The traditional utility business model once again is blocking a new opportunity for utilities to be more nimble and innovative, but regulators say they are on the case.
New technologies are flooding utility databases with system and customer information. To manage it, many companies add servers and software. But utilities are not IT providers, and many are struggling to make sense of all that data on their own.
The best answer, many in industry say, is to move the information off utilities’ own computer systems and outsource data management to experts. But utility leaders know they can make a regulated rate of return from capital expenditures on servers, not spending for expertise in the cloud.
“It is what many in the utility industry call the capital bias,” said Richard Caperton, director of national policy research at Oracle. “Things they pay for out of the capital budget are good and things like software that they have to pay for out of the operating budget are bad.”
Oracle Utilities’ January 2016 survey of 100 utility executives found 45% were using some form of cloud-based applications or computing resources delivered as services over a network connection, rather than using on-premises infrastructure.
That hardly puts the power sector at the cutting edge. According to a 2014 industry survey, 83% of healthcare companies used cloud-based services that year. And a 2016 survey of more than a thousand IT professionals by Rightscale found that “95% of respondents are using the cloud.”
“Utilities corporate peers in banking, healthcare, financial services, and other regulated industries, are all moving to cloud computing at a very fast rate,” said Illinois Commerce Commission (ICC) Chair Brien Sheahan. At the Illinois commission, Sheahan is leading the only regulatory proceeding in the U.S. examining the value of software as a service (SaaS) and cloud computing to utilities.
The proceeding is part of a growing interest among regulators in cloud computing for the power sector. According to a Oracle follow-up survey of 76 commissioners and commission staffers, “nearly 80%” think regulators have a role “in determining whether utilities use cloud,” and more than two-thirds (69%) are in favor of allowing utilities to rate base cloud-based software.
Regulatory attention to the cloud was on display at the annual meeting of the National Association of Regulatory Utility Commissioners (NARUC) in November 2016. There, commissioners adopted a non-binding resolution encouraging state regulators to improve “regulatory treatment of cloud computing arrangements.
“NARUC encourages state regulators to consider whether cloud computing and on-premise solutions should receive similar regulatory accounting treatment,” the resolution concluded. “Both would be eligible to earn a rate of return and would be paid for out of a utility’s capital budget.”
The resolution and Oracles survey “show regulators understand the value the cloud can be to the utility industry and want to find a way to remove the barrier of not being able to capitalize investments in it,” said Guerry Waters, Oracle vice president for product strategy and marketing.
But before utilities can move to the cloud, two questions are key: Will the transition deliver tangible benefits, and if so, what is the best way for regulators to eliminate the capital bias?
The many uses and benefits of the cloud
Oracle’s earlier survey found that, in the next three years, 89% of utilities are planning to access cloud services for meter data management and 69% plan to move their customer information systems to the cloud.
Additionally, 86% of respondents plan to use SaaS for big data/analytics, 72% for business intelligence, 55% for mobile workforce management, 70% for enterprise asset management, and 38% for outage management.
Customers’ expectations “have set the bar for functionality, flexibility and efficiency at an unprecedented high level across all industries,” Oracle authors wrote in the survey report. Regulators are cognizant that “the cloud can help utilities stay ahead of the technology curve.”
In the survey, 74% of regulators saw “flexibility” for utilities as a benefit of the cloud, 70% saw it helping utilities keep up with technology changes, and 61% indicated it will give utilities better access to applications.
Regulators also saw the cloud offering utilities support “outside of their areas of expertise” with meter data management, big data analytics, and distribution and network automation.
But despite optimism from both utilities and regulators, cloud computing “is still more of a concept than a way of life for most utilities,” according to Michael Kanellos, technology analyst for software applications giant OSIsoft.
While opportunities for new revenue and improved operations stemming from cloud computing are clear, Kanellos said many utilities are worried of "latency and reliability" threats.
“A four-hour outage for Twitter is an embarrassment, but for a utility it’s a crisis,” Kanellos said. But, he added, "utilities aren’t allergic to software. Shifting it to capex will help.”
As more applications move to the cloud, utilities will be able to sell their data to services vendors, Kanellos said. Eventually, though some services will need to remain on-premises, utilities will use the cloud’s computing power for long-range analytics on things like circuit map planning and customer demographics.
According to Oracle’s Waters, many utilities continue to work with obsolete technology because it was capitalized and is still being depreciated. Replacing it with new infrastructure would be a costly and potentially losing proposition, he said. “At the pace of current technology, it may be obsolete by the time it is ready to be used.”
If the capital bias was eliminated by regulators, utilities could begin using state-of-the-art cloud applications much sooner, Waters said. SaaS providers are continuously updating their technologies and capabilities, so the utility would stay more up-to-date than if they had invested in capitalized, on-premise assets.
The regulatory disconnect
In Illinois and elsewhere, ICC Chair Sheahan said the present regulatory paradigm typically does not offer utilities “a level playing field” on which to choose between on-premises software and cloud-based software.
“A utility can rate base the capital expenditures for on-premise tangible hard assets like data centers, as well as intangible software licenses that meet certain conditions,” he said. “But the purchase of or subscription for intangible software from a cloud-based provider is generally treated as an operating expense.”
The regulator’s dilemma is easily understandable with a familiar example, Sheahan said. The utility can rate-base the purchase of Microsoft Office, which it runs on its own computer system, but a subscription to Office 365, which is a cloud-based product, is an operating expense.
“Most people agree the regulatory construct should not pick winners and losers,” he said. “My premise and the premise of the NARUC resolution is that regulators should treat the two software assets the same. They are not physically different. The only difference is where they are located.”
A utility should not “face a financial conundrum” when choosing between technologies, Sheahan said. “There is a potential for significant savings by using big data and analytics to implement predictive efforts and make deployment of assets more efficient. That benefits ratepayers and shareholders by helping utilities reduce O&M expenses.”
Currently, utilities are not outsourcing significant portions of their IT services to the cloud but that is going to dramatically change, he added. The grid is evolving quickly and some experts say utility investment in communications and IT infrastructure to serve evolving needs will, in the near future, exceed investment in wires and hardware. That infrastructure will be cloud-based, Sheahan said.
Utilities at the cutting edge
“Almost every person in the United States uses the cloud in some way although most do not know it,” according to a white paper co-authored by ICC Chair Sheahan.
The rush to cloud computing by the likes of Amazon, Google and Netflix demonstrates the sound economics and reliability of the cloud, the paper argues, “but it remains to be seen whether the utility industry will follow suit.”
Sheahan’s white paper highlighted a number of utilities leading the way on cloud computing.
One is Southern California Edison’s work with Opower on energy management. Another is San Diego Gas & Electric’s smart meter operations center.
Regulatory mandates and market pressures are imposing significant data challenges to California’s investor-owned utilities — so much so that SCE, SDG&E and Pacific Gas and Electric have begun to move to SaaS and cloud computing in spite of the capital bias.
Cloud-based computing “can provide improvements in time-to-service and some flexibility in our solutions,” said SDG&E Communications Manager Hanan Eisenman. It also offers benefits in “development, testing, peak workload areas, and emergency response and recovery.”
The utility’s use of SaaS is growing and it is still exploring options, though always with care for “cybersecurity, audit, privacy and compliance standards,” Eisenman said. Because California has no provision for rate-basing SaaS, SDG&E is “continuing to discuss how costs associated with the benefits of cloud services are recovered.”
PG&E supported the NARUC resolution “to encourage discussion around this issue and explore the potential benefits,” Spokesperson Donald Cutler told Utility Dive. Though customer privacy and data security remain critical concerns, “cloud computing platforms allow the utility to “reduce cost of data management infrastructure and increase the flexibility to use this data.”
In its 2018 general rate case, SCE asked regulators to approve spending for upgrades to its “capitalized” software. But it will also use cloud-based services, including Microsoft Office 365, the SAP Ariba procurement application, and HR Platform Modernization, a cloud-based human resources application. They are operating expenses and will not be rate based, Spokesperson Jude Schneider told Utility Dive.
In spite of these programs, the persistent capital bias in California and other states prevents utilities from investing further, Sheahan’s white paper argues. But if the regulatory construct shifts, programs like SDG&E’s smart meter operations center could evolve to do “applied data analytics, exception management, asset management, and predictive modeling.”
Regulatory reforms take shape
“While utilities are starting to embrace cloud technologies, the decision is often not theirs alone to make,” the new Oracle survey notes. “Regulators’ rulings on whether public utilities’ investments in cloud technologies can be capitalized are central to paving the way for accelerated cloud adoption.”
Oracle’s Caperton sees a pathway to the cloud for utilities in regulators’ authority. “Utility incentives can be aligned with the public interest under current regulatory accounting rules in each state by making sure cloud computing is treated the same way as on-premise software.”
Regulators can use the Federal Energy Regulatory Commission (FERC) Uniform System of Accounts (USOA) as a rationale for rulings that would level the playing field, he argued.
The NARUC resolution and the Sheahan-led ICC proceeding are both indications the issue is beginning to get traction in the national discussion about new utility business models, Caperton said. Another is the May 2016 New York Public Service Commission order allowing utilities to earn a rate of return on prepaid SaaS subscriptions.
As part of the Reforming the Energy Vision Track 2 proceeding, the New York commission ruled that utilities may rate-base the expense for leased software paid for upfront, Caperton said.
“As utilities evaluate whether to purchase or lease these applications, their ability to earn a return on a portion of the lease investment should help to eliminate any capital bias that could affect that decision,” the commission ruled in its “Order Adopting a Ratemaking and Utility Revenue Model Policy Framework” (Matter 14-00581).
This is an example of a commission using the FERC USOA to make a ruling, Caperton said,
and demonstrates how other state regulators can similarly act to eliminate the capital bias.
Despite the new opportunity, the New York Department of Public Service has not yet received any proposals for utilities to rate-base SaaS or cloud computing systems, said Department spokesman James Denn.
In Illinois, Sheahan and his fellow commissioners asked for feedback from the IOUs when they launched their SaaS proceeding.
“Every utility recommended that the ICC allow them to categorize cloud-based software as ‘intangible plant’ and argued it would solve the capital bias and works within existing regulatory rules,” Caperton said.
“The benefit of this treatment is that it places identical investments (cloud and on-premises solutions) on equal footing,” The Peoples Gas Light and Coke Company said in its filing. This means “a cost benefit analysis of different computing solutions would be indifferent to the rate implications.”
Leveling the playing field would not create a undue incentive for cloud-based software, the utility said. “Like any investment, inclusion in rate base and recovery of a return on and of the investment would be subject to review in rate cases.”
Sheahan said that his expectation is that the ICC will move toward formal rulemaking for cloud and SaaS service and, out of that, to a ruling that levels the playing field for SaaS.
“The heart of the issue is how to remove the barrier, because the economics of cloud-based computing are so compelling,” Sheahan said. “My view is that cloud-based services are like long-term capital leases that are capitalized in most U.S. jurisdictions."
“My hope is that the Illinois work will be a model that other states can use,” he added.