Ratemaking and Utility Business Models

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The United States’ electric power industry is changing fast. For a century, vertically integrated monopoly utilities built power plants, strung transmission and distribution lines, billed customers, and were rewarded with a predictable return on investment. But now, consumers and businesses are demanding more control over the energy they use, and surveys show they prefer a 100% clean electricity supply. Options for reducing and modifying electricity consumption through community choice aggregation, self-supply, storage, and smart appliances keep proliferating – making customers more independent from utility service.

Under the current regulatory system, these market trends constitute a considerable threat to traditional business models. Utilities face declining sales and increasing competition from distributed energy resources and clean energy providers at a time of increasing need to invest in grid modernization and resilience.

To adapt, utilities require new business models and new regulatory models that spur innovation instead of stifling it. Energy Innovation provides and curates solutions to state and local decision makers’ work with utilities to meet consumer demand, harness innovation, and overcome barriers to the clean energy transition. Our goal is to ensure that electricity consumers and producers alike thrive as the U.S. undergoes profound shifts to a clean, affordable, resilient electricity sector.


Resources

Navigating Utility Business Model Reform: A Practical Guide to Regulatory Design, by Dan Cross-Call, Cara Goldenberg, and Leia Guccione – Rocky Mountain Institute, Rachel Gold – American Council for an Energy-Efficient Economy, and Mike O’Boyle – Energy Innovation (November 2018)

Navigating Utility Business Model Reform seeks to establish foundational elements of different reform options, poses key questions to explore their applicability, identifies illustrative experiences for ideas and concepts, and explores policy implementation options to help spur action.

Navigating Utility Business Model Reform wasreleased alongside a set of case studies focused on experiences with business model reform options to help industry actors craft innovative approaches that are tailored to local context and circumstances. The report was produced in a joint collaboration between Rocky Mountain Institute, America’s Power Plan, and Advanced Energy Economy Institute.

New Utility Business Models: Utility and Regulatory Models for the Modern Era, by Ron Lehr – Western Grid Group (October 2013)

“Utility and Regulatory Models for the Modern Era” examines the evolving relationship between utilities and public utility commissions (PUCs). This paper offers recommendations for several types of utilities, but focuses mostly on vertically-integrated and regulated utilities. It outlines three future scenarios for utilities: minimum utility involvement, medium involvement as a “smart integrator” or “orchestrator,” or maximum role as an “energy services utility.”

Getting the Most out of Grid Modernization, by Mike O’Boyle and Sonia Aggarwal – Energy Innovation (February 2017)

The prospect of large grid modernization investment triggers a key question – is it worth it? As different states consider upfront investments in modernizing the grid, regulators need ways to ensure utilities maximize the potential benefits of grid modernization. This white paper provides program design considerations and metrics that can guide utility investment and increase the chances that customers get the most out of grid modernization efforts.

You Get What You Pay For: Moving Toward Value in Utility Compensation, Part 1 – Revenue & Profit, by Steve Kihm – Seventhwave, Ron Lehr – Western Grid Group, Sonia Aggarwal – Energy Innovation, and Edward Burgess – the Utility of the Future Center (June 2015)

This paper corrects two widely held notions in the regulatory community: that the utility’s rate of return is the sole value driver for utility shareholders and that rates of return are set at the cost of equity. Neither of these perceptions is correct. Instead, the financial “value engine”—the difference between a utility’s return on investment and its cost of capital—drives shareholder returns.  The authors argue that regulators should use this value engine to align utilities’ financial motivations with delivering value to customers and society. They can offer utilities opportunities to earn increased revenues when they provide value-based products and services.

You Get What You Pay For: Moving Toward Value in Utility Compensation, Part 2 – Regulatory Alternatives, by Dan Aas – E3 and Mike O’Boyle – Energy Innovation (June 2016)

This paper applies the utility shareholder “value engine” framework from part one to explore which regulatory models align utility profit with societal value under scenarios in which traditional, utility-owned, capital solutions may not be optimal for customers. The cases in this paper draw on simplified financial models to provide high-level insights into whether and to what extent cost of service, rate of return regulation and its alternatives (including performance incentive mechanisms and revenue-caps) can align utility shareholder value creation with societal value creation. Read the Executive Summary.

New Regulatory Models, by Sonia Aggarwal – Energy Innovation and Edward Burgess – the Utility of the Future Center (March 2014)

“New Regulatory Models” builds on “New Utility and Regulatory Models for the Modern Era” to propose new policy and regulatory opportunities for utilities, with a particular focus on performance-based ratemaking. The paper includes seven case studies to demonstrate lessons from experience with performance-oriented utility compensation mechanisms, and draws out some principles for policy design.

Utility Models: Questions for Regulators and Stakeholders to Ask and Answer as Utilities Evolve, by Ron Lehr and Sonia Aggarwal – Energy Innovation (February 2017)

Every utility regulatory model has embedded incentives. This list is intended to help state policymakers and other stakeholders pinpoint questions they can ask, and answers to explore how incentives from cost of service regulation and performance-based regulation relate to today’s power system goals.

Improving Performance in Publicly-Owned Utilities, by Sonia Aggarwal and Mike O’Boyle – Energy Innovation (November 2015)

This paper presents case studies about performance management in publicly-owned utilities, drawing out concrete steps that can support municipal utilities, public utility districts, and cooperatives to adapt to changing technology and market trends. These steps – which involve taking “no regrets” actions, exploring evolutions in government, and considering more drastic action if performance lags – can enable POUs to deliver greater value to their customers.

Series: Going Deep on Performance-based Regulation: Incentive Mechanism Design – Energy Innovation (April 2016)

Given the momentum toward performance-based regulation across the country, these briefs provide perspective on how regulators might decide to design performance incentive mechanisms for success.

Designing a Performance Incentive Mechanism for Peak Load Reduction: A Straw Proposal, by Michael O’Boyle – Peak electricity demand drives electricity system investment, including many of the most carbon-intensive generators called “peaker” units. Peak demand growth also drives utility investment, a key component of utility profits. In this white paper, we examine a straw proposal for a new performance incentive that would motivate utilities to reduce peak demand, improving the electricity system’s affordability and environmental performance.

Metrics for Energy Efficiency: Options and Adjustment Mechanisms, by Robbie Orvis, Sonia Aggarwal, and Michael O’Boyle – Adopting energy-efficient technologies across the economy is a key outcome for an affordable, reliable, clean electricity system. In many states, utility revenue is linked to energy efficiency, but the programs are bogged down in tedious and controversial evaluation, measurement, and verification requirements. In this white paper, we explore different approaches to simplify the measurement of energy efficiency savings to better align utility incentives with efficiency outcomes.

Avoiding Counterfactuals in Performance Incentive Mechanisms: California as a Case Study, by Robbie Orvis – When designing performance incentive mechanisms, regulators may consider using counterfactuals to measure utility savings. While counterfactuals may be appropriate as an adjustment mechanism, they can also lead to unfair outcomes and unnecessary regulatory conflict. This white paper examines California’s Risk-Reward Incentive Mechanism as a case study, and distills lessons for incentive design.

The Great Reinvention of the Electric Utility, by Hal Harvey – Energy Innovation (May 2015)

This paper describes three factors that will drive a change in the utility business model: new technology, declining electricity demand, and U.S. climate policies. Together, these forces result in a bleak financial picture for utilities under traditional regulatory structures; they demand a new business model. The piece argues for a new business model that rewards utilities for reliability, affordability, and environmental performance. It recommends a time-scale for performance objectives (five-seven years), a method for rolling out these changes, and opportunities for utilities to win in the power grid transformation.

Distributed Energy Resources: Policy Implications of Decentralization, by James Newcomb, Virginia Lacy, Lena Hansen, and Mathias Bell – Rocky Mountain Institute

Distributed energy resources can help deliver an efficient power system that is cleaner, more affordable, and more reliable. But these disruptive technologies are encountering a regulatory system designed for centralized power plants, monopoly utilities, and passive consumers. To incorporate distributed energy resources, policymakers must first quantify the full range of costs and benefits, analyze tradeoffs, and incorporate distributed energy and services into resource planning.  New market mechanisms and business models are needed for both utilities and new companies in order to drive innovation while preserving reliability. This paper lays out recommendations for taking advantage of distributed resources.

Distributed Generation: Supporting Generation on Both Sides of the Meter, by Joseph Wiedman – Interstate Renewable Energy Council, Inc., and Tom Beach – Crossborder Energy

Consumers are demanding increased control over their own energy production, especially through distributed generation. This paper provides recommendations for policymakers aiming to maximize the benefits of distributed generation. It details several policies that can support distributed generation.

An Adaptive Approach to Promote System Optimization, by Mike O’Boyle – America’s Power Plan, prepared for SEPA 51st State Initiative (Apr. 2015)

This paper was selected as one of three papers to be featured at the Solar Electric Power Association’s (SEPA) 51st State Summit on April 27, 2015 in San Diego in conjunction with its 2015 Utility Solar Conference. The 51st State Initiative asked authors to re-imagine our energy future in a hypothetical 51st State with no existing regulations or market structures.  Rather than focusing on specific policy recommendations, the paper returns to first principles of rate design and market structure that can guide regulatory policy in any state, no matter the constituency, resource availability, or regional market structure.

In response to interest at the Utility Solar Conference, Mike O’Boyle prepared an addendum to the 51st State concept paper – Who Should Own and Operate Distributed Energy Resources? This short paper presents a series of case studies seeking to draw experience from different ways of tackling the same problem: how to integrate cost-effective distributed technologies that have run into outdated regulatory models. By reviewing utility-owned and operated DERs, third party-operated DERs, and customer-operated DERs, this paper identifies strengths and weaknesses in each approach.


Articles

Overcoming Barriers to 100% Clean Energy, Part One: The Electricity Distribution Network.Eric Gimon. Forbes, July 2019.

U.S. Utilities Face Dramatic Change: Here’s How to Succeed at Utility Business Model Reform. Amanda Myers. Forbes, November 2018.

How Dumb Distribution Spending Crowds Out a Smart Clean Energy Future. Ric O’Connell. Greentech Media, November 2018.

Can a ‘DER Authority’ Fix the Utility Information Problem to Boost Clean Energy? Mike O’Boyle. Utility Dive, July 2018.

America’s Utility of the Future Forms Around Performance-Based Regulation. Sonia Aggarwal. Forbes, May 2018.

How to Build a Foundation for New Utility Business Models. Mike O’Boyle. Greentech Media, April 2018.

After Investing Billions, is Illinois Grid Modernization Paying Off for Utilities and Customers?Mike O’Boyle. Forbes, November 2017.

Emerging Lessons on Performance-Based Regulation From the United Kingdom. Sonia Aggarwal. Greentech Media, October 2017.

Three Ways Electric Utilities Can Avoid a Death Spiral. Mike O’Boyle. Forbes, September 2017.

Energy Efficiency’s Existential Crisis Is Also an Opportunity. Matt Golden. Greentech Media, July 2017.

Electric Grid Modernization: We Don’t Really Need You, Mr. President. Sonia Aggarwal. Forbes, March 2017.

How a Smart Grid Relies on Customer Demand Response to Manage Wind and Solar. Mike O’Boyle. Forbes, March 2017.

Harnessing the Power of the People Through “Value of Solar”…and Beyond. Mike O’Boyle. Forbes, February 2017.

Four Reasons 30% Wind and Solar is Technically No Big Deal. Aaron Bloom. Utility Dive, December 2016.

How Utilities Can Become Efficiency Innovators. Mike O’Boyle. Greentech Media, November 2016.

Alternatives to Conventional Utility Compensation Can Unlock Untapped Value. Mike O’Boyle. Greentech Media, July 2016.

Utilities in the Information Age: Moving From Construction to Optimization. Mike O’Boyle. Greentech Media, May 2016.

New York REV Shows Utilities and Regulators How to Manage Change. Eleanor Stein. Utility Dive, March 2016.

After Paris: The State of America’s Electricity Sector Emissions Headed Into 2016. Eric Gimon. Greentech Media, January 2016.

3 Ways Public Power Providers Can Prepare for Technology and Market Changes. Mike O’Boyle and Sonia Aggarwal. Greentech Media, December 2015.

Skin in the Game: New Case Studies Illuminate Best Practices for DER Ownership and Operation. Mike O’Boyle. The Energy Collective, September 2015.

From Old to New: How Rethinking Regulation Can Deliver a Smarter Electricity System.Sonia Aggarwal, Steve Kihm, and Ron Lehr. Greentech Media, August 2015.

Should Utilities Own Distributed Battery Storage? Mike O’Boyle and Sonia Aggarwal. Greentech Media, June 2015.