Outcomes from Expanded Earning Opportunities, Information Access, and Competition Could Influence Utility Reform Nationwide

Key Takeaways:

• The New York State Public Service Commission (NY PSC) Order to adopt a policy framework for ratemaking and revenue models aims to better align utility financial interests with consumer benefits
• The framework will add market-based platform earnings and outcome-based earning opportunities to conventional cost-of-service ratemaking
• The changes will nurture a retail market and a transactive power system that can be adapted to integrate resources both in front of and behind the meter
• Enhanced information and market tools will diminish the distinction between REV and conventional activities, and program outcomes could inform similar proceedings underway in other states, including California, Minnesota, and Hawaii

Entities Mentioned:

• Central Hudson Gas & Electric Corporation
• Consolidated Edison Company of New York
• National Grid
• New York State Electric & Gas Corporation
• New York State Public Service Commission
• Orange and Rockland Utilities

Insight for Industry – New Electric Utility Revenue Model Aligns Earnings with Market-Enabling Activities

On May 19, 2016, the New York State Public Service Commission (NY PSC) issued an order adopting a framework for a ratemaking and utility revenue model under the Reforming the Energy Vision (REV) initiative (Case 14-M-0101). Unveiled in 2014, REV seeks to transform the utility regulatory structure by integrating greater levels of distributed energy resources (DER) and empowering customers with energy management options.

The Order is a major step forward in providing a framework for utilities to generate revenue as distributed system platform (DSP) providers under REV. Moving away from the classic rate-setting mechanisms suitable for centralized power systems, the Order seeks to create a regulatory model that better aligns the interests of utility shareholders and customers. Utilities will be required to develop retail markets for DER, such as solar, geothermal, wind, fuel cells, combined heat and power, battery storage, energy efficiency, and other advanced energy services. New products and services will enable customers to manage their energy usage and reduce their energy bills through a bidirectional, transactive approach between customers and service providers. Still, the consumer sector will largely determine the success of REV, since customer-side resources can become the primary tool in improving the efficiency and resiliency of New York’s grid. The outcome could balance immediate measures that draw on market forces and technology innovation with long-term reform that preserves stable and reliable electric service while earning a fair return.

Innovations in ratemaking will also open market opportunities for technology pioneers and third party aggregators – energy service companies, retail suppliers, and demand-management companies – to develop products and services that enable customer engagement. In a mature DER market, utilities serving as platforms will be able to generate additional revenues from third-party market participants, offsetting traditional revenue requirements and providing utilities with financial incentives to foster an efficient mix of third party and utility investment.

The REV proposals have garnered cautious support from the state’s major electric utilities: Central Hudson Gas & Electric Corporation, Consolidated Edison Company of New York, New York State Electric & Gas Corporation, National Grid, Orange and Rockland Utilities, and Rochester Gas and Electric Corporation. The utilities concur with the concept of market-based earnings, but also emphasize the need for careful implementation without risk to current utility revenue streams and have sought to preserve traditional revenue streams until proven alternatives are achieved. The Order requires the utilities to file an overall system efficiency proposal by December 1, 2016.

New Regulatory Model Seeks to Align Utility Financial Incentives with Customer Interests

According to the NY PSC, a modernized electric system should align utility financial incentives with consumer benefits. Consumers benefit when utilities adopt cheaper alternatives compared with traditional rate-based capital investment and when they include cost-effective energy efficiency measures and DER into their basic business operations. The changes adopted in a previous May 19 Order envision a regulatory environment in which a utility would naturally seek system-level solutions that maximize the benefits of consumers and the earnings of utilities themselves. To this end, the Order seeks to reform the conventional cost-of-service ratemaking approach by adding a combination of market-based platform earnings and outcome-based earning opportunities. Utilities could integrate innovative third-party customer value-centric solutions and capital to create shareholder value that is equivalent to or better than conventional investments.

As an example, the NY PSC cited Consolidated Edison’s Brooklyn/Queens Demand Management (BQDM) Program, approved in December 2014 (Case 14-E-0302), as a non-wires alternative that demonstrates an early step toward cooperative arrangements. Through solar, batteries, and energy efficiency, the BQDM program enabled Consolidated Edison to defer the construction of a $1 billion electrical substation in Brooklyn. Recognizing that the utility had replaced capital investment with operating expenses to achieve the same goal, the Commission authorized a return on total program expenditures, as well as performance incentives tied to goals on customer savings. As such, the BQDM program represents innovation in planning and operations, as well as a new direction in ratemaking by aligning utility financial incentives with consumer interest. Among other REV demonstration projects, ConEd’s Virtual Power Plant project integrates behind-the-meter solar and storage resources into the distribution grid by aggregating residential installations into a virtual power plant, enabling the utility to harness an intermittent power source to provide distribution and transmission benefits.

As REV has moved from conceptual policy to practical implementation, several initiatives begun to yield results (Table 1). These include NY Sun, which supported 457 MW installed solar at the end of 2015; NY Green Bank, which leverages ratepayer funds to support clean energy objectives; and utility demonstration projects that enable utilities and third parties to form partnerships and business models to create consumer value. While some of these programs stem directly from REV and others were initiated in the lead-up to REV, all of them seek to advance the goals of REV in various sectors across New York’s energy industry. The most successful programs, such as NY Green Bank, could be replicated in other states that are also  following New York’s footsteps toward energy industry transformation. For example, California has been pursuing utility market reform, through multiple proceedings, to facilitate energy storage, smart grid deployment, demand response, and more recently, development of distributed resource plans.

 

By way of background, the REV proceeding involves two parallel tracks – Track One focused on developing the structure of the new utility market and DER ownership issues; and Track Two focused on changes in the current regulatory, tariff, market, and incentive structures to better align utility interests. On February 26, 2015, NY PSC issued the REV Track One regulatory framework to guide a transition for the utilities to serve as a DSP provider and develop DER markets for a reformed retail electric industry. The May 19 Ordercodifies Track Two of the REV proceeding. This most recent Order underscores three goals from the February 2015 policy framework that are also relevant to ratemaking reform:

• Evolving the unidirectional grid into a more diversified and resilient distributed model engaging customers and third parties;
• Changing the role of regulated utilities to ensure universal, reliable, resilient, and secure delivery service at just and reasonable prices;
• Combining utility and third party investment to improve the overall efficiency of the system and consumer value and choice.

New Earning Opportunities Include Transitional Measures toward Mature Markets

In addition to the traditional cost-of-service revenue stream, under the new May 19 policy framework utilities can now also receive earnings from the following sources:

• Alternatives that reduce utility capital investment and deliver clear-cut consumer benefits, such as cost-effective DER;
• Market-facing platform activities, such as facilitating value-added services by active DSP users; and
• Transitional outcome-based performance measures.

In addition to these, the Order outlines Earning Adjustment Mechanisms (EAMs) as transitional outcome-based performance measures in the transition toward mature markets. These EAM activities will include:

• System efficiency – facilitating a combination of peak reduction and load factor improvement by requiring utilities to propose system efficiency targets with achievement strategies, cost-effectiveness demonstration, and earnings incentive;
• Energy efficiency – implementing measure to reach targets recommended by the Clean Energy Advisory Council, which are above and beyond the currently approved targets;
• Interconnection –improving cooperation between utilities and renewable projects through a positive incentive tied to developer satisfaction with utility responses;
• Customer engagement –encouraging EAMs that are tied to customer uptake in specific innovative programs.

While EAMs pertain to near-term measures to create customer savings to develop market-enabling tools, Platform Service Revenues (PSRs) are a new form of utility revenues associated with operating and enabling distribution-level markets. Initially, utility revenues would come from displacing traditional infrastructure projects with non-wires alternatives. As markets mature, PSRs would form a larger component of utility revenues, thereby diminishing the need for EAMs. NY PSC outlines a process to facilitate the approval of PSR-generating products and services, pricing of those services, and revenue allocation between ratepayers and shareholders. The process will differentiate monopoly services from services that could be performed by third parties. The Commission underscores that this distinction is critical in the ratemaking treatment of new revenue sources.

In addition, utilities would have earning opportunities tied to overall cost reduction of achieving the Clean Energy Standard (CES) goal of achieving 50 percent renewable generation by 2030. Unregulated utility subsidiaries can also take part in competitive value-added services and generate competitive market-based earnings.

Information Access and Customer Choice Will Foster Innovation under the New Model

With the new Order, the NY PSC has recognized that dramatic advances in information technology and automation, changes in competitive markets outside the utility industry, and improvements in customers’ ability to compare options and maximize value will foster innovation. Information transparency and ease of consumer access – characteristic of more competitive markets and multi-sided platform businesses – will serve to mitigate concerns on the ability to monitor utility costs. While the Order prioritizes REV activities such as DER integration and grid modernization, it notes that there is no boundary between REV activities and conventional activities and that the distinction will become less relevant with enhanced information and market tools that facilitate whole-system approach to efficiency.

One critique of traditional cost-of-service regulation, in which utilities receive an approved rate of return on their investments, is that it has caused utilities to remain insulated from the competitive pressures and opportunities of the current information economy, resulting in low capital productivity and slow adoption of information technologies and new business models. In addition, while the old model has been suitable for a centralized system with ever-growing load, the approach lacks sufficient incentives for innovation given the fast-changing market, new technologies, and evolving environmental factors. The Commission underscored several assumptions that framed the development of cost-of-service regulation, such as independent demand-driven investment or economies of scale from large utility-scale investments no longer hold. The new model, abandoning these obsolete assumptions, now aims to boost innovation and overall efficiency in the sector.

New Rate Designs Encourage Price-Responsive Behavior and Voluntary Participation in Advanced Rate Setting

As the customer side of the grid must also serve as a system resource under the new model, energy prices must spur more efficient investment decisions on the part of customers. To that end, NY PSC seeks rate design changes that improve price signals and opportunities for customers to participate in DER markets. The Commission will utilize enhanced technology and markets, such as information-sharing and incentives, to boost efficiency, productivity, and affordability of the grid, while monitoring the impact on consumer bills – particularly for the most cost-sensitive residential and commercial customers.

In order for the REV initiatives to be effective, customers need additional demonstrations and analyses of bill impacts prior to the adoption of generalized demand charges or default time-of-use (TOU) rates for mass-market consumption. In the near-term, rate design changes will focus on opt-in programs. The May 19 Order requires opt-in TOU rates given the current low customer adoption level, and it also requires each utility to develop promotion and customer education tools. To increase customer acceptance, utilities are encouraged to use shadow billing that allows customers to compare their existing bills against a TOU option as well as temporary bill protections to ensure accurate charges for comparable total usage.

Another customer-side model is the Smart Home Rate (SHR), currently under examination in the context of demonstration and early adoption, provides a rate design model that could be widely adopted as markets mature. The SHR combines highly granular time-based rates with location-and-time-based DER compensation, facilitating automatic management to optimize value for the customer and the system. SHR participants would be able to offer load shifting, peak reduction, voltage, and other ancillary services, and automatic response on a utility-specified time interval. Energy service companies (ESCOs) supported the concept of a more granular rate, but argued that only third parties, such as themselves, should offer SHRs which include DER products that utilities are not permitted to provide. The Retail Energy Supply Association argued that SHRs would put utilities into direct competition with ESCOs. However, the Order said that SHRs should initially be offered on a demonstration basis by utilities, ensuring participants that investments will not be stymied by superseding developments. The Order explained that SHRs are associated with substantial risks and uncertainties, which could impede investment in the near term and continued evolution of rate design and markets could cause other developments to take precedent over an early SHP version.

Customer Empowerment with Information-Sharing Tools Will Facilitate Market Development

Empowering consumers with tools to readily share energy data usage information with vendors will facilitate market development under the new model. In addition, ruling out charges for basic data will reduce barriers to consumer use. The Order establishes a scorecard to track at least ten measures of utility performance against REV-envisioned outcomes. With continued deployment of advanced metering infrastructure, basic data – which is simply “adequate information to enable customer management of energy usage” – will evolve to include near real-time data. Under the Order, utilities may not charge for basic data shared with the customer or customer-authorized vendors; and information will be free of charge where the utility meter installation and associated costs are borne by utility customers as part of regulated rates. However, utilities may assess charges for information beyond basic data.

To ensure customer privacy, NY PSC will continue to require that individual customer usage data be released only to developers authorized by customers on an opt-in basis. The Commission also intends to take steps through Green Button and other initiatives to facilitate such authorizations and transfers. With regard to standardized reporting of aggregate energy usage data, the NY PSC directs utilities to continue to provide updates for Community Energy Reports and Utility Energy Registry and intends to revisit charges once fully automated systems are developed. Regarding data privacy, utilities will follow their existing internal policies to ensure that aggregated data is adequately anonymous, withhold data if necessary, and allow for opt-outs.

These reforms will be implemented in the context of rate proceedings, or the Distributed System Implementation Plan (DSIP) process, as appropriate. The Commission recognizes that some measures require earlier action as utilities are under different stages of their rate plan cycle. Measures beyond the context of a rate plan would be subject to specified deferral mechanism provisions of existing rate plans.

Growing Demand for Distributed and Demand-Side Resources Spur Ratemaking Reforms across States

Several other states have initiated regulatory proceedings on DERs and the role of the utilities in the distribution system, although not as ambitious as REV’s overhaul of ratemaking practices (Table 2). For these, New York’s REV proceeding will provide valuable insights in terms of best practices and challenges encountered. Among the other proceedings, several notable examples include:

California: In August 2015, California Public Utilities Commission (CA PUC) issued a decision (R1410003) adopting an expanded scope and definition for the integration of demand-side resources, casting a new vision to the October 2014 proceeding intended to find better ways for existing demand-response and energy-efficiency programs to support broader policy goals. The decision takes California a step closer to New York’s REV in terms of envisioning open markets for DER. The decision aims to address concerns regarding the current regulatory framework and utility business model as they relate to the expanded DER deployment, integrating demand-side resources, including relevant valuation methodologies, sourcing mechanisms, and adoption of localized incentives.

Minnesota: Xcel Minnesota is involved in the E21 Initiative, an innovative project to develop new performance-based regulatory models — the basis of new energy legislation in the state. The Minnesota Public Utilities Commission (MN PUC) has initiated a proceeding (15-556) to consider development of policies related to grid modernization with a focus on distribution system planning. In March, MN PUC staff released a report noting that while Minnesota did not face a pressing need to address the issues due to its vertically integrated utilities and relatively low penetration of distributed generation, distributed generation was increasing and would gain importance in the future, allowing the state to address these issues in a more measured and reasoned manner.

Hawaii: In April 2014, the Hawaii Public Utilities Commission (HI PUC) rejected (2012-0036) the Integrated Resource Plan from the Hawaii Electric Company (HECO) and associated utilities. The PUC issued new directives, which would align the utilities’ business models with customers’ demands and requirements of Hawaii’s energy policies, including lower power prices, faster interconnections for distributed generation, and better integration of distributed generation into the state grid. A proposed takeover of Hawaii Electric Industries (HEI), the state’s largest public company, by NextEra Energy has prompted activists to push for a publicly-owned alternative like the one proposed by the Hawaii Island Energy Cooperative (HIEC). Governor David Ige has opposed the suggested merger citing failure to align with the state’s renewable energy goal – 100 percent renewable generation by 2045.

 

Table 2 – Open Dockets Related to Utility Business Model Reforms (Source: EnerKnol)

State	Docket	Description
California	R1410003	Rulemaking to create a consistent regulatory framework for the guidance, planning, and evaluation of integrated distributed energy resources
Hawaii	2015-0022	Proceeding on application for approval of proposed change of control and related maters
Minnesota	15-662	Proceeding regarding alternative rate design stakeholder process for Xcel Energy
Michigan	U-17301	Proceeding regarding regulatory reviews, revisions, for Consumer Energy Company to file a proposed renewable energy plan (REP)
Massachusetts	15-155	Investigation on the propriety of the rates and charges proposed by Massachusetts Electric Company and Nantucket Electric Company in their petition for approval of an increase in base distribution rates for electric service
Missouri	ER-2012-0166	Proceeding regarding Union Electric Company’s tariffs to increase its revenues for electric service
Wisconsin	5-UR-107	Proceeding on application of Wisconsin Electric Power Company and Wisconsin Gas to conduct a biennial review of costs and rates –Test Year 2015 Rate

 

New York’s structural reforms represent a major step forward in achieving the state’s future electricity system, and developments in New York’s REV proceeding will provide insight for regulators, utilities, and stakeholders in other states seeking to address challenges and opportunities in the evolving electricity sector.

Reforms that aim to incentivize DERs within the traditional cost-of-service regulatory framework could be more appealing for utilities, as they would retain their existing revenue model and status to attract investors. Over the two years of the REV proceeding, utilities have agreed with goals of increased DER penetration, while stressing the need to preserve traditional revenue streams until alternatives are established. By expanding the list of sources for utility revenues, New York has ensured that the utilities share the incentive of increased distributed generation and technology-driven grid efficiency and productivity, an approach that could likely be replicated.

Originally published by EnerKnol.

EnerKnol provides U.S. energy policy research and data services to support investment decisions across all sectors of the energy industry. Headquartered in New York City, EnerKnol is proud to be a NYC ACRE company.