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Regulatory change and the smart grid, Part II

David O'Brien is director of regulatory practices for Bridge Energy Group, a reader of Intelligent Utility and an occasional contributor to our forum. We spoke with him recently on what needs to change to foster a positive regulatory environment for grid modernization efforts. This is Part II of a two-part interview. (We ran the first part yesterday. See "Regulatory change and the smart grid.")

IU: So the challenges we discussed in Part I of this interview only get multiplied for an IOU with operations in multiple states. 

O'Brien: That's true. For example you've got Ameren, with a service territory in Missouri, where they're doing nothing at all on smart grid, and territory in Illinois, where there's a state mandate from legislation that they invest in smart grid. There are plenty of cases like that. First Energy is in Ohio, but they also have properties in Pennsylvania, where they have Act 129. So, yes, multi-state companies have to navigate rules made state-to-state.

[Editor: See First Energy subsidiary Penelec's homepage on "PA Act 129 Demand Response Program."]

We've seen some efforts to get regulators and other stakeholders together to at least reach consensus on what issues might hold the promise of common ground. We wrote about the Critical Consumer Issues Forum held by investor-owned utilities with state regulators and consumer advocates in three cities last year. (See "Consumer Issues in `Grid Modernization.'")

O'Brien: How we regulate utilities and set rates is based on a half-century-old approach whose principles are set forth in "Bonbright's Principles of Public Utility Rates" (1961). One of those principles is that "rates should be stable." In a smart grid world where, increasingly, you should have time-of-use rates—which I'd argue are critical—the rules need to be changed. We live in a different world now. 

Beyond rate design there are a host of other issues such as defining what is an acceptable amortization schedule for advanced meters and switchgear, or a clear cut means to establish net benefit from smart grid platforms.  Most new regulators are new to the topic as they come to the industry as political appointees not always with an energy background or as college graduates filling staff positions. They're coming in fresh. All those people have to be trained in how rate-making works, because it's a unique enterprise. They all go to something called "Camp NARUC" at Michigan State University in East Lansing, Michigan. It can be a two- to three-year program depending on how far they want to take their education. They learn rate-making, "allowed returns," rate design—all these concepts. 

One thought that keeps coming back to me over the past year that I've been away from [participation as a regulator] is that until we actually address the curriculum and how rate-making is informed and how it's taught to the next cadre of regulators, we're not getting to the root of the matter. 

Back to rate design because it is instructive of how we have done things for a long time a certain way and presume it is sound and effective. Rate design assigns the cost of the utility to customers by attempting to measure who and what is driving costs in the utility system.  

This is what gets us residential versus commercial or industrial customers and the assignment of fixed and variable costs-your fixed monthly charge and kWh rate. If you look at that process today, a lot of the cost causation discipline that was intended to be there has been tweaked over the years as other criteria have been added to influence consumption or protect a particular sub-group of consumers.  At the end of the day the rates that have been divined via traditional rate design have not been effective in altering peak demand and that is the dominant driver of system capacity the cost of which is continually added to consumer bills.

The central role of regulators is to protect the interests of consumers, and to certainly take into account any populations that are less able than others to represent themselves. Consumer advocates have said that low-income people are especially at-risk with smart grid because they're going to pay for the cost of this technology but they're not going to benefit from it. I disagree with that—that if you're low-income you're somehow less able to take advantage of rate-related offers or advanced technology. 

In fact, Ahmad Faruqui at The Brattle Group has worked on and written about rate design and low income customers. One of his findings is that the best thing you can do for low-income customers right off the bat is to introduce a peak time rebate, because under current rate design, they are subsidizing larger, more wealthy homeowners in their territory because the larger homes with peakier loads are more costly to serve. Yet they're all grouped together in the residential class, despite their usage patterns being so different.

You can take that further. If you give that low-income customer information on how they're using energy and what it's costing them throughout the month, not just at the end of the month, and the ability to pre-pay, then they can actually manage their expenses. A lot of the concerns about remote disconnect would go away because you've given the customer the means to avoid it. 

I would not accept the premise that new technology is going to only benefit the more wealthy customers because, somehow, they're more capable.

The reason I raise rate design is that if you're a utility deploying an AMI platform (advanced metering infrastructure) one of the best paybacks is to defer investment in capacity by shaving the peak by giving customers the option to pay a lower price during less expensive off-peak hours. If you look at Oklahoma Gas & Electric, for example, one of the benefits of their AMI system, is that they expect to defer 500 megawatts of new generation. That's a very powerful thing to put in play. But you've got to be willing to deploy time-differentiated rates. Reviewing rate design can make that possible.

I will add that of the tens of millions of smart meters deployed so far, a very, very small fraction have time-differentiated rates accompanying them.  

As Rick Morgan, a commissioner with the D.C. Public Service Commission, has said: "What's the point of smart meters with dumb rates?" He's 100 percent right. 

My argument to policymakers is that until we provide electricity at the real cost of producing it in the 24-hour, 365 day cycle, customer behavior won't change. That leaves us with an inefficient system with high costs to expand. Consumers benefit when they understand usage and are offered pricing that reflects costs.

IU: I'd suggest that one hurdle for consumers, which we hear from them on, is mistrust of utility motives. Not understanding how electricity is generated, transmitted, distributed and priced leaves them leery of the introduction of dynamic rates. We hear some say it's just a ruse to gouge the customer right when they need electricity the most. 

O'Brien: I'm glad you brought that up, because I think a major problem in this industry is this: most people do not appreciate that a utility, at the end of the day, is only what we want it to be. The utility can only spend what state law and regulatory orders allow them to. So 100 percent of what a utility does comes from us in the sense that the laws applied by regulators are passed by our elected leaders. That does not mean that there is 100 percent compliance.  Certainly utilities are found to have "over-earned" or have been imprudent in numerous cases.  I am not suggesting that utilities do not make errors.  The point is they cannot act alone in any material way to the detriment of customers without consequence.

So it's unfortunate that people believe that the utility is going to enrich itself by deploying this technology to make itself more money. In point of fact, what they earn is absolutely set in stone and limited by regulators. All they can do is recover costs and a return established by regulators. So the utility is only a conduit, a facilitator of getting electricity to customers. And they're doing it on behalf of society.  So in the end a decision about smart grid, is it important, needed, valuable etc. is a public policy call.

Phil Carson
Intelligent Utility Daily


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