How to Regulate the Electricity Distribution Utility of the Future
Summary: Regulators need new tools to manage greater uncertainty and incentivize electricity distribution utilities to both accommodate distributed energy resources and take advantage of the capabilities these new technologies provide.
The electric power sector is currently being transformed by the growth of rooftop solar power and other distributed energy resources, including distributed generation and storage, demand response, and electric vehicles, as well as the proliferation of advanced power electronics and information and communication technologies commonly referred to as “smart grid” technologies. These trends have the potential to reshape the way electricity services are delivered and electric power systems are designed and managed.
This ongoing transformation of the power sector presents new challenges for the regulation of electricity distribution utilities. In particular, regulators face greater uncertainty regarding how distributed resources will change the use of distribution networks as well as the costs and capabilities of new smart grid technologies. In addition, distribution utilities are on the front lines of the evolving power sector and interface regularly with customers and equipment vendors. Utilities thus know far more about emerging technologies and the changing use of the grid than their regulators. The regulator is therefore at an informational disadvantage, which exacerbates temptations for utilities to engage in strategic behavior to increase allowed revenues. These new challenges plague both conventional cost-of-service regulation and so-called “incentive regulation” approaches to remunerating utilities.
New solutions are thus needed to regulate the distribution utilities of the future. Regulators need forward-looking tools to overcome information asymmetries and identify the impacts of new technologies on the cost of building and maintaining distribution networks. In addition, regulators need remuneration mechanisms that incentivize utilities to not only accommodate distributed energy resources but also to take advantage of these new resources in combination with smart grid technologies to reduce system costs and improve performance. Finally, regulators need to manage the systemic uncertainty they now face while preserving incentives for utilities to be more efficient and safeguarding the regulatory compact that prudently-managed regulated firms shall remain financeable.
In an MIT Center for Energy and Environmental Policy Research working paper recently released to the public, I propose a novel process that equips regulators with the tools they need to establish the allowed revenues of distribution utilities in the uncertain future ahead. Along with my advisor, Prof. Ignacio Pérez-Arriaga, I outline a novel method combining three state-of-the-art regulatory tools.
First, an engineering-based reference network model (RNM) is employed to generate a forward-looking benchmark of efficient network expenditures. The RNM designs an efficient distribution network that can accommodate expected growth of distributed energy resources as well as new network smart grid technologies and practices. In short, the RNM helps the regulator “peer into the future,” reducing both information asymmetry and systemic uncertainty.
Second, a menu of profit-sharing regulatory contracts creates strong incentives for utilities to pursue cost-saving efficiencies while managing uncertainty by sharing risks between the utility and ratepayers. In addition, if designed correctly, the menu of contracts will preserve “incentive compatibility”—that is, firms will always be better off when they provide regulators with accurate forecasts of their expected costs. This feature further reduces information asymmetries and helps the regulator establish an accurate revenue baseline.
Finally, we propose novel automatic adjustment mechanisms, or “delta factors,” which can be used to adjust allowed revenues after the fact to accommodate deviations in the evolution of network uses (i.e. load growth or DER penetration) from forecasted levels.
We also simulate a realistic, large-scale urban distribution network to demonstrate, step-by-step, the practical implementation of this novel regulatory process and illustrate the advantages for the economic regulation of electricity distribution utilities under increasing penetration of distributed energy resources and smart grid technologies.
- Jenkins & Pérez-Arriaga (2014). The Remuneration Challenge: New Solutions for the Regulation of Electricity Distribution Utilities Under High Penetrations of Distributed Energy Resources and Smart Grid Technologies.CEEPR Working Paper (No. 2014-005). Cambridge, MA: Massachusetts Institute of Technology, September 2014.
- Rothstein, Besser & Jenkins (2014). Leading the Next Era of Electricity Innovation: The Grid Modernization Challenge and Opportunity in the Northeast. Boston, MA: New England Clean Energy Council, August 2014.
- Pérez-Arriaga et al. (2013). From Distribution Networks to Smart Distribution Systems: Rethinking the Regulation of European Electricity DSOs. THINK Project (Topic 12). Florence, Italy: European University Institute, May 2013.