This is the first of a two-part series on performance-based ratemaking.
There is accelerating work to transform the utility business model through performance-based regulation (PBR).
Traditionally, utilities earn profits through regulator-approved rate increases that recover investment costs and add a margin of return. Many power sector stakeholders have unfulfilled ambitions to instead reward utilities for providing value to customers, for example through integrating more renewable resources and energy efficiency.
Setting multi-year rate plans with incremental rate increases in order to contain costs is "one of the two main components of PBR," Synapse Energy Economics Principal Associate Melissa Whited, who co-authored a 2015 PBR handbook, told Utility Dive. "Performance incentive mechanisms are traditionally, but not necessarily, a second component."
PBR is necessary to replace the traditional utility business model to one that serves policy goals and customer demand, advocates told Utility Dive. But instead of replacing the business model, leading PBR efforts are using regulatory proceedings to layer components of PBR for a more incremental, but nevertheless substantial, shift in objectives.
After Illinois mandated the use of PBR mechanisms in 2011 and New York's Reforming the Energy Vision (REV) began working on them in 2014, contemporary interest began spreading.
PBR has now been used or considered in 19 states and the District of Columbia since 2015, according to the Enerknol-Wood Mackenzie Power and Renewables June market report.
Traditional cost-of-service regulation (COSR) works when electricity demand produces revenue increases to meet utility expenses without frequent rate cases, Eversource Energy Vice President for Distribution Rates and Regulatory Requirements Doug Horton told Utility Dive in an email.
Today's rising penetrations of energy efficiency and DER lead to falling revenues and "are straining" COSR, Horton said. Grid modernization investments are necessary to protect against "unprecedented weather" and for reliability purposes as increased customer demand calls for variable resource and technology integration, he said.
"A good use [of PBR] is to help utilities do valuable things like investing in grid modernization. PBR can also relieve overburdened commissions, utilities and stakeholders of frequent rate cases."
Executive Director, Pace Center for Energy and Climate
PBR can "address the changing paradigm" while protecting the utility's ability "to operate efficiently, profitably and reliably," he added.
Combining PBR with multi-year rate plans (MRP) and performance incentive mechanisms (PIMs) can align utility incentives with policy objectives, Synapse's Whited agreed.
PIMs can also be layered on to traditional COSR if regulatory oversight assures the PIMs' rewards and penalties do not over- or under-compensate utilities for the benefits they provide and the costs and risks they incur, she added.
There are good and bad reasons for pursuing PBR, Pace Center for Energy and Climate Executive Director Karl Rabago told Utility Dive.
"A bad reason is using PBR to allow a utility extra earnings while making it seem it is being held accountable for performance," Rabago said. "A good use is to help utilities do valuable things like investing in grid modernization. PBR can also relieve overburdened commissions, utilities and stakeholders of frequent rate cases."
Rabago is a former member of the Public Utilities Commission of Texas, a rate case expert witness and a participant in New York's REV.
Illinois, New York and Massachusetts have the longest-running major PBR efforts. Illinois demonstrates how PBR mechanisms, especially PIMs, can work for utilities and customers. In New York and Massachusetts, utilities are making PBR components work, but customer advocates remain dissatisfied.
"You can't talk about meaningful PBR without talking about Illinois," Energy Innovation (EI) Director of Electricity Policy Mike O'Boyle told Utility Dive.
The state's 2011 Energy Infrastructure Modernization Act created PIMs and a formula rate that allowed Commonwealth Edison (ComEd) and Ameren to invest billions of dollars in grid modernization. Layered on to existing COSR, they "imposed penalty-only incentives for failing to improve reliability," said O'Boyle.
"We don't want more PBR for the sake of PBR, but we are interested in aligning utility incentives with goals we know will reduce customer bills."
Executive Director, Citizens Utility Board of Illinois
The law included a $2.6 billion investment program that "is delivering record reliability," ComEd spokesperson David O'Dowd emailed Utility Dive. "Eleven million customer outages have been avoided in the last six years producing more than $2.1 billion in societal savings" and the utility this year requested its fourth rate decrease.
Then came the 2016 Future Energy Jobs Act (FEJA), which added reward and penalty PIMs for energy efficiency programs. Though data has not yet been fully reviewed, "it appears that efficiency is more than ever incorporated into the utilities' culture," Citizens Utility Board of Illinois Executive Director Dave Kolata told Utility Dive.
And new legislation could also lead to peak demand reductions, O'Dowd and Kolata said. "We don't want more PBR for the sake of PBR, but we are interested in aligning utility incentives with goals we know will reduce customer bills," Kolata said.
New York's multi-pronged REV proceedings "have done more than any other state to evolve the utility business model," O'Boyle said. REV has made PBR "real" by allowing utilities a rate of return for non-infrastructure expenditures on non-wires solutions, and by allowing an earnings adjustment mechanism (EAM) for energy efficiency expenditures.
Consolidated Edison considers the program a success because of those returns, spokesperson Allan Drury told Utility Dive in an email.
But customers have seen little savings or increased access to new resources, according to O'Boyle.
EAMs, layered onto New York's COSR, reward the utility for expanding energy efficiency. But REV policymakers "have gotten away from looking at high-level outcome-based metrics on overall energy usage and peak demand," Advanced Energy Economy Director Danny Waggoner told Utility Dive.
The REV vision was intended to incentivize utilities to use their system knowledge to benefit customers, he said, but EAMs were not "implemented in a way that gives flexibility to deliver high-level value," so it's difficult to measure success.
The 2017 Eversource rate case in Massachusetts created a five-year MRP plan with penalties of "about $50 million annually" for failing to meet existing safety and reliability standards, Eversource's Horton said. Though implementation is early, they "expect performance to change," he said.
The Massachusetts Department of Public Utilities (DPU)-approved plan did not include new metrics or PIMs for achieving state policy goals, drawing objections from climate policy advocates.
"The Eversource rate case has shown us that Massachusetts utilities can get automatic rate increases without doing anything differently," Acadia Center Attorney Amy Boyd emailed Utility Dive.
Eversource is working with DPU to develop new metrics on which PIMs can be based, and hopefully have a larger impact on policy goals, Horton said.
Newer PBR efforts are addressing metrics and PIM design early.
Unlike Illinois, Massachusetts and New York, work in Minnesota and Rhode Island is still incomplete. But stakeholders in both states have explicitly addressed the connection between PBR and COSR in new ways.
In advising the stakeholder-led PBR effort in Minnesota, Whited "recommended starting with performance metrics." And stakeholders' filings with the Minnesota Public Utilities Commission emphasized the need for a measured study of basic PBR components, including how they might be layered into COSR.
It is critical that metrics be quantifiable, verifiable, clearly defined and subject to utility control, according to the filing from the Minnesota Attorney General's office. Additionally, metrics and PIMs should be linked with the design of a MRP, the filing read.
The office's recommendation for a regulatory proceeding on PBR is currently under commission study.
The Rhode Island Public Utilities Commission's landmark PIM Principles, proposed by Commissioner Abigail Anthony, are "a framework on PIM design to guide regulators and stakeholders," Regulatory Associate Project Attorney Mark LeBel, who intervened in the rate case as an attorney with advocacy group Acadia Center, told Utility Dive.
A detailed study of utility-proposed PIMs in Rhode Island found them "often" lacking justification. But instead of the PUC defining or articulating performance objectives, "we want to set out the structure and the evidentiary framework," Commissioner Anthony told Utility Dive.
The Principles do not endorse PBR and PIMs can be a supplement to cost recovery under COSR, Anthony said. Other stakeholders agreed.
"The principles say 'prove your PIM allocates the right level of reward to shareholders and that consumers will benefit from it.' That burden of proof is on the proponent."
Commissioner, Rhode Island PUC
The essence of the five principles is that a PIM should only be available if "the utility does not already have a financial incentive to undertake the action or to advance the outcome that is being proposed," Anthony said. The PUC's systematic review of recent proposals showed rates of return were often available under the existing COSR, making PIMs redundant.
"Another main theme of the principles is the allocation of cost, benefit and risk," Anthony said. "The principles say 'prove your PIM allocates the right level of reward to shareholders and that consumers will benefit from it.' That burden of proof is on the proponent."
Another critical value in the Principles is that utilities must produce data to verify their proposals.
"The most difficult challenge for the commission is obtaining quality data," Anthony said. "If we demand high-quality data and utilities have something to gain from making it available, we'll start to see it."
The New Hope
There is a regulatory proceeding underway on PBR in Hawaii, but the state's dominant utility Hawaiian Electric Companies (HECO) hopes the result will maintain a connection to traditional regulation, a spokesperson told Utility Dive.
Other stakeholders say Hawaii could become the first state to truly change the utility business model instead of just changing the way utilities do business.
Phase One of the legislatively-mandated PBR proceeding was meant to set intended goals and lay out steps to reach them. It then established "guiding principles" for creating a customer-centric approach, administrative efficiency and utility financial integrity meant to carry Phase Two.
Like Minnesota, Hawaii approached PBR through a stakeholder-driven process, but unlike Minnesota, stakeholders and the state's leading utility seem split on how they will fit into COSR.
The Phase One order "appears" to be committed to "gradualism," HECO VP for Regulatory Affairs Joseph Viola told Utility Dive in an email. Details established in Phase Two "will be very important in understanding how the new regulatory model will really work."
Phase One's framework will allow "a deliberate next step" from traditional COSR "toward a more performance-based system" Earthjustice Attorney Isaac Moriwake, who represents environmental group Blue Planet in the PBR proceeding, told Utility Dive in an email. It positions Hawaii "to break the traditional link of 'the utility spends money to make money.'"
PIMs were left to Phase Two and "the PUC is looking to develop only three to six PIMs," he said. So few PIMs will not "reshape the utility business proposition, but it's a start" in bringing solutions from customers and third-party market participants "to the grid on a truly level playing field."
The "more critical and fundamental step" will be measuring and capping utility revenues through a "multi-year rate period" with an "index-driven revenue formula," Moriwake said. That will be key "for moving away from traditional cost-plus regulation."
Part two of this series will focus on "next generation" PBR.