Developing a Twenty-first Century Model for
Regulating Electric Utilities
Paul Centolella, Vice President
Policy Institute for Governors' Energy Advisors
Electric Utility Regulation for the 21
stCentury
•
Most state regulated electric rates set using conventional cost of service model
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Proposed in 1898 by Commonwealth Edison President Samuel Insull: “all charges
for services fixed by public bodies to be based on cost plus a reasonable profit.”
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Objective: Prevent utility monopoly from charging unreasonable or discriminatory
prices or providing inadequate service – Static Efficiency
•
Is cost of service regulation the appropriate model for this century?
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Information, communications, and other advanced technologies can produce large
efficiency gains – Dynamic Efficiency
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Electric utilities are being asked to perform fundamentally new functions:
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Make the grid resilient from increasingly frequent severe weather events
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Become a front line cyber security defender
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Integrate variable and distributed resources
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The traditional source of revenue for new investment – sales growth – may not be
available
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U.S. electricity sales declined by 1.8% in 2012 and have fallen in four of the last
five years. – U.S. Energy Information Administration
Is Conventional Regulation Meeting its Primary Objective?
• The average U.S. generation capacity factor is below 50% and average utilization of transmission and distribution assets is frequently lower – U.S. Energy Information Administration
•
Average asset utilization in other capital intensive industries typically exceeds 75%• The number of reported major disturbances – outages involving large numbers of customers – has more than doubled since the early 1990s. - North American
Electric Reliability Corporation
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Few commissions expressly consider the value to customers of uninterrupted service• Electric utilities spend approximately 0.2% of revenue on research and development – Battelle Global R&D Survey
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This is less one-tenth the average rate of 3.6% for all sectors of the U.S. economy and much lower than in the most productive sectors“The single most widely accepted rule for the governance of the regulated industries is regulate them
in such a way as to produce the same results as would be produced by effective competition, if it were
feasible.“
- Dr. Alfred Kahn,
The Economics of Regulation: Principles and Institutions
(1970)
0% 5% 10% 15% 20%
R&D Spending as a Share of Sales Pharmaceuticals Aerospace and Defense Computers and Electronics Automotive Electric Utility
0 100 200 300 400
Germany Netherlands Italy France Great Britian Czech Republic Portugal United States Poland
Average Minutes of Service Interruption Per Customer
Is Conventional Regulation Protecting Consumers?
•
American Society of Civil Engineers: Maintaining
reliable electric infrastructure (with limited
modernization) would require $673 billion in new
investment by 2020 – ASCE (2011)
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Required investment exceeds the market capitalization of U.S. Investor Owned Electric Companies•
ASCE: If utilities fail to close the investment gap –•
“As costs to households and businesses associated withservice interruptions rise, GDP will fall by a total of $496 billion by 2020. The U.S. economy will end up with an average of 529,000 fewer jobs than it would otherwise have by 2020. …. In addition, personal income in the U.S. will fall by a total of $656 billion from expected levels by 2020.”
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In conventional ratemaking, regulatory lag can have
negative impacts on utility cash flow & earnings,
becoming a significant barrier to needed investment
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From 2005 through 2012, investor owned electric companies experienced $153 billion free cash flow deficit (after capital spending and dividend payments) – Edison Electric Institute•
Frequent rate cases undermine the incentive for utilities
to achieve cost savings:
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Cost savings in one year mean lower allowed revenue in the next-$60 -$40 -$20 $0 $20 $40 $60 $80 $100
Billion
$
U.S. Investor Owned Electric Utility Capital Spending & Free Cash Flow
Is Conventional Regulation Creating an Affordable & Sustainable Future?
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Conventional regulation provides little incentive for utilities to innovate
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Conventional regulation creates first mover disadvantages
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Costs may be disallowed in innovation fails and utility may be criticized for failing to implement more
rapidly or broadly if the innovation succeeds
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Utility may be subject to a lengthy regulatory review process before implementing a new
system or change a previously approved practice
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Competitive firms can rapidly experiment, learn, and, if necessary, redirect efforts
Commercial Price Range Levelized Cost of Electricity $500 $400 $300 $200 $100 Combined Cycle Gas Turbine (CCGT)
Coal Coal / CCGT CCS On-Shore Wind Off-Shore Wind
Nuclear PV CSP
$/M
W
h
•
Innovation is essential to creating options
for ensuring sustainable, affordable power
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Low carbon electric generation remains
more costly than higher emitting sources
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Without RE < C, carbon goals (80%
reduction in 40 years) are much less likely
to be globally accepted and achieved
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Neither customer participation nor the
operation of the grid are designed to
integrate variable renewable generation
What are the Existing Forms of Alternative Regulation?
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Rate Making Models that Lean Toward Supporting Investment
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Constructive PUC / utility relationship needed: May involve advance planning & after the fact prudence reviews•
Limited incentives to reduce costs or improve productivity and efficiencyModel
Examples
Form
Key Implications
Annual Rate Case Wisconsin Forecast test year Limited efficiency incentive, administratively burdensome
Capital Expenditure Tracker
Pennsylvania, California, Ohio
Separate rider for investments
Incents investment, retains incentive to reduce other costs
Formula Rate FERC, Illinois Reported costs + return on capital
Little efficiency incentive,
any regulatory risk reduces spending
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Rate Making Models that Lean Toward Incenting Efficiency
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Strong incentive to cut costs between rate proceedings (may share cost savings)•
Absent strong reliability incentives, associated with reduced reliability & inconsistent with increased investmentModel
Examples
Form
Key Implications
Multi-year Revenue or Price Cap
Central Maine Power, NSTAR, Ontario
Price index – productivity +/- extraordinary items
Indices may not be representative during an investment cycle (Earnings sharing
An Emerging Regulatory Framework:
Results based, Forward Looking Regulatory Contracts
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U.K. Office of Gas & Electric Markets’ review of 20-years of price cap regulation
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RIIO: “
R
evenue set to deliver strong
I
ncentives,
I
nnovation and
O
utputs,”
•
Developed after extensive multi-year stakeholder consultation
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Seeks to mimic competitive markets with incentives for efficiency, delivery of long-term
value to customers and innovation
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Forward looking regulatory contract that combines: multiple strong output incentives, cost
savings incentive, management flexibility on how to deliver outputs and savings, sharing
with customers of earnings variances above and below target levels, and funding for
innovation projects
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Massachusetts Electric Grid Modernization Stakeholder Working Group
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Commission initiated, nine month facilitated dialogue with active participation of twenty-seven
stakeholder organizations
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“Utility of the Future Today” Regulatory Framework
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Forward looking performance based model
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First choice of National Grid, Massachusetts Department of Energy Resources, ISO New
England, and fifteen other parties
An Emerging Regulatory Framework:
Results based, Forward Looking Regulatory Contracts
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RIIO Components•
Eight year revenue cap based on regulatory review of utility’s business plan•
Duration provides utility incentive to innovate•
Fast vs. slow (capitalization) recovery percentages set in advance – utility can efficiently adjust itsactual capital and operating spending
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Efficiency incentive: Earnings sharing mechanism•
Utility has continuing incentive to reduce total costs•
Significant output incentives for:•
Reliability (based on the value to customers of uninterrupted service)•
Conditions for interconnection•
Environmental impacts•
Customer satisfaction•
Social Obligations•
Safety•
Funding for Innovation:Paul Centolella
Vice President
111 Huntington Ave. 10th Floor
Boston, MA 02199 (617) 425-8182
