New utility business models and the nation's first distributed energy markets are fast emerging in New York. On Tuesday, regulators took one big step towards making them a reality as the New York Department of Public Service (DPS) issued a white paper that starts to crystallize what those new utility models may look like.

The paper, issued under track two of the state's Reforming the Energy Vision (REV) docket, proposes comprehensive and groundbreaking reforms to current utility ratemaking practices and revenue models that will reverberate across the U.S. electric power industry. The paper was put forth to seek input from all relevant stakeholders. 

The reforms are based on the foundational premise that New York utility revenue models are outdated and misaligned with new technologies, clean energy policy goals, system needs and customer desires. The REV vision posits that the integration of distributed energy resources on the customer end of the grid represents a unique opportunity to reduce costs and increase system flexibility, but there are "significant disincentives" for utilities to do so, according to the document.

"The current mass-market rate design, like current cost-of-service ratemaking, fails to encourage optimal realization of the potential of DER," the paper says.

Utilities have traditionally relied on capital expenditures to make money, but do not earn money by incurring operating expenses. Utilities can only make money off operating expenses by cutting them, as the paper notes. 

"Optimally integrating DERs may, though, require increases in utility operating expenses and decreases in capital spending," the paper reads. "Consequently there is a financial misalignment between the utilities’ economic interest, the interests of third-party DER providers and other service providers, and customers."

Based on these foundational principles, the paper then proposes comprehensive reforms to ratemaking in order to find ways for utilities to earn a fair return in a distributed energy landscape. 

New utility business models

The new utility models being drafted in New York center around the creation of distributed system platforms (DSP), which will effectively function as a customer-facing marketplace to enable two-way flows of energy, services, and value across the distribution grid.

Under the REV order, utilities will be able to increase revenues earned from serving as the DSP provider under what regulators are calling market-based earnings (MBE). The paper recommends utilities develop opportunities for MBEs and "further analyze potential revenue streams from platform services."

The white paper suggest that new approaches, and new performance incentives in particular (or earnings impact mechanisms, as the paper calls them), are necessary to achieve the REV's goals. However, the paper notes that, eventually, platform service revenues and other MBEs in a fully developed distributed market "should supplant some or all EIMs [earnings impact mechanisms]."

"When utility performance and revenue contribution demonstrate that MBEs provide the required incentives to support sustainable and beneficial market growth, the need for regulator-specified EIMs and attendant regulatory risk, may prove redundant and may be eliminated," the paper reads.

As these -- and many other changes -- take place, the paper suggests that "the relative balance between base rates, performance incentives, and MBEs will change." Regulators anticipate their role will shift from determining incentive levels in the near-term to simply supervising distributed markets in the long-term.

As system costs go down and are allocated to participants "who benefit directly from the market," regulations expects that fewer costs will socialized among all ratepayers. "This will promote both equity among customers and the incentive for utilities to encourage and facilitate innovation in the market," according to the document.

The future of electric rate design and DER valuation

The key to changing utility business models lies in ratemaking, which the paper discussed at length. Regulators noted they should be cautious about reforms to rate design and the rate at which they take place, as time is needed "to assess potential bill impacts and foster customer acceptance ... [and] develop information and infrastructure capabilities to implement an improved rate design. 

"Through gradual reforms, rate design for mass-market customers should begin to place a greater weight on the peak demand of the customer, which is closely related to the cost of the system and which can be managed by the customer to control their electricity costs," the paper reads.

While more comprehensive rate design reforms will come into form more gradually, the paper notes that it "should not delay action by those customers who have the desire and capability to respond to more granular value signals now." To that end, New York utilities will be tasked with making an opt-in "smart home rate" available to residential customers in the near future. The paper also suggests rates for larger business customers, which are currently already demand-based, can be improved through revised standby service tariffs, including the addition of a campus netting tariff and a reliability credit.

The big goal of these ratemaking reforms is to properly compensate customers for bringing DERs into the marketplace. This pressing question of how to value DERs has been asked in many other regions across the U.S. as the technologies proliferate, and the paper acknowledges there is no easy answer.

The simplificity and functionality of net energy metering (NEM) "has proven a very successful tool to support the growth of the solar industry," the paper notes in recommending that it continue to be used. Regulators suggest a "bill-crediting transactional mechanism, similar to that used in NEM, should be considered for DER resources, beyond those to which NEM already applies, that transact with the system either through actions that respond to DSP requests for service, or through the ability to inject power into the system."

The more controversial question is, at what rate should customers be compensated for DERs? "The current convention of crediting at the average retail rate may be either too little or too much based on the nature of the resource and its location," the paper says. Regulators suggest a new method of calculating for the value of DERs, based on a formula the paper calls LMP+D (or location-based marginal price plus distribution value), should be adopted.

Notably, however, New York regulators anticipate that any changes to ratemaking are not on any pre-established timeline. "The pace of the comprehensive ratemaking reform discussed in this white paper cannot be predicted at this time," it says.

Furthermore, any changes to utility business models and rate design may themselves change as new developments take place. "The pace of change, however, will not be dictated by regulation alone," the paper said. 

"All markets, and particularly technology markets, evolve at speeds that are often unpredictable and frequently faster than anticipated. The Commission, utilities, and stakeholders should be in a position to respond to market developments and should not be rooted in a particular set of expectations."

As New York's new utility models and first-in-the-nation distributed energy markets start to take shape, the rest of the industry will be raptly watching to see how it goes about enacting these radical changes. It is all but certain that what happens in New York will have a ripple effect across the rest of the industry in the coming years.