Brewing Up the Regulation of the Future
The regulatory system that governs U.S. electric utilities is 130 years old—while our power grid is rapidly modernizing. Utility regulators need a tool that can facilitate reform to keep pace with this change. One tool they are increasingly exploring: performance-based regulation, or PBR for short (no, it’s not a beer, it just sounds like one).
A variety of states are now eyeing the idea of tying revenues to utilities’ ability to meet performance goals, and RAP has been providing recommendations on how to put PBR ideas to work in various contexts. This blog is the first in a series that will examine best practices, design considerations, and specific applications. What goes into the 21st-century brew that is PBR? Let’s learn more.
The Traditional Model
Most utility regulation in the United States today is cost-of-service (COS) regulation. This means that consumers pay utilities for the cost of providing electric service (e.g., for transmission, distribution and other utility infrastructure), plus a regulated return on their investment. The regulators’ job is to oversee this arrangement, ensuring that service is safe and reliable and that rates are fair. This approach incentivizes certain behaviors: regulated utilities recognize they can maximize revenue and profits by building more generation, transmission, distribution, and other infrastructure, and by selling more electricity between rate cases. This works particularly well for a system with large, centralized power plants that required substantial capital investments.
But today, average residential customers are increasingly able to control their energy usage through efficiency upgrades and energy management tools, and even to become grid resources themselves through behind-the-meter solar or storage. This is a fundamental shift from the 20th-century era of large, centrally operated generating plants. Consumers are seeking different energy options, and in much of the United States, electricity use is not growing – which would serve to keep rates down – as it did in the 20th century.
Can the aging regulatory paradigm adapt to the changing nature of resources, delivery, and consumption of energy? How can regulation help deliver what customers want today, and still keep utilities profitable and responsive in the face of these fundamental changes?
The Modern Approach
PBR is one route to accomplish this regulatory reform. Instead of solely evaluating utilities’ costs, PBR focuses on the outcomes that policy makers and stakeholders (regulators, utilities, consumers, advocates) establish, and then rewards utilities based on their performance. While traditional COS regulation looks at performance in terms of sales, revenue, rates, and often reliability, PBR addresses these concerns and additionally incentivizes goals like customer engagement and empowerment, environmental outcomes, and cost-effectiveness.
The good news for regulators looking to reform the current regulatory system – but unsure how to proceed – is that PBR can take a variety of forms and pursue different goals, from simply adding individual mechanisms to revising the whole regulatory paradigm.
Individual mechanisms, or performance incentive mechanisms (PIMs), act as an overlay on a traditional COS regulatory framework. PIMs set specific performance metrics to affect utility behavior in a way that furthers public interest priorities. They provide a bonus – or penalty – to strengthen performance in target areas. Many jurisdictions in the US have experience using PIMs for energy efficiency incentives.
At the other end of the spectrum, PBR can be designed to transform the whole regulatory system to focus on specific goals. The United Kingdom’s Revenues = Incentives + Innovation + Outputs (RIIO) approach focuses on six major outputs as a means to evolve the energy system of the future. These outputs are linked to incentives to advance the overall goal of a lower cost, more sustainable energy system. Similarly, New York’s Reforming the Energy Vision (REV) process is constructing a regulatory system that rewards distribution utilities for high levels of customer satisfaction, facilitates power sector transformation to cleaner and more distributed resources, and focuses increasingly on outcomes rather than inputs.
Like home brewers choosing from a range of recipes, utility regulators have a range of options for implementing PBR, and they can readily review mechanisms that worked (or didn’t work) elsewhere for lessons learned. Having considered “what” PBR is here, the next post in this series will introduce “how” PBR can be implemented, and examine design practices to ensure that performance incentive mechanisms are successful.