A lot of folks out there (including we at RAP) have, for the last four decades, been devising ways to make utilities more economically efficient, their customers more energy-efficient, and the power system cleaner, sustainable, more equitable, and non-emitting. But now they have a problem: the world has changed, and suddenly we need more of that thing that they for so long tried to constrain. Now that the time has finally come to make the leap that has to be made if our climate crisis is to be solved, we’re like the proverbial deer in the headlights — if only for a moment. The prospect of wild load growth in electric demand is a bit hard to swallow at first. It’s both frightening and, well, electrifying.
Efficiency has been the central theme of electric sector reform for nearly a half century. It is the recognition that meeting a society’s energy needs is not simply a matter of “more is better” but rather of “no more than is necessary (and it’d better be as environmentally benign as possible).” This insight meant that we should not use energy when it was cheaper and more valuable to save it. And it meant that the traditional business model of the monopoly electric utility had to change—that profitability could no longer be linked to growth in commodity sales but to the least-cost provision of energy service and achievement of express public policy objectives.
So what’s the problem?
Well, it turns out that we need more, lots more, of a particular kind of energy — electricity from non-emitting resources — if we’re going to decarbonize as much of the economy as we possibly can. We need clean electricity for transportation, heating and cooling, agriculture, and industry. Are the regulatory reforms that we’ve advanced in the past thirty-odd years — in particular, integrated resource planning, revenue decoupling, and systems of performance-based rewards and penalties — appropriate to a vision that calls for a great expansion in our use of electricity and therefore a sea change in how we produce and deliver it?
The answer is yes, and it shouldn’t surprise us. It follows directly from an approach to economic analysis and policy — aimed at maximizing the net societal benefits of energy use — that we’ve relied on for decades. Thirty years ago, given the costs, expectations, and constraints we faced, the analyses pointed us in certain directions. Today, given different costs, expanded expectations, and more urgent constraints, they point us in new directions. In both cases, they told us how to minimize the costs — that is, maximize the benefits — of our desired path.
At a conceptual level, the problem isn’t daunting. It’s time to truly look at the energy system in its entirety, not just the electric system. How do we minimize the total costs of energy production and use, while meeting our climate, economic, and social goals?
It’s simple. The least-cost path is characterized by massive fuel-switching — from fossil fuels to clean, emissions-free sources, primarily electricity. But it’s not that simple. It doesn’t relieve us of the duty to make sure those new loads are as efficient as possible and are managed as efficiently as possible — indeed, it insists upon it, since any waste only increases costs. It isn’t right simply to say “Electrify!” How we electrify matters.
The good news is that our planning tools and regulatory methods are up to the task. We know how to think about the problem, consider alternatives, test uncertain futures. We know how to change course when circumstances dictate. And we know that utilities and market actors respond to the forces that act upon them, which means that we should still care deeply about whether their private financial incentives align with the public interest. We want these players to be successful by doing the right things.
So what does this mean for the utility business model? For the “wires” sides of the business — transmission and distribution — in both vertically integrated and competitively restructured markets, there’s still every reason to remove the “throughput incentive.” Whether load is growing or not, a utility whose revenues and profits are a direct function of kilowatt-hour sales (that is, of kWh deliveries) has a very powerful incentive to encourage usage, even if that usage is inefficient. We shouldn’t think that, simply because the electricity is clean, we have license to be profligate. The recent decision of the Massachusetts Department of Public Utilities to scrap Eversource’s decoupling regime, on the grounds that good ol’ fashioned price-only regulation will encourage the company to promote electrification. Probably it will, but, alas, it won’t give the utility much, if any, reason to care whether the electrification is in the best interests of society.
Revenue decoupling remains a critical element of a regulatory regime that aims for least-cost investment in, and operation of, the grid. It keeps the regulated monopoly focused on efficient operations. But, by itself, it doesn’t guarantee utility enthusiasm for preferred outcomes. Legal and regulatory obligations go a long way to solving that problem, but there’s a place for carrots and sticks too. Performance measures, with achievement rewards and penalties, overlaid on a decoupling mechanism, are powerful drivers of policy objectives.
What about the commodity side of the business? Again, in both vertically integrated and restructured markets, investment has been and will continue to be propelled in significant measure by policy requirements, such as renewable portfolio standards and emissions reductions requirements (e.g., cap-and-invest programs). These have been effective in transforming our resource portfolios and, moreover, have helped drive deep cost reductions in clean energy technologies, so that now the relative costs begin to favor the preferred investments. Important wholesale market reforms are still needed, but the outlook is good.
In those places where utilities remain vertically integrated, the question of how power costs should be recovered is of acute interest, especially where price risk has been shifted to consumers by means of fuel adjustment clauses and power-cost pass-throughs. How these mechanisms, intended to insulate shareholders from the volatility of global energy prices, distort management imperatives to manage power costs and investment for the long-term good of both consumers and shareholders has been well understood for decades. It’s time to revisit these tools, to consider whether and how they can be reformed to better align private incentives with the public good. Utilities and other load-serving entities possess the comparative advantage for bearing price, climate, and other market risks. Some simple fixes to power-cost recovery mechanisms will go a long way to reordering those risks and creating the environment in which clean, reliable electricity flourishes.
By all means, let’s let utilities and other market actors make money providing the energy and energy services we want. And that includes where increased load is societally most efficient—which is to say, the least-cost means of meeting demand for reliable, equitable service and, among other things, our climate goals.
Stay tuned for more blogs in this series. We’ll dig into some of the knottier regulatory challenges that large growth in load raises and try to answer the question: “Just what does a regulatory scheme look like that promises to achieve these ends?”