined by regulators. Distributed energy resources (DERs) are undermining that business model.
DERs, including customer-sited solar, battery storage, electric vehicle chargers and smart energy efficiency improvements, put power in customers’ hands. But, because they also put power out of utilities’ control, DERs are seen as a threat by some to utilities’ safety and reliability standards.
"[S]urveys show customers tend to only look at the monthly bottom line of their bill so a subscription rate will feel natural."
Tension has developed between customers demanding DERs and utilities protecting their standards. Rate design that aligns utility focus and customer demand would dissipate that tension by allowing both new technologies and utilities to flourish.
Policymakers are already introducing rates that value specific DER time and location attributes that benefit both utilities and customers. A performance-based rethinking of regulation would more precisely align utility incentives with customer demand.
But the Energy Service Subscription Plan could shift the paradigm much further, according to Navigant Director and rate design innovator Lon Huber. Working with Tucson Electric Power, he has drawn on the successes of e-commerce giants like Netflix and Amazon, with its Prime membership, to propose allowing customers to choose between fixed monthly prices for varying levels of utility-provided products and services.
Customer charges versus rates for time and place
DER growth has accelerated the post-financial crisis flattening of electricity sales. In response, many utilities asked regulators for higher fixed residential customer charges that deliver revenues regardless of per-kWh consumption, according to Autumn Proudlove, manager of policy research for the North Carolina Clean Energy Technology Center (NCCETC).
In 2017, there were 84 pending or decided utility proposals for higher customer charges, though only 6 were fully approved, Proudlove recently told Utility Dive. In the first half of 2018, there were 51 utility proposals. Of 24 decided, only two utilities got the full increase. These rejected utility proposals for customer charges suggest regulators expect "something better," Proudlove said.
Rates based on DER time and location attributes could be the 'something better.'
New technologies tend to be more valuable if they serve when or where the system needs them. In many states, policymakers are working to design price signals into rates that reward developers and customers for adding resources with useful time and location attributes.
So far, "almost no utilities have locational values," RAP's Lazar reported. Utilities and DER advocates in California’s locational net benefit analysis working group found the state’s planned tool to value resources for delivering services where they are needed is "not yet ready" and "needs refinements," according to the group’s final report to state regulators.
"The longer-term goal is a locational net benefit analysis tool that can be used to more proactively identify locational value of DER," Marc Monbouquette, senior regulatory analyst for the California Public Utilities Commission (CPUC), told Utility Dive.
Rates that value when resources deliver their services are proliferating. According to a Brattle Group study, about half of U.S. investor-owned utilities and 14% of all utilities have a time-of-use (TOU) rate through which customers pay more per-kWh when demand is high. Most are voluntary, chosen by customers who see an opportunity to lower their bills by shifting their usage to off-peak times. On average, 3% of customers opt-in, though 51% of Arizona Public Service (APS) customers have done so.
"Energy as a service and subscription models are also relevant in states with retail competition, and they provide potentially attractive business models for retailers looking to differentiate themselves."
Associate Professor of Economics, Purdue University
The suite of APS optional TOU rates is "arguably the most advanced in the industry," Director for Rates and Rate Strategy Leland Snook emailed Utility Dive. "Customers have a choice of three TOU service plan options with a demand, or peak-use, component, and a fourth TOU option without demand."
An Xcel Energy TOU rate pilot is one of the first "opt-out" plans that has won wide praise from rate design experts. It was designed to find out if price signals can get customers to shift their energy usage away from the utility’s peak demand period, VP of Rates and Regulatory Affairs Aakash Chandarana told Utility Dive. It is also expected to drive greater use of renewables and deliver customer cost savings over time.
The two-year pilot will launch in 2020 with three price tiers. A four times higher-priced on-peak period will be from 3pm to 8pm, the lower-priced off-peak periods will be from 6am to 3pm and 8pm to 11:59pm, and a very low-priced super off-peak period will be from midnight to 6am.
"Substantial" tools and education, considered "critical" to knowing how to respond to the price signals in the new rates, will be provided for 10,000 customers, Chandarana said. Customer protections to prevent fears of change were built into the rate to limit opt-outs.
Xcel’s TOU rate "is promising and applies many good design elements," Rocky Mountain Institute rate design authority Dan Cross-Call emailed Utility Dive. It was largely designed by Navigant Director Lon Huber, who told Utility Dive the 4:1 price differential and five-hour peak period will shift usage away from peak demand and toward times when more renewables are in the utility’s power mix.
Xcel expects a 15% reduction in its system peak demand from the rate. The pilot is the utility’s first step toward the "next wave of rate design," Chandarana said.
A newer, less-tested type of ratemaking is starting to get attention.
COSR allows regulated utilities to meet their revenue requirement, which is their cost of delivering electricity, by collecting rates that include per-kWh customer charges. The cost of infrastructure investments and a regulator-approved percentage above their cost, as a shareholder return, goes into the rate calculation.
In its most rigorous form, PBR eliminates COSR’s reward to utilities for making investments, Lazar said. Instead, utility profits are from regulator-approved performance incentive mechanisms paid to the utility for accomplishing policy objectives. But PBR is evolving, and some state regulators are using it as an "overlay" on COSR, he added. Minnesota stakeholders recently chose that direction.
A group of utilities and environmental and consumer advocates — led by Minnesota’s e21 Initiative — concluded that PBR raises challenging questions about performance goals and metrics, The wrong solutions could result in unintended consequences, like perverse incentives that discourage desired policy outcomes, and innovative alternatives within the COSR paradigm would likely be more effective in the near term, they decided.
The Minnesota PBR proposals, which stakeholders say have been uniquely well-developed through the e21 process, now await a full regulatory proceeding at the state utilities commission.
But "all regulation is incentive regulation" and the only difference is how incentives guide utility behavior, Lazar wrote in a RAP paper on PBR. COSR rewards capital investment while all versions of PBR provide incentives that "guide behavior in the desired direction."
This past spring, Hawaii regulators ordered a proceeding to "investigate" PBR-related "economic and policy issues." Separately, the Hawaii legislature’s SB 2939, enacted in April, called for a move to a "performance-based" utility business and regulatory model "for the twenty-first century." Both acknowledged the influence of a prior commission's landmark 2014 "Inclinations" white paper that called for guiding utilities toward a "customer-focused business strategy."
"The future is not going to look like the past," Sonia Aggarwal, VP for clean energy think tank Energy Innovation, told Utility Dive. PBR is forward looking because it begins by identifying what customers want and uses a stakeholder-based regulatory forum to create opportunities for utilities to earn money by meeting those demands, she said.
In addition to Hawaii and Minnesota, utilities and policymakers in eleven states are working on PBR.
Utility Dive’s 2018 State of the Electric Utility found only 4% of utilities now have a "PBR environment," but 81% "either already have or want" regulatory reform. And almost three-fourths (73%) of utilities expect a COSR-PBR or PBR-based regulatory system in the next decade, the survey found.
But they may be in for a surprise.
Subscriptions for electricity?
PBR may not satisfy emerging consumers whose demand has been shaped in the subscription e-commerce market, according to Navigant Director Lon Huber and Tucson Electric Power Manager for Pricing and Analytics Richard Bachmeier.
That subscription market, covering cable TV and online entertainment offerings, grew over 100% per year from $57 million in 2011 to more than $2.6 billion in 2016, they report in a forthcoming white paper describing their energy service subscription plan that Utility Dive got a sneak preview of.
The more than 200 million subscriptions in 118 million U.S. households are expected to grow to 350 million by the end of the 2020s, they add.
Subscription markets "remove the essential element of competition — the ability at any time to choose to not consume, or consume something else, and avoid paying for the (subscribed) product."
Senior Advisor, Regulatory Assistance Project
"Technology unlocked this subscription revolution by providing new ways for customers to acquire products and services, particularly on e-commerce platforms," the paper reports. Energy sector innovation can now be leveraged by technologies like advanced meters, smart thermostats, distributed generation and digital apps, to make utility subscriptions possible.
"It is a complete paradigm shift," Huber told Utility Dive. "But surveys show customers tend to only look at the monthly bottom line of their bill so a subscription rate will feel natural."
Tucson Electric Power sees the energy service subscription plan concept as "a conversation starter" for a new "utility service option" that could be a "win-win," Bachmeier said. The utility is "developing this concept internally" and will propose a pilot "in the near future."
An energy service subscription plan allows customers to pay a fixed monthly bill for electricity and other services provided by the utility, the paper reports. Tiered offerings can integrate a wide choice of new customer-sited technologies through higher-priced, longer-term contracts, in the same way that phone and cable TV offerings add more and better services for bigger and longer-term commitments.
Customers would subscribe to service plans that meet their individual needs. Some would opt for a lower-priced "economy" package that would provide electricity and require customers to allow utilities to control their load on limited and pre-announced occasions to help meet grid needs.
For a high-priced premium plan with a long-term subscription, the utility might give customers access to new technologies and services without any upfront cost. Those technologies and services might include renewables-generated electricity, smart thermostats or EV chargers.
A "symmetric offering" could allow private sector providers to "act on behalf of the customer and share in the benefits," Huber said. "Both subscriptions would avoid shifting costs to non-participating customers, allowing regulators to approve the plans."
"A subscription model is a way to implement electricity as a service "in a vertically-integrated, regulated setting" and properly values utility offerings that meet diverse customer preferences, Professor Keisling emailed Utility Dive.
As renewable over-generation drives their market value down, rate designs that value DER as grid assets will be more important than "cost-based volumetric rates," she added. "Energy as a service and subscription models are also relevant in states with retail competition, and they provide potentially attractive business models for retailers looking to differentiate themselves."
Jorge Fuentes, deputy director of Arizona's Residential Utility Consumer Office, agreed. The subscription-based rate design “meets the expectations of 21st century customers and in many ways simplifies the antiquated and complex way energy rates are currently set,” he told Utility Dive via email.
Subscriptions could give low- and moderate-income customers access to new technologies and appliances that might otherwise not be affordable, the paper reports. Access to customer loads could provide cost-effective grid services for utilities. Putting utilities in the DER and energy efficiency businesses through long-term contracts could benefit the customer and the utility, by lowering bills without disrupting revenue streams.
But the purpose of utility regulation has always been "to impose on monopolies the pricing discipline that markets impose under competition," RAP's Lazar emailed. For most products, the costs of making and delivering them are built in, "and we pay for the 'grid' in proportion to how much we use" it.
Subscription markets "remove the essential element of competition — the ability at any time to choose to not consume, or consume something else, and avoid paying for the (subscribed) product," he added.
Some may argue the fixed bill of a subscription plan sends customers no price signal, but energy service subscription plans shift the incentive to limit and direct usage to the utility, which is "better at managing risk than a typical customer," the paper reports. The utility can design price signals that move usage to where it is most valuable and least expensive for the system. "This now puts the utility in full alignment with energy efficiency goals."
If the utility provides a compelling value proposition, its load will fall while its revenue from subscriptions does not, Huber said. That could be the ideal performance incentive, perfectly aligning customer and utility interests.