A Dec. 23 order by Hawaii's utility commission may lead to the most significant change in power system regulation in U.S. history by giving Hawaiian Electric new control over its future, proceeding participants said.
Hawaiian Electric will become the first U.S. investor-owned utility to transition away from cost of service (COS) regulation. Over five years, it will move from earning revenues based on capital expenditures to Performance Based Regulation (PBR) and financial stability, based on limited rate-based revenues and rewards for achieving public policy goals and cutting customer costs.
The commission's order, developed over an almost three-year stakeholder proceeding, aligns "the company's actions, the customers' experience and Hawaii's ambitious clean energy goals," Hawaiian Electric spokesperson Jim Kelly said in a statement. It provides "the right incentives to aggressively move ahead with modernizing our company and Hawaii's energy system."
Hawaii's regulators and stakeholders acknowledged they are asking a lot of their electricity provider.
"The utility has faced more regulatory innovation in the last ten years than over the prior century, and this holds its feet to the fire," said Murray Clay, president of the Ulupono Initiative, which led advocacy for a key PBR component. COS regulation "has protected Hawaiian Electric and this asks it to act more like it is in a competitive environment."
"There will be day one savings when this goes into effect and we expect to see more savings as the other opportunities are used."
Chair, Hawaii Public Utilities Commission
To support the utility through this unprecedented transition, the order includes reviews, opportunities to revise, and allowances for limited guaranteed returns. But the commission asserted its intention to make PBR work and "not to return" to traditional regulation.
If successful, this PBR framework could be a template for U.S. power system transformation, said commissioners from the mainland who helped design the framework.
Keys to Hawaii's PBR
The PBR order accomplished three guiding principles set out in the first phase of the proceeding (Docket 2018-0088) to align utility and customer interests and state policy goals, Hawaii Public Utilities Commission Chair James Griffin told Utility Dive. It offers "day 1 customer savings," streamlines the utility's "regulatory burden," and provides safeguards to protect the utility's finances and credit ratings.
PBR's challenging acronyms, detailed below, begin with a multi-year rate plan (MYRP) that reduces the regulatory burden by lengthening rate case intervals from three years to five years. That will allow the utility to use rewards from performance incentive mechanisms (PIMs) and earnings sharing mechanisms to innovate and expand benefits to customers and shareholders, Griffin said.
Day 1 Savings
"Hawaii has very aggressive clean energy goals, but we also have a very high cost of energy," Griffin said. "The revenue cap regulation will be a strong incentive for cost control."
The Annual Revenue Adjustment limits revenue growth to inflation and returns on specially allowed expenditures minus earnings shared with customers. But the utility has PBR mechanisms to increase earnings during the five-year rate plan.
Customers get a 0.22% share of those performance earnings. In the first five-year MYRP, they also get an average of $22.16 million/year in the form of a further reduction in the utility's allowed annual revenues to compensate them for waste found by a commission-ordered management audit in Hawaiian Electric's last general rate case. Together, these should result in lower monthly bills.
In the fourth year of the MYRP, the commission will "comprehensively review" the performance and make necessary adjustments, the order reported.
"There will be day one savings when this goes into effect and we expect to see more savings as the other opportunities are used," Griffin said.
The performance incentive and earnings sharing mechanisms will act as rewards for over-performing and penalties for under-performing, and the accelerated Renewable Portfolio Standard (RPS-A) PIM is the "centerpiece," Griffin said.
The RPS-A, on which Clay's Ulupono Initiative took the advocacy lead, rewards Hawaiian Electric for adding renewables faster than scheduled under Hawaii's 100% renewables by 2045 mandate.
The utility will get $20 for every MWh exceeding the annual mandate for 2021 and 2022, $15 for every extra 2023 MWh exceeding the annual mandate, and $10 for 2024 and 2025 MWhs above the mandate for that year. The intent is to "maximize cost-savings early" and also to make renewables "part of Hawaii's economic recovery from the COVID emergency," Griffin said.
"This is the most consequential decision in the commission’s history in terms of its comprehensive scope and leadership vision."
Senior Attorney, Earthjustice
In many places, accelerating renewables reduces utility costs and rates, and "in Hawaii, renewables back out much more expensive fuel oil," said Gridworks Senior Fellow Mike Florio, a former California utilities commissioner and advisor to Hawaii's commission.
Initially, there was a concern about "narrow, programmatic, activity-based PIMs that suited parties' particular interests" but led to "a suboptimal portfolio of incentives," Ulupono's Clay said. But Ulupono modeling showed the RPS-A keeps revenue growth at inflation while growing large-scale renewables and meeting objectives like reduced rates and increased distributed resources, he said.
There are also PIMs rewarding the utility for streamlining distributed resources' interconnection and using them to provide grid services, he added. Other incentive mechanisms can accelerate pilots, improve the use of advanced metering, expand energy efficiency, and protect reliability. But "the value of non RPS-A PIMs collectively is far less than the $10 million/year value of the RPS-A," he said.
"The RPS-A is the first U.S. clean energy PIM," said Earthjustice Managing Attorney Isaac Moriwake, representing clean energy advocate Blue Planet Foundation. "After debate about its calculation, even the utility ended up supporting it."
Careful consideration is needed for the final PIM metrics, to be designed by a PBR stakeholder working group by June 1, 2021, cautioned Hawaii Consumer Advocacy Executive Director Dean Nishina. "Having more than one PIM that focuses on the same activity or measured outcome could provide mixed signals to the utility."
And if Hawaiian Electric earns PIMs for streamlining interconnections and for accelerating deployment of the renewables it is interconnecting, that is "double rewards for a single activity," Nishina said.
But the grid services PIM may have a big market impact, said Rábago Energy Principal and former Texas electric utilities regulator Karl Rábago. "It recognizes that there must be a transactional framework or tariff in which the utility compensates the system value of distributed resources," he said.
The utility has long used the order's performance metrics on reliability and customer engagement, the statement from Hawaiian Electric's Kelly said. But "others are new and promising for the company and its customers, including incentives for creating innovative pilot programs and achieving renewable energy goals faster."
The first safeguard of the utility's finances is the Annual Revenue Adjustment, Chair Griffin said. The automatic annual rate adjustments "reduce some of the regulatory lag" of getting revenues to the utility through rate cases, allowing investment in innovations that can earn PIMs, which benefits Hawaiian Electric, its customers and its investors, he said.
A second safeguard is the Earnings Sharing Mechanisms, "which protect the utility and customers from excessive earnings or losses," according to the order. Hawaiian Electric must share with customers, through bill credits or charges, earnings over 3% above its currently set return on equity (ROE) of 9.5% or losses more than 3% below it.
"If Hawaiian Electric's ROE drops too low, it gets money shared back and if the ROE goes too high, customers share in the returns," Ulupono's Clay said.
A third safeguard is the commission's discretion to use a "Re-Opener" provision to consider adjusting or modifying elements of the order, Chair Griffin said. It would be "triggered" if rating agencies forecast "a potential credit downgrade below investment-grade status" or if the utility's earnings or losses are excessive, he added.
The PBR framework's other safeguard is the Exceptional Project Recovery Mechanism. It allows the utility "above Annual Revenue Adjustment" recovery of costs for certain large expenditures, with "case-by-case" commission approval, the order said. Because it allows recovery of operations and maintenance and program costs as well as recovery for capital expenditures, it can "mitigate" biases toward spending in COS, the order said.
While the commission is committed to PBR and many proceeding participants are supportive, they will be watching indicators of Hawaiian Electric's performance.
Things to watch
First reactions from the financial community are inconclusive. Analysts with Moody's and Credit Suisse who followed the proceeding did not respond to Utility Dive queries.
The order "derisks downsides" such as "PUC denial of new capital investments or lower authorized ROEs," acknowledged a Dec. 24 Bank of America financial analysis. But "upside risks" like opportunities for expanded ROE kept Hawaiian Electric's rating at "underperform considering considerable execution risks."
The biggest thing to watch, however, may be whether elements that protect the utility's financial stability preserve COS regulation and defeat the new paradigm. It is a reasonable concern, but the order shows the commission's commitment to PBR will prevent it, stakeholders said.
COS regulation "drove the capital expansion that created the modern grid, and its capital bias is strong," said Earthjustice's Moriwake. But this order is "tough love" because it includes a revenue cap, ambitious but doable goals, and safeguards to protect the "transformation to a new paradigm."
And the Exceptional Project Recovery Mechanism will impact no more than a third of the utility's capital expenditures, added former Colorado Public Utilities Commission Chair and Blue Planet advisor Ron Binz. "Two-thirds of its returns will depend on how Hawaiian Electric runs its business."
"[This order] begins building a bridge to a new regulatory paradigm that gives the utility achievable goals and safeguards and protects investors and private sector participation."
Principal, Rábago Energy
Given the utility's "past tendency" to rely on approval of "special cost recovery" from the commission, the consumer advocate's office will be watching "applications for additional cost recovery" through the Exceptional Project Recovery Mechanism, said Nishina.
Though stakeholders agreed with Nishina's hesitations, many said this PBR framework could change U.S utility regulation.
"This is the most consequential decision in the commission's history in terms of its comprehensive scope and leadership vision," Moriwake said.
Three former mainland utility commissioners agreed.
A national template
Hawaii's high energy costs make it uniquely able to benefit from the transition to renewable generation, acknowledged Binz. But "this approach to PBR can be transferred to other utilities because this is regulation of the company, not fuel costs."
Unlike traditional regulation, PBR can drive utility innovation to accomplish "societal goals like reducing emissions, and improving customer engagement without compromising safety or reliability," he added.
Wires-only companies could use MYRPs for ongoing infrastructure builds and Hawaii's Exceptional Project Recovery Mechanism for large investments, he said. Regulators in the Southeast can extend the period between rate cases and offer performance incentives to drive innovation. Even utilities like NV Energy and Xcel Energy can use PIMs "to increase earnings by being smart," he added.
California needs "business model reform to move beyond disincentives to distributed resources," GridWorks' Florio said. "The RPS-A is an incentive to distributed resources growth, and the grid services PIM is a hidden gem because it will increase the use of renewables plus battery storage and accelerate natural gas plant retirements."
Hawaii's PBR can be a national model, agreed Rábago.
"This order may thread the needle by thinking big picture, but [also by] asking what can in reality be done," he said. "An example is that it extends three-year rate plans to five years instead of the originally proposed eight years, but includes specific language indicating the transition will last beyond five years."
It is "based on precedent and years of work" and "begins building a bridge to a new regulatory paradigm that gives the utility achievable goals and safeguards and protects investors and private sector participation," Rábago said. "It will take five tough years of overseeing complex metrics and a difficult cultural transformation at the utility, but it is a good plan for building that bridge."