Nearly one year ago, Hurricane Sandy struck the East Coast of the United States, leaving 72 dead, damaging 650,000 homes and knocking out power for 8.5 million Americans. This anniversary serves as a reminder of the challenges facing electric distribution companies as they plan for the future design and operation of the power grid. These utilities are expected to improve their resiliency during severe weather events, replace aging infrastructure, integrate greater quantities of renewable and distributed generation and secure their systems against cyber and physical attacks.
“Tackling today’s emerging challenges is a daunting task for utilities, considering that most operate under a regulatory model set in the first half of the last century,” said David Malkin, director of Government Affairs and Policy for GE’s Digital Energy business. “If we wish to build out a modern grid—one that meets these challenges and delivers long-term value to consumers—then we must rethink how utilities are currently regulated.”
GE has released a new report outlining the benefits of modernizing the power grid, hurdles that impede the upgrade of U.S. electrical infrastructure and how moving to a results-driven regulatory model could support the transition to an efficient, reliable and sustainable power system.
The report, titled Results-Based Regulation: A Modern Approach to a Modern Grid, finds that the current model impedes a utility’s ability to recover fixed costs and discourages much-needed capital investment. Today’s increased expectations of utilities arise at a time of slowly growing, flat or declining sales, as total U.S. electricity sales decreased by 1.8 percent in 2012 and have fallen in four of the last five years2. This dilemma is rooted in the fact that the rates of most electric distribution companies continue to be set under a model focused on the utility’s cost of service rather than on delivering value to customers.
“We are in the early stages of modernizing the power grid, with many utilities across the country reporting promising results,” Malkin said. “But these utilities continue to face cost recovery rules that can negatively impact their cash and earnings, and may compel them to defer needed capital investments. Equally important, most utilities have little incentive to improve efficiency or service quality beyond the minimum levels required by regulators. Given these conditions, it’s not clear that the current regulatory model will support the investments needed to meet today’s challenges.”
Some regulators have experimented with alternative models to provide greater support for new investments or stronger incentives to reduce costs. However, such alternatives may not effectively integrate incentives for efficiency, innovation and service quality. A new regulatory model is needed to create a 21st Century power grid and enable utilities to deliver greater value to their customers.
An Emerging Regulatory Model: Results-Based Regulation
As regulators seek to meet current challenges without discarding the traditional objectives of regulation, a results-based model offers an attractive alternative. Results-based regulation is designed to support investments that share the cost savings with customers, reward utilities for exceptional performance, remain affordable by encouraging operational efficiencies and address emerging issues that impact the public good.
Results-based regulation creates a forward-looking contract to achieve desired objectives and provide incentives for delivering long-term value to customers. Key elements can include:
- Revenues set based on the regulator’s review of a forward-looking utility business plan.
- A multi-year revenue plan that provides an incentive for cost reductions.
- An earnings-sharing mechanism that enables customers to benefit from utility cost savings.
- Clearly defined performance metrics and incentives for delivering value to customers.
- Funding set aside for innovation projects.
The goal of this report is to advance conversations on the design of forward-looking regulatory models to meet today’s energy challenges. The authors of this paper include David Malkin, director of Government Affairs and Policy for GE’s Digital Energy business, and Paul Centolella, former utility commissioner and current vice president at Analysis Group, a leading economics consulting firm.