Performance Based Regulation

Connected and efficient home appliances coupled with an increase in renewable megawatts in the grid are ushering in a new era of Beneficial Electrification (BEL). All vertically integrated utilities entities have traditionally used a cost-based model (COS)for rate making. COS model simplistically consolidates all cost of services for utilities – known as Utilities revenue and aims at recovering the cost from consumers and users.

 COS also takes care of three other important factors 

1. Functionalization i.e. cost coming from different areas – Generation, Transmission, etc. 
2. Classification i.e., Cost of Energy (KWh), Peak Demand (kW) 
3. and Allocation i.e., responsible cost allocation based on customer class e.g., residential, small and medium, and industrial 

Few additional complexities were later added to the Tariff design model such as seasonality of rates (summer vs. winter), Tiered structure (e.g., rate increase every - 1 KW consumption slab), and Time of Use (rates differing throughout the day based on when energy is consumed). COS model for rate making was perfectly fine for a regulated monopolized utility market to date and provided predictability of investments and consumer tariffs. However, it has 3 shortcomings 

1. During the rate-making process, utilities determine what is the cost needed or capital allocation is required. These costs are subjected to approval by regulators but it’s often too complex and human capability-driven exercise to validate. Utilities are incentivized to increase their capital base to increase their profits. This may lead to exaggerated estimates.
2. As Utilities need to demonstrate the need for capital investment requirements in rate reviews, it necessitates greater utilization of the rate base. This leads to the promotion of greater consumption by customers which is counterproductive concerning the energy efficiency push.
3. COS is a risk-averse model as Utilities are provided certainty for their capital expenditure. This calls for a status quo for utilities management or board. 

This poses an interesting question to us - 

How can we utilize a progressive rate-making mechanism in this highly regulated energy market to motivate organizations to achieve net-zero targets?

The answer may lie in regulatory reforms such as service unbundling, and alternative rate-making approaches such as PBR to name a few. In PBR, where the rate of return is not tied back to the cost and different energy-efficient measures are promoted. So, what it means for the end consumer is the adoption of cleaner technology such as renewable generation, battery, demand-side management, electric vehicles, reduction of GHG in industrial segments, etc. and for Utilities creating an environment of performance-based services rather than a cost based model.

Performance Based Regulation (PBR) – incentivizing for improving efficiency.

The idea to use Performance Based Regulation to encourage regulated entities to participate in BEL to meet energy goals, reduce carbon footprint, and improve and diversify electric sales and consumption, is not a new one. American Council for Energy-Efficient Economy(ACEEE) 2020 report - State Policies and Rules to Enable Beneficial Electrification in Buildings through Fuel Switching there are ~9 states that have supportive policies and guidelines for fuel substitution or fuel-neutral goals. One can site California as an example - pilot projects in the San Joaquin Valley meant to replace propane and wood-burning appliances with either electric or natural gas alternatives.

Another example is dual fuel utilities companies in Connecticut like – Eversource and United Illuminating Company, which have allowed for fuel switching. They have roadmaps built to measure fossil fuel savings and increased electricity usage going forward.

However, using PBR to encourage BEL or fuel switching is still at an initial state in the US with most states mandating BEL in the same way they mandate energy efficiency and ~10 states directly prohibiting the use of electricity as an alternative to propane, gas and fossil fuels. And while many investor-owned utilities have shareholder incentives or EPS adjusted for energy efficiency they haven’t yet applied those mechanisms to BEL initiatives.

The end goal of PBR is to mimic the competitive nature of monopolized utility market where utilities will strive to balance efficient cost allocation vs maximizing outputs within the optimal rate base. It is supposed to reduce direct linkages between costs and rates. The proposed PBR model will be modeled for an agreed PBR regime (e.g., 1 year) where previous regime rates will form a base. The following three factors will change the rates e.g. 

• Rates will grow to in impact of inflation (for labor, material, etc.) affecting the cost of input
• Rates will reduce for productivity gains – which Utilities are supposed to be met
• Additional adjustments outside the control of utilities.

Unarguably these factors will push Utilities to understand their performance data in several categories such as 

• Technical Reliability (Interruption frequency or duration)
• Customer service (Customer complaints, availability of electricity, power quality, etc.)
• Asset Condition (planned vs unplanned maintenance, OPEX reduction, failure rates)
• Operating efficiency (asset capacity utilization, safety-related time or life loss, etc.)

The mechanism or extent up to which PBR may be implemented could vary largely based on jurisdiction, operating conditions, asset bases, etc. Irrespective of the adoption pattern we anticipate - this will bring new changes to the IT ecosystem of utilities such as 

Beneficial Electrification and Behind the meter technology evolution 

BEL is the one-stop solution to reduce energy costs, increase grid resilience and benefit the environment. When consumers switch to electricity — such as replacing an oil furnace with an electric heat pump or switching from a gasoline-powered car to an electric vehicle — they benefit through cost savings, convenience, and a cleaner environment. It can provide a solution where environmental benefit and economic progress can work together to build the low-carbon economy of the future. It pays to highlight that Beneficial Electrification promotes “reduced energy spend” and not “reduced cost”. This opens up energy auditing or advisory services for the utilities.

Expansion of Home Energy Services Market

Identifying, Replacing, or retrofitting non-energy efficient home appliances and creating customer awareness. Creating or expanding into new markets for home energy services for handling / installing solar panels, batteries, energy-efficient heat pumps, etc.

Gradual expansion of Smart Grid components

Smart Grid makes smart appliances possible. An evolved and intelligent/smart grid is too smart appliances what the skeleton system is to the human body. It forms a backbone of all technological advancements in the area - renewable energy, Distributed Energy Resources, Smart appliances, and BEL. It combines IoT, digital communication, and automation with the current grid system to create a resilient, reliable, and efficient grid. 

The smart grid has a 2way communication system integrated within the existing grid to monitor parameters of energy generation, utilization, and transmission losses. This makes the smart grid more energy efficient and consumer transparent. The most common technology used is SCADA, PLC, and wireless. This communication system coupled with IoT-enabled Smart Appliances helps consumers make intelligent and informed decisions to reduce energy consumption and cost. For example, non-emergency devices like water pumps can be turned on only during low-demand hours. This reduces the energy cost for the consumer and reduces the further load on the grid during peak hours.

While the smart grid is mandatory to promote and support decentralized energy generation, like all advanced technology it faces its challenges including the high initial cost of set up, low demand due to lack of awareness, lack of regulatory framework, and security concerns arising out of high data sharing across the grid.

Conclusion

Utilities have always been one of the best examples of a closed seller-centric economy. High CAPEX and infrastructure cost coupled with stringent regulations pose high entry barriers and has made the utilities sector an impregnable fortress. With the prevalent culture of centralized energy generation and distribution, the privilege of regulating the cost of a unit of electricity consumed was almost solely owned by the government support power generating giants. Lack of alternate options and government back cost regulations, rendered end consumers helpless when it came to energy bills and cost.

For the very first time, we see a historic albeit slight shift in this power dynamics. Consumers are now far more cognizant of energy consumption. Advanced technology inventions like DER – including rooftop solar panels, IoT-enabled smart appliances, and 2way communicating Smart Grid are responsible for creating a shift in the industry by giving consumers the power to monitor their electric consumption which can considerably reduce energy consumption. It is crucial to utilize the advanced technology under the umbrella of a customized PBR framework to offer an economic and feasible solution for carbon reduction.