NEW YORK – JULY 23: A woman walks past power lines on the sidewalk as workers try to restore electrical service July 23, 2006 in the Queens borough of New York City. Many Con Edison and other electrical workers have been working long hours attempting to restore power to thousands of people that were left without electricity after a blackout a week ago. (Photo by Chris Hondros/Getty Images)
New York can begin to catalyze the transformation of its electric utilities by putting the right incentives in place for utilities to perform some of the duties envisioned for its distributed system platforms of the future.
In a February order, the New York State Public Service Commission (PSC) released the first major decision of its “Reforming the Energy Vision (REV)” proceeding, announcing that it would give utilities the first shot to act as distributed system platform (DSP) providers. To fill this role, utilities will have to serve as “air traffic controllers” for the electricity sector, facilitating flows of energy between the bulk and distribution systems in a way that animates markets for distributed energy resources.
This transition signals fundamental changes to utilities’ traditional way of doing business that will not take place overnight. The PSC can begin to catalyze this shift by incentivizing utilities to start performing some of the duties it eventually hopes the DSPs fulfill. To do this, regulators should retool their approach to determining how much money they permit utilities to collect, moving away from cost-based regulation to an “integrated” form of performance-based regulation (more on this concept below).
Under the traditional “cost-of-service” convention, regulators limit the revenue that utilities can collect to an amount that gives them a reasonable rate of return on their spending. Over time, New York has moved away from a pure cost-of-service approach and made tentative steps toward what is known as performance-based regulation (PBR), in which revenues are at least partially determined by the quality of utility service, rather than just utilities’ reported costs.
PBR uses performance incentives to encourage utilities to meet targets in categories that typically include reliability, energy efficiency, and customer satisfaction; if utilities miss their targets, they won’t be able to earn a rate of return comparable to what they’d have gotten under cost-of-service regulation. New York and several other states currently use a form of PBR that provides performance incentives to reinforce a narrow set of objectives, namely maintaining service reliability and strengthening energy efficiency. To advance REV’s lofty ambitions, regulators will need to broaden the range of performance incentives to address more of REV’s policy goals, including reduced greenhouse gas emissions and improved system-wide efficiency.
Regulators should also revisit how they determine the guaranteed portion of revenues, known as the base revenue allowance, to ensure that utilities deliver these broader performance attributes cost-effectively. At present, the PSC sets base revenues at a level that covers and provides a reasonable return on a utility’s past costs. But as noted by participants of a recent roundtable discussion at NYU, this approach encourages utilities to run up expenses as a way to increase profits and thus hinders New York’s efforts to economize utility costs. To break this pattern, the PSC should limit base revenue allowances to cover only efficient costs, as determined through a process called “benchmarking.” The use of benchmarking should lead to less generous allowances than those set through cost-of-service regulation, which should help to keep costs down.
The PSC can promote REV’s ambitious policy agenda by combining broader performance incentives and benchmarked base revenue allowances—a package best described as “integrated PBR.” These features allow integrated PBR to limit guaranteed revenues and amplify the potential for performance-based earnings, which should enhance utilities’ focus on the desired policy outcomes of performance incentives.
New York will need to proceed with caution as it transitions towards a more integrated approach. The state’s prior experiences with benchmarking didn’t fare too well (see page 22 of this report), so regulators have to come up with a better benchmarking solution to compare costs and performance across utilities. In addition, regulators will have to gather extensive performance data to determine appropriate performance targets and financial incentives. This could be quite a lengthy process, particularly for newer measures that utilities have never had to track. The PSC should also conduct careful analysis to ensure that financial incentives are large enough to motivate utilities, but not so large that they overshoot the net benefits to customers.
PBR gives New York a tool to steer its utilities into bold and uncharted territory in pursuit of REV goals. But the PSC must hone this instrument through conscientious data collection and analysis to ensure that it gets the incentives right.
Benjamin Mandel is an Energy Law & Policy Fellow at the Frank J. Guarini Center on Environmental, Energy and Land Use Law at NYU Law School.
Making New York’s ‘Energy Vision’ a Reality through ‘Integrated’ Performance-Based Regulation
By Benjamin Mandel on May 07, 2015 at 12:00 PMNEW YORK – JULY 23: A woman walks past power lines on the sidewalk as workers try to restore electrical service July 23, 2006 in the Queens borough of New York City. Many Con Edison and other electrical workers have been working long hours attempting to restore power to thousands of people that were left without electricity after a blackout a week ago. (Photo by Chris Hondros/Getty Images)
New York can begin to catalyze the transformation of its electric utilities by putting the right incentives in place for utilities to perform some of the duties envisioned for its distributed system platforms of the future.
In a February order, the New York State Public Service Commission (PSC) released the first major decision of its “Reforming the Energy Vision (REV)” proceeding, announcing that it would give utilities the first shot to act as distributed system platform (DSP) providers. To fill this role, utilities will have to serve as “air traffic controllers” for the electricity sector, facilitating flows of energy between the bulk and distribution systems in a way that animates markets for distributed energy resources.
This transition signals fundamental changes to utilities’ traditional way of doing business that will not take place overnight. The PSC can begin to catalyze this shift by incentivizing utilities to start performing some of the duties it eventually hopes the DSPs fulfill. To do this, regulators should retool their approach to determining how much money they permit utilities to collect, moving away from cost-based regulation to an “integrated” form of performance-based regulation (more on this concept below).
Under the traditional “cost-of-service” convention, regulators limit the revenue that utilities can collect to an amount that gives them a reasonable rate of return on their spending. Over time, New York has moved away from a pure cost-of-service approach and made tentative steps toward what is known as performance-based regulation (PBR), in which revenues are at least partially determined by the quality of utility service, rather than just utilities’ reported costs.
PBR uses performance incentives to encourage utilities to meet targets in categories that typically include reliability, energy efficiency, and customer satisfaction; if utilities miss their targets, they won’t be able to earn a rate of return comparable to what they’d have gotten under cost-of-service regulation. New York and several other states currently use a form of PBR that provides performance incentives to reinforce a narrow set of objectives, namely maintaining service reliability and strengthening energy efficiency. To advance REV’s lofty ambitions, regulators will need to broaden the range of performance incentives to address more of REV’s policy goals, including reduced greenhouse gas emissions and improved system-wide efficiency.
Regulators should also revisit how they determine the guaranteed portion of revenues, known as the base revenue allowance, to ensure that utilities deliver these broader performance attributes cost-effectively. At present, the PSC sets base revenues at a level that covers and provides a reasonable return on a utility’s past costs. But as noted by participants of a recent roundtable discussion at NYU, this approach encourages utilities to run up expenses as a way to increase profits and thus hinders New York’s efforts to economize utility costs. To break this pattern, the PSC should limit base revenue allowances to cover only efficient costs, as determined through a process called “benchmarking.” The use of benchmarking should lead to less generous allowances than those set through cost-of-service regulation, which should help to keep costs down.
The PSC can promote REV’s ambitious policy agenda by combining broader performance incentives and benchmarked base revenue allowances—a package best described as “integrated PBR.” These features allow integrated PBR to limit guaranteed revenues and amplify the potential for performance-based earnings, which should enhance utilities’ focus on the desired policy outcomes of performance incentives.
New York will need to proceed with caution as it transitions towards a more integrated approach. The state’s prior experiences with benchmarking didn’t fare too well (see page 22 of this report), so regulators have to come up with a better benchmarking solution to compare costs and performance across utilities. In addition, regulators will have to gather extensive performance data to determine appropriate performance targets and financial incentives. This could be quite a lengthy process, particularly for newer measures that utilities have never had to track. The PSC should also conduct careful analysis to ensure that financial incentives are large enough to motivate utilities, but not so large that they overshoot the net benefits to customers.
PBR gives New York a tool to steer its utilities into bold and uncharted territory in pursuit of REV goals. But the PSC must hone this instrument through conscientious data collection and analysis to ensure that it gets the incentives right.
Benjamin Mandel is an Energy Law & Policy Fellow at the Frank J. Guarini Center on Environmental, Energy and Land Use Law at NYU Law School.
Topics: Comment, Demand Management, Energy Efficiency, New York, NYU, NYU Law, Reforming the Energy Vision, Reliability, REV, Utilities