performance-based regulation for us electric … newton lowry presents.pdfperformance-based...

Performance-Based Regulation for US Electric Utilities

National Conference of Regulatory Attorneys Portland, Oregon

10 May 2017

Mark Newton Lowry, PhD President

Pacific Economics Group Research, LLC

Introduction

Performance-based regulation (“PBR”) is an increasingly popular alternative to traditional cost of service utility regulation (“COSR”)

Berkeley Lab has published several white papers on PBR, including

Comnes et al, Performance-Based Regulation for Electric Utilities (1995)

Lowry and Woolf, PBR for a High Distributed Energy Resources Future (2016)

The Lab has retained Pacific Economics Group Research LLC to prepare a paper drilling down on the popular multiyear rate plan (MRP) approach to PBR

Energy Analysis and Environmental Impacts Division 2

Multiyear Rate Plans for US Electric Utilities: Report Objectives

Broaden understanding of MRPs and their usefulness in electric utility regulation

Rationale for MRPs in today’s business environment

Key plan design challenges

MRP case studies

Impact of MRPs on utility cost performance

• Incentive Power Model

• Empirical research on utility productivity trends

growth Multifactor Productivity (MFP)

= growth Output – growth Multifactor Input Quantity Index

3 Energy Analysis and Environmental Impacts Division

Cost of Service Regulation


Modern COSR • Base rates adjusted in rate cases • Trackers for energy procurement expenses • Trackers increasingly used to address other costs (e.g., capital) • Usage (e.g., volumetric and demand) charges collect many “fixed” costs

COSR Problems

• Utility performance incentives and regulatory cost vary with business conditions (e.g., inflation and average use trends)

• COSR became a tradition in decades of favorable business conditions; rate cases were infrequent and good performance was encouraged

• Adverse business conditions trigger frequent rate cases and more expansive cost trackers which raise regulatory cost and weaken performance incentives

• Performance can deteriorate just when good performance is most needed

o Utility performance deteriorated in period of frequent rate cases o Business conditions less favorable today than in years before 1970 when

COSR became a tradition 5 Energy Analysis and Environmental Impacts Division

Adverse Business Conditions Weaken Incentives under COSR

Performance-Based Regulation

PBR: Regulation designed to improve utility performance with stronger incentives

3 established approaches (can be used in combination):

Targeted Performance Incentive Mechanisms (“PIMs”)

Multiyear Rate Plans

Incentivized Cost Trackers


Multiyear Rate Plans


Key Components

• Reduced rate case frequency (e.g., 4-5 year cycle) • Attrition relief mechanism (ARM) provides automatic relief for cost pressures

based on forecast or a business condition index with a productivity growth commitment --- not a cost tracker or “formula rate”

• Performance incentive mechanisms link earnings to service quality and other outcomes

Optional Components

• Trackers for some costs (e.g. energy) • Revenue decoupling • Earnings sharing • Marketing flexibility • Additional PIMs (e.g., for conservation and peak load management) • Efficiency carryover mechanisms use benchmarking to reward long term

performance gains that benefit customers

MRP Rationale

Streamlined regulation

Fewer, less overlapping rate cases Balanced, stronger performance incentives

Increased operating (e.g., marketing) flexibility

Revenue tracks utility’s own cost less closely

Fourth “leg” for the DSM “stool”

1) Revenue decoupling 2) Tracking of DSM Expenses 3) DSM Performance Incentive Mechanisms 4) MRP strengthens incentive to use DSM to contain cost


MRP Precedents: US


MRPs are now used in many states

Source: Lowry, Makos, and Deason (2017 forthcoming)

Recent MRP Precedents: Canada


Impetus for MRPs in Canada has come mainly from policymakers

Source: Lowry, Makos, and Deason (2017 forthcoming)

MRP Case Studies in LBNL Report

7 case studies

Central Maine Power: lengthy operation under MRPs w/ marketing flexibility

MidAmerican Energy: lengthy operation under MRPs

California: longstanding but conservative MRP practitioner

New York: longstanding practitioner developing “utility of the future” reg

Extended (e.g., 12+ years) Informal Rate Stayouts

Ontario: longstanding, innovative Canadian MRP leader

Britain: “RIIO” approach to MRP design has attracted U.S. attention


Case Study: Central Maine Power

Attrition Relief Mechanism: growth Rates = growth GDPPI – X (X=1%)

Capital Cost Tracker: Automated metering infrastructure Earning Sharing: Asymmetric sharing of surplus earnings Plan term: 5 years (2009-2013) Service Quality: Multi-indicator penalty mechanism Marketing Flexibility: Light-handed regulation of optional targeted rate schedules and rate discounts

Reference: Maine Public Utilities Commission, “ARP 2008 Settlement,” June 2008

Impetus for MRPs in Maine came from Commission


Impact of MRPs on Performance


Distributor MFP Trend of Central Maine Power Under MRPs

Productivity growth typically faster for utilities under MRPs

Impact of MRPs on Performance (cont’d)


Distributor MFP Trend of California Utilities Under MRPs

Conservative MRP approach in California has not produced good productivity results

Incentive Power Research

Incentive Power Model uses numerical analysis to compare cost performances of a hypothetical utility under alternative regulatory systems

Key Results o Multiyear rate plans can materially improve cost performance

(e.g. cost 3-10% lower after ten years)

o Benefit greater when alternative is frequent rate cases or expansive cost trackers

o Transitional (“baby-step”) MRPs do not greatly improve performance

o New approaches to MRP design (e.g. efficiency carryover mechanisms based on statistical benchmarking) can “turbocharge” performance


Conclusions

MRPs can streamline regulation and benefit utility customers Impetus often comes from policymakers COSR is still more popular than MRPs in the U.S. for various reasons COSR well established Commissions prefer to address new attrition challenges with incremental

reforms like revenue decoupling and new cost trackers Hard to design MRPs that generate stronger incentives than COSR without

undue risk MRPs more easily address some business conditions (e.g., brisk input

price inflation and declining average use) than others (e.g., high capex) MRPs can invite strategic behavior, and some plan design issues are

controversial Utilities may make more money (or the same money more easily) with

frequent rate cases and more expansive cost trackers Consumer advocates may lack expertise and resources to secure good

outcomes


Conclusions (cont’d)

Use of MRPs in U.S. regulation should grow in coming years

Use of MRPs is already growing, especially for vertically integrated electric utilities Key business conditions (e.g., inflation and DER penetration) may well worsen, triggering more rate cases and expansive cost trackers under COSR Increasing need for marketing flexibility, which MRPs facilitate Continued innovation in MRP design is producing better approaches; late adapters will benefit

• Accommodation of capex surges • Efficiency carryover mechanisms and benchmarking

strengthen incentives and promote customer benefits


Appendix


Limits of COSR have been acknowledged by regulators who embrace MRPs This initiative proceeds from the assumption that rate-base rate of return regulation offers few incentives to improve efficiency, and produces incentives for regulated companies to maximize costs and inefficiently allocate resources…. Regulators … must critically analyze in detail management judgments and decisions that, in competitive markets and under other forms of regulation, are made in response to market signals and economic incentives. The role of the regulator in this environment is limited to second guessing…The Commission is seeking a better way to carry out its mandate Alberta Utilities Commission, “AUC letter of February 26, 2010,” pages 1-2, Exhibit 1.01 in Proceeding 566.


Regulators Acknowledge Incentive Problems

Several well-established approaches to ARM design Indexing (e.g., ∆Revenue = Inflation – X + ∆Customers)

Stairstep (e.g., 3% in 2018, 5% in 2019, 2% in 2020)

Hybrid (e.g., Indexing for O&M revenue Stairsteps for capital revenue) Tracker/Freeze (e.g., Rate Freeze + generation capacity cost tracker)

ARM Design Options 20


Marketing flexibility may be needed to meet complex, changing customer demands, manage cost, and provide new smart grid enabled services MRPs can afford utilities more marketing flexibility and strengthen marketing incentives Infrequent rate cases…

● Reduce chore of cost allocation ● Lessen concerns about cross subsidization ● Postpone passthrough of other operating revenues

Permits light-handed regulation of optional tariffs and services ● Special contracts ● New services


Marketing Flexibility

Bibliography

G.A. Comnes, S. Stoft, N. Greene, and L.J. Hill, Performance-Based Regulation for Electric Utilities, Lawrence Berkeley Laboratory, 1995 Comnes et al. https://emp.lbl.gov/publications/performance-based-ratemaking-electric

Ken Costello, Multiyear Rate Plans and the Public Interest, National Regulatory Research Institute, 2016 http://nrri.org/download/nrri-16-08-multiyear-rate-plans/

Mark Newton Lowry, Matt Makos, and Jeff Deason, Multiyear Rate Plans for U.S. Electric Utilities, Lawrence Berkeley Laboratory, 2017 (forthcoming)

Mark Newton Lowry and Tim Woolf, Performance Based Regulation for a High Distributed Energy Resources Future, Lawrence Berkeley Laboratory (2016) https://emp.lbl.gov/projects/feur


About the Author

Mark Newton Lowry is President of Pacific Economics Group Research LLC in Madison Wisconsin.

• Active in PBR since 1990s • Specialties: multi-year rate plans, productivity and benchmarking

studies, revenue decoupling • Multinational practice • Diverse client base includes utilities and regulators • Former Penn State University energy economics professor • PhD Applied Economics, University of Wisconsin


Contact Information

Mark Newton Lowry, PhD President

Pacific Economics Group (“PEG”) Research LLC

www.pacificeconomicsgroup.com

44 East Mifflin St., Suite 601, Madison, WI 608-257-1522

[email protected]


Acknowledgements

25

The work described in this presentation was funded by the U.S. Department of Energy’s Office of Electricity Delivery and Energy Reliability – Transmission Permitting and Technical Assistance

Office, and the Office of Energy Efficiency and Renewable Energy – Solar Energy Technologies Office under Lawrence Berkeley

National Laboratory Contract No. DE-AC02-05CH11231, Task 1.4.29 – Future Electric Utility Regulation of DOE’s Grid

Modernization Initiative

Energy Analysis and Environmental Impacts Division

Berkeley Lab

26

Lisa Schwartz Deputy Group Leader, Electricity Markets and Policy Group

Lawrence Berkeley National Laboratory

(510) 486-6315

[email protected]

https://emp.lbl.gov/

Click here to join the LBNL Electricity Markets and Policy Group mailing list and stay up to date on our publications, webinars and

other events. Follow the Electricity Markets & Policy Group on Twitter: @BerkeleyLabEMP

Energy Analysis and Environmental Impacts Division

mailto:[email protected]

https://emp.lbl.gov/

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