Texas stakeholders find common ground in utility revenue recovery for DERs
State power sector players say DER growth should not hurt utility finances, but consensus over rate design reform remains elusive
A broad coalition of stakeholders in the Texas grid say investor-owned utilities (IOUs) should not have to risk their revenues to meet the demands of 21st century power consumers.
Regulated utilities that advance energy efficiency and distributed energy resources (DERs) should have incentives or a rate structure that keeps them financially whole, according to a new consensus statement from the South-central Partnership for Energy Efficiency as a Resource (SPEER).
SPEER members include top executives with Texas transmission and distribution (T&D) utilities, competitive electricity retailers, and advocates for efficiency, distributed resources, and energy management software. Though the group broke new ground by agreeing in principle that regulated utilities have the right to financial protection, it could not agree on a specific remedies in the ratemaking process, said SPEER CEO Bob King.
DERs — including demand response (DR), energy efficiency, storage and on-site generation like rooftop solar — can help relieve system congestion and avoid traditional infrastructure costs, King said. But because of a “complex and multidimensional” set of disincentives embedded in traditional ratemaking, “utilities have no incentive to invest in them, even if they reduce overall costs.”
T&D utilities are obligated to their shareholders make investments on which they earn a rate of return, said Doug Lewin, vice president for energy efficiency provider CLEAResult.
“The hundred-year-old regulatory construct was created to drive those investments,” he said. “But we need utilities to use new resources that reduce customer costs and strengthen the system.”
To do it, “the regulated utilities need to have as much financial incentive to invest in DER as they do for investing in physical infrastructure,” Lewin said. “That is not the way the system is set up now, but it is what the consensus statement points toward.”
IOUs' revenue can be compromised if they move toward “alternative cost-effective, non-traditional infrastructure solutions, such as energy efficiency, that offer the same level of safe and reliable service,” SPEER participants agreed. They should be allowed the same cost-recovery and rate of return for DER expenditures as they would if they were making capital investments in physical infrastructure, the statement asserted.
IOUs should also get financial incentives if they “reduce revenue requirements relative to what they would have been" through investments in non-traditional solutions, the statement said.
But the consensus splintered on exactly how to change the rate structure in a way that allows regulated utilities to remain financially healthy, said Ned Ross, director of government affairs for retail electricity provider Direct Energy.
“The story is that there was an extremely diverse group that delivered meaningful input but, at the end of a months-long process, we could not come to terms on even a multi-solution compromise,” Ross said. “That reveals the difficulty.”
The SPEER recommendations will now be submitted to Texas regulators, who will direct the next phase in utility reform efforts. Should they be adopted, the principles could help form the foundation for utility ratemaking reform in the state and serve as a model for other jurisdictions.
When ... utilities identify and stimulate alternative cost-effective, non-traditional infrastructure solutions, such as energy efficiency, that offer the same level of safe and reliable service, these utilities should be allowed cost-recovery and a rate of return for those expenditures as though they were capital investments. The Commission supports awarding financial incentives to Investor Owned Utilities that reduce revenue requirements relative to what they would have been through such investments.
2017 SPEER Commission Consensus Statement
The SPEER consensus
SPEER's focus involves market-based approaches to overcoming persistent market barriers so as to “accelerate the adoption of advanced building systems and energy efficient products and services,” according to the partnership's final report.
The SPEER participants developed their statement following study sessions on impacts T&D utilities are likely to face from the rapid growth of energy efficiency and other DERs. Reaching consensus was a significant accomplishment for Texas stakeholders because deregulation has made unanimous consent problematic among the marketplace's increasingly diverse stakeholders, King said.
Though lacking in specific directives, the consensus agreement included several important acknowledgements. One is that the revenue of regulated IOUs can be compromised by investments in “alternative cost-effective, non-traditional infrastructure solutions” even if they “offer the same level of safe and reliable service.”
IOUs should, therefore, not only be allowed cost recovery and a rate of return but should also get financial incentives if they reduce their revenue requirements through investments non-traditional solutions, it also asserted.
IOUs “are profit making entities with responsibility to their shareholders” but they were given “monopoly status” to deliver electricity “because it serves a public purpose,” the paper reports.
To achieve reliable service, current regulatory policies allow IOUs “revenue recovery sufficient to recover costs, plus earn a rate of return on capital investments sufficient to attract the capital required,” it adds.
The T&D utilities face “complexity and new challenges” from a rising move by consumers to the growing array of DER, the paper goes on. But IOUs can capture DER benefits “to avoid or defer costs” or deliver electricity “with less capital expenditure or lower maintenance expense.”
The obstacle to those savings is current laws prohibiting IOUs from owning DERs or competing with private sector DER providers in the Texas competitive market, the paper asserts. IOUs will not have an incentive to implement DERs and capture their benefits at scale “until regulatory processes reward such actions appropriately,” it concludes.
The Public Utility Commission of Texas (PUCT) can, however, target utility spending in the state’s energy efficiency program “to cost-effectively avoid or defer specific distribution system upgrades,” the paper proposes.
The PUCT could also “recognize distribution system costs avoided or deferred through implementation of energy efficiency and demand response programs.”
CenterPoint Energy Senior Vice President Ken Mercado said his company "agrees with the final consensus statement." The T&D utility "will continue to explore alternative options available, in addition to traditional infrastructure," he said.
Oncor, the state's largest distribution utility, declined to comment.
Toward new ratemaking mechanisms
SPEER’s ongoing work over the last few years has paralleled efforts at the PUCT to consider alternative ratemaking mechanisms, King said. But there has been little impetus behind the reform process because the state’s T&D utilities remain financially sound.
“Demand for electricity didn’t grow as quickly as the economy but we didn’t see flat or declining consumption either because Texas is growing so fast," he said.
The lead line in the SPEER agreement was that DERs can be a valuable tool in support of reliable electricity delivery with the right utility incentives, King said. But the second sentence is also important, he stressed.
“There is an opportunity cost problem for utilities,” he said. A utility may avoid a $1 million investment in system infrastructure by spending $100,000 on rebates to drive $400,000 in homeowner investments in energy efficiency. “But that utility could get a 10% return on the million-dollar infrastructure investment and get nearly $100,000 in revenues every year.”
Ratepayers would be better off with the efficiency investment in that example, “but the utility doesn’t make anything on it,” King said. To address that, the second sentence proposes giving utilities an additional reward to overcome their loss.
“Give them $100,000 return on the $400,000 investment, which is a 25% return," King said. “You’ve still only spent $500,000 instead of a million.”
This is similar to performance-based ratemaking, King added. But, more importantly, it asks big questions. “Are we paying for what we want? Is the incentive structure for utilities set up to get what we want?”
As the power system resource mix changes, “we’re going to have to convert the way they make money,” King said. "But that can open the door to a huge range of possible utility opportunities.”
SPEER will next push the PUCT to allow utilities to get credit for avoided T&D costs provided by energy efficiency, King said. “Utilities are mandated to spend $150 million on efficiency, why not give them an incentive to reduce their own costs?”
They should also be authorized to use the $15 million per year allotted to research and development to do pilots involving non-wires alternatives (NWA), King added. "And why look only at the state’s energy efficiency funds? Texas spends over a billion dollars a year on T&D. We should be looking at non-wires alternatives for all of those expenditures.”
CLEAResult’s Lewin agreed the report “is an important step in the right direction.” For effiency and DER providers, a regulatory treatment that makes alternatives “at least as attractive” is vital because “no utility is going to decide to earn less.”
Rate design sparks contention
Direct Energy was one of two retail electricity providers in the SPEER process. NRG-Reliant, the other retail provider, declined an interview request.
Direct Energy's Ross said feedback from the SPEER participants was "really impressive," and pointed to the consensus statement as particularly important.
“We were trying to think about rates that will keep the poles and wires companies financially healthy,” Ross said. “As they lose load to local energy sources, it removes payers from the system and policymakers will find it difficult to find a new rate structure to suit that reduced load.”
Though much of the discussion revolved around potential alternative rate structures, none were agreed to as acceptable, Ross said. “It would have been almost an epiphany to find something agreeable to industrial customers, renewables advocates, utilities, and the others in the room.”
Details of the SPEER discussions were kept largely private, but King said full decoupling was rejected and Ross said a straight fixed variable rate was also among the proposals that could not achieve consensus support.
“Direct Energy is involved in discussions like this in every state where there are competitive electricity markets,” Ross said. “They will probably continue for some time because there probably is no one answer.”
There was agreement that the Texas competitive market is working, Ross said. “Nobody, including energy efficiency and renewable energy providers, said they wanted to go back to a system where the utility says what it will charge to install solar or energy efficiency.”
But SPEER found no agreement on a workable rate structure to meet the emerging DER challenge.
“We could not even agree on a three-solution compromise or a mix and match of rate structures," Ross said. "The conclusion was that what is in place is working for T&D utilities but going forward those utilities may be challenged. There was no agreement on how to meet those challenges.”
CLEAResult’s Lewin was more tempered.
“In a room like that, everybody is obviously and rightfully defending their own position and their own perspective,” he said.
“We were trying to get from rate reform to what is right for customers and how we lower the overall cost of electricity,” Lewin added. “That would give everybody around the table, including utilities and third-party providers, the opportunity to grow. And regulators could find that of value.”
Will the PUCT take over?
The SPEER report called on the PUCT to initiate a rulemaking project that would include “a stakeholder discussion of changes needed in our overall approach to utility ratemaking.” The commission, it said, should “support efficiency and innovation in the marketplace, while protecting the integrity of our public utilities.”
While no consensus could be reached on rate design in the SPEER process, Lewin said the true test will come at the commission.
“The right regulatory treatment could mean a great deal to energy efficiency and DER providers because they can be part of non-wires alternative solutions,” he said. But that regulatory treatment must have the support of the utilities, so “deciding what it will be has to happen in a regulatory proceeding.”
The important story, he said, is that stakeholders in Texas think utilities “should not go out of business and, if they can, use non-traditional solutions to reduce overall costs."
“Maybe that’s not news in California or New York but it is here," Lewin said.
The consensus statement implies the stakeholders agreed there is a way T&D utilities can use DER to offset the need for infrastructure investments and bring overall system costs down, Lewin added. “It also implied the next step is the regulatory process because it is all about financial incentives for utilities to meet revenue requirements and you can’t do that without commission action.”
Direct Energy’s Ross said the SPEER participants “would appreciate the PUCT looking at the consensus statement and forming their own opinions and it would be a healthy dialog for the PUCT.”
Lewin said the question raised by the SPEER process is essentially unavoidable.
“There is strong evidence that significant investment is needed in the grid,” he said. “The question is whether utilities will only look at investments in physical infrastructure or consider the full spectrum of alternatives before making those investments.”