Navigating utility business model reform: A practical guide
This is the first in a six-part series on utility business model reform provided by Rocky Mountain Institute, America's Power Plan and Advanced Energy Economy Institute.
It's increasingly likely that conventional fossil-fuel power plants won't comprise the core of our future electricity grid. A growing number of state mandates require a transition to cleaner generation, while utilities are embracing renewable energy as key investment strategies.
Xcel Energy's recent announcement to eliminate carbon emissions from its power plants by 2050 complements MidAmerican's pledge to reach 100% renewable energy by 2020 without increasing customer rates.
But these leaders belie a host of utilities around the country that still see significant barriers to fully embracing a cleaner grid that's affordable and reliable. Utilities are limited in their ability to respond to current forces — be they economic, technological or policy-driven — due to regulatory structures that were created for a bygone system of large, fossil fuel-powered, centralized generation.
To build a modern grid suited to the next century's needs, the utility business model needs to evolve, and in some circumstances, may need to transform.
Variable generation like wind and solar may be the lowest-cost resources, but consumers only benefit if those resources are complemented by cheap, flexible demand-side management and system optimization that fully leverage all available resources. Numerous approaches are available to reform utility regulation to meet this challenge; however, it can be difficult to make sense of the options.
Rocky Mountain Institute, America's Power Plan and Advanced Energy Economy Institute released a new report to give actionable guidance on leading options to reform utilities' business models. Navigating Utility Business Model Reform: A Practical Guide to Regulatory Design provides a menu of 10 options to guide policymakers as they work to modernize electric utilities.
This guide is released in conjunction with a set of five case studies, which go into additional detail for how some of the reform options have been applied by select states and utilities, providing added insight into design options and lessons from past experience.
The utility business model is not prepared to serve 21st-century needs
Powerful trends are impacting the electric system, including demands for improved environmental performance, the increasing availability of distributed energy resources like rooftop solar and storage, more customer demand for energy choice and the need for strengthened resilience in the face of extreme weather events.
Meanwhile, utilities must continue to deliver on traditional responsibilities of safety, reliability and affordability — all while managing very different physical assets than they have historically.
There are significant new economic opportunities for utilities and other market players as a result of these trends; however, fundamental attributes of the utility business and regulatory framework inhibit them from reorienting to present-day needs. These barriers include financial incentives to grow energy sales and to invest in capital projects instead of more cost-effective solutions.
Policymakers need practical guidance to navigate utility business model reform
As U.S. states advance efforts to modernize the grid and utilities pursue higher renewable energy goals, legislators and regulators increasingly face major policy decisions that affect the utility business.
Participants in both legislative and regulatory activities, no matter the stage of reform, benefit from clear guidance on knowing the key questions and where to go to find helpful information. The list of jurisdictions grappling with these issues is long and grows longer everyday.
Minnesota is one state at the front of the pack.
Regulators there are investigating ways to expand performance-based regulation (PBR) for the state's largest utility, Xcel. The Minnesota Public Utilities Commission (PUC) is exploring how additional performance metrics, as well as possible financial incentive mechanisms, can better align Xcel's investments and operations with public policy objectives, including affordability and environmental performance.
Developments over the next few months will establish a suite of metrics for Xcel, as well as new ways to encourage improved outcomes by the utility and across the power system.
In Ohio, stakeholders recently concluded an investigation into a range of grid issues, including distribution planning and rate design. The PUC of Ohio will soon begin the next stages of its PowerForward initiative, including further consideration of new utility procurement approaches that reduce system costs. As Ohio transitions from investigation toward decision-making, regulators, utilities and other stakeholders will have the opportunity to create new solutions for system design.
As these and other states pursue reform, the need to update the utility business model will only increase. Navigating Utility Business Model Reform can help participants in reform activities develop more effective regulations to achieve these objectives.
10 reform options to modernize the utility business
The report focuses on 10 reform options, ranging from the relatively common (e.g., revenue decoupling) to more novel ideas (e.g., platform revenues). The set of options is not exhaustive, but reflects a range of responses to different pressures on the existing utility business model.
Although these options defy easy groupings, we provide a suggested categorization that organizes them according to similar approaches or objectives:
- Adjustments to the cost-of-service model
- Options that level the playing field and emphasize technology and resource neutrality
- Mechanisms that address retirement of uneconomic assets, such as coal power plants
- Reforms for a reimagined utility business
These options can be shaped in conjunction with other elements of the energy transition, including public policy shifts, new market structures, diversifying utility investments, bringing greater transparency and access to grid planning processes and offering consumers advanced rate designs.
The guide describes each option in simple terms while identifying best practices and key questions for reform proceedings. It also points to important references and past experience to support improved decision-making.
Of course, the best learning comes from direct experience with reforms. Five case studies from Advanced Energy Economy Institute, which will be examined in future installments of this series, provide insight into attempts to put some of these reforms to work.
Putting the pieces together
Unfortunately, there is no easy playbook for modernizing the utility business model. Whereas this guide catalogs options and best practices for pursuing reform, implementation will be customized to the context of each state and utility.
A few universal tenets are applicable, however, which the report discusses in more detail:
- Begin every reform activity with a clear articulation of goals and objectives.
- Make reforms fit for purpose (e.g., new grid investments) and scaled to the reform's ambition.
- Encourage fair market development, including giving opportunities for competitive service providers, and ensure that utility roles are consistent with their monopoly charter.
- Make adaptiveness a central feature of the transition to new utility business models.
One way or another, all changes to the electricity system go through one key player: the electric utility.
Finding a way through the digital transition to a clean, reliable, affordable grid involves real-time experimentation. At the same time, regulatory institutions that rely on a century old model will have to increase their agility to enable new utility business models and support the widespread use of leading-edge technologies.
With a growing number of reform efforts and ambitious utility commitments underway, it's clear that utilities, regulators, and other policymakers recognize the need for business model and regulatory change. By offering this guide, we hope that policymakers, utilities and policy influencers can work together more effectively to understand their options and take these efforts further, faster, together.
Dan Cross-Call and Cara Goldenberg work in RMI's Electricity practice, where they partner with regulators, utilities and industry stakeholders to modernize utility business models. Mike O'Boyle directs America's Power Plan, a platform connecting policymakers with experts, tailored research and resources to create a clean, resilient, affordable electricity system.