Is the electric power industry facing an evolution or a revolution? It seems that the answer depends on with whom you speak. Hubbell, the maker of electrical, electronic, lighting, data-com and utility products has a nifty advertisement that sums up the situation succinctly: “EXPERIENCE [R]EVOLUTION.” The author of this ad appears to believe, as do I, that we are going to see some of both.
Nearly everyone associated with the electric industry recognizes the need for utilities and their regulators to revisit the business models that have served the industry faithfully for more than 100 years. Aging infrastructure, changes in fuel choices, advances in renewables, demand response, storage and distributed generation constitute a partial list of the issues disrupting the status quo; making it more and more likely that utilities must change the way they do business to remain relevant. I personally would like to see electric utilities unencumbered and allowed to compete in emerging business areas. However, it seems that the quid pro quo is removal or erosion of monopoly status in the areas where the utilities want to compete, and isolation of those business segments from the regulated business.
That sounds so messy, both for utilities and the regulators who will essentially have to become cross-subsidy policemen. Today’s dilemma goes back to the traditional regulatory structure for compensating utilities. Utilities seek a fair return based on investment. The numerator for the most common cost-of-service ratemaking calculations is total sales, so every time a customer relies on a distributed energy resource or demand response or energy efficiency to reduce his purchase from the utility, the utility must make up the shortfall by raising rates for the remaining customers. Recall the fear of the death spiral for utilities that arose when deregulation first began.
Arguments abound for approaches to allow limited competition in regulated electric markets without fatally harming the regulated utilities. One is paying utilities on the basis of something other than total revenue, thereby ending the conflict that arises when customer revenues decline due to energy efficiency or demand response. Some protagonists even argue that utilities should not be paid for investment in new T&D infrastructure. Instead, that money should go into energy efficiency or demand response. Tell that to the millions of people who experienced reduced outages despite the unprecedented hurricanes this year due to transmission and distribution investment in system hardening! Maintaining service reliability and resiliency must remain a top priority for utilities and that needs to be properly incentivized.
So how do we structure the utility business going forward?
The New York State Public Service Commission has created a Value of Distributed Energy Resources (VDER) mechanism for compensating solar and other distributed resources, designed to value the flexibility that the facilities bring to the electric grid. This program is intended to be a replacement for net energy metering (NEM), which did not value such things as the locational and environmental benefits of DERs. Part of the new program’s credit value is based on the degree to which projects (particularly solar) help utilities avoid making investments in traditional infrastructure like substations, poles and wires. Parties on both sides of this new program differ on whether the new mechanism fairly compensates distributed resources. Our issue here, however, is will this program keep New York utilities healthy and able to provide fundamental reliability and resiliency services?
A number of states are pursuing more fundamental fixes, such as disconnecting utility sales from a utility’s allowable return calculation. In Maryland, regulators and utilities have agreed to this new approach and also have taken a step further by allowing utility investment in programs like energy efficiency and demand management to be capitalized, so utilities can earn a return on these programs the same way they do for investments in infrastructure. Maryland also uses performance incentives, which allow extra earnings when utilities exceed program goals for demand response. These structural changes protect the health of the state’s utilities while pursuing cost and usage reductions that serve customers and the greater good.
Regulatory structure is such a dry topic for so many folks that we writers often hesitate to cover the topic. The reality, however, is that utility structure is a life and death issue for our industry today. Our regulators and the public want greater levels of reliability and resiliency than ever before; they want more options; and, they want it all at historically low prices. At the same time, billions of dollars are needed to maintain and upgrade the U.S. electrical system. Furthermore, utilities are being scrutinized by the investment community harder than ever before, so we have to achieve a healthy utility structure with high prospects for long-term viability to ensure our utilities get the investment dollars needed to create the electrical system that meets our long term needs and expectations. Whether it will occur as an evolution or a revolution, it is likely that we’ re only going to have one chance to get many of our electric infrastructure decisions for the future correct.