New York REV Order Gives Utilities Ways to Make Money in Changing Role

Posted by Ryan Katofsky on May 26, 2016 3:15:17 PM


We’ve blogged several times over the last two years on New York’s landmark Reforming the Energy Vision (REV) proceeding, which seeks to fundamentally reorient the way electric utilities are regulated in New York State. We have been strong supporters of this effort and, along with our state and regional partners, Alliance for Clean Energy New York and the Northeast Clean Energy Council, have filed comments at nearly every opportunity. Back in 2014, we blogged that The Devil is in the Details and later reviewed some of those details when the Department of Public Service issued its Track 2 White Paper. We also weighed in on benefit-cost analysis and, most recently, utility-solar collaboration on the future of net metering and compensation of distributed energy resources (DER). Truly, there is virtually no aspect of the regulatory framework that is not up for consideration in REV.

The details of what utility regulation will look like in New York just got clearer, when the Public Service Commission (PSC) issued its Track 2 Order on May 19. This Order addresses the fundamental issue of the utility revenue model as well as certain aspects of rate design. While there are many details still to be worked out (the Order is mainly about the framework and process), the PSC has formalized some bold ideas for how the utility business model will evolve in order to keep up with changing technology, evolving customer needs, and state energy and environmental goals.

As the Order notes, the basic utility business model has served us well for decades but is no longer sustainable. It is a model build upon the premise that the utility business is a natural monopoly, and it rewards utilities for inputs, whereby they have the opportunity to earn a regulated rate of return on capital investment that has been deemed prudent by regulators. And this model really did work well for decades: Utilities invested in providing universal, equitable, reliable service, and as marginal costs fell and electricity consumption rose, everybody was happy. Utilities grew their rate base and made larger profits even as the price of their product fell. Consumers used more electricity and derived greater value from that electricity. This drove more investment, lower costs, more consumption, and more profits.

This virtuous circle has now largely played itself out. Load is flat to declining in many parts of the country, driven by significant improvements in energy efficiency, energy management enabled by information technology, and increasing use of distributed generation. New customer-sited options exist for shaving peak demand that are better and cheaper than building more power plants and power lines. At the same time, utility costs are rising, not falling, as worn-out infrastructure needs to be replaced and other investments are required for reliability and resiliency. Moreover, the new technologies being deployed by customers are not part of a monopoly service - they are provided by the competitive market. In short, the same technological changes and competitive pressures that have disrupted other industries have finally hit the electric power sector with full force.

In some states, these changes have prompted utilities to dig in their heels. But New York, under the leadership of a forward-thinking utility commission, is tackling this transformation, not by digging in, but by stepping out. The Track 2 Order is perhaps the most significant attempt at this so far, at least in the United States. While it’s not possible to cover all the details here (the Order is 170 pages long), this is basically what it does.

New revenue and earnings opportunities for utilities

With no change in the regulatory framework, we would expect to see large capital investments by New York’s utilities over the coming years. This would drive revenue growth under a traditional cost-of-service model, but at the expense of steep rate increases in a state where rates are already among the highest in the country. Instead, the PSC has directed the utilities to lean more heavily on private investment in DER to meet system needs rather than rely on their own investment, resulting in a decline in profits under current regulation. Under the Track 2 Order, as utilities roll out the “Distributed System Platform” (DSP), they can propose new “Platform Service Revenues” (PSRs). Instead of adding costs to the rate base, PSRs will allow utilities to derive an increasing amount of their revenue from services they can offer to DER providers, associated with the operation or facilitation of distribution-level markets.

The PSC did not specify what these PSRs will be. Instead, they established criteria and a process by which utilities can propose them and have them implemented via new tariffs. Importantly, the PSC signaled that these services should not compete with the competitive market and laid out criteria aimed at preventing overlap with services that the competitive market is able to provide. At the same time, investments to establish the DSP - a core monopoly utility function - will be subject to traditional cost-of-service regulation.

PSRs are predicated on a vibrant multi-sided marketplace, which will take time to develop. Thus, in the near term, the PSC has also ordered utilities to develop “Earnings Adjustment Mechanisms” (EAMs), which is New York’s term for performance-based regulation. The idea is simple: reward utilities for performance (desired outcomes) instead of capital investment (inputs). In competitive markets, companies are not rewarded for what they spend, but for the value they bring. EAMs are intended to mimic this in monopoly markets, and the PSC has said utilities could earn up to 100 basis points, or 1%, in additional profit using EAMs. But to sever the link in traditional ratemaking between greater capital expenditures and profits, the actual reward payments will be predetermined dollar amounts rather than adjustments to allowed rate of return. In other words, the reward itself will not grow because the utility spent more money to achieve it.

Utilities will need to develop EAMs in three areas: System Efficiency (peak load reduction and load factor improvement), Energy Efficiency, and Interconnection. We were disappointed that the PSC decided not to require an EAM for customer engagement, but if utilities are to be successful in other areas, they will have to be successful at engaging customers. It’s also not decided what the actual targets and rewards will be. Those details are still to come as utilities propose EAMs, some of which will need to wait until individual rate cases, which only occur every three years. Still, EAMs move utilities a little further from the cost-of-service model, as profits will be driven at least partly by performance and less by capital spending. Interestingly, the PSC views EAMs as a transitional strategy - as PSRs grow in importance, the importance of EAMs is expected to decrease.

The PSC also decided that utilities will have two opportunities for earnings related to greenhouse gas reductions: first, by finding ways to reduce the costs of the Clean Energy Standard, and second, by finding ways to help customers decarbonize their use of energy (for example, by switching to ground source heat pumps for heating and cooling). Some of these details will depend on the final form of the Clean Energy Standard, which will be set later this year.

Finally, to encourage near-term deployment of non-wires alternatives to traditional investments, utilities will be able to keep revenues associated with avoided capital investment if they can demonstrate that DER was used instead. Normally, in a multi-year rate plan, if the utility invests less than anticipated it must return the associated earnings and unspent capital budget to ratepayers in the next rate case. This is called the “clawback” provision, and it makes sense - utilities should not earn profits on capital they didn’t invest. Under the “modified clawback” in the Track 2 Order, if utilities can demonstrate that the avoided capital was due to procuring services from a DER solution, they will get to keep the associated revenues. At the next rate case, base rates will be “reset” to remove future earnings associated with that avoided capital, but the ongoing operating expenses for the DER solution will be added. Although this mechanism does not put DER on an equal footing with utility capital investment, as part of the package of reforms, it is a sensible and immediate step in that direction.

New Rate Designs

If the utility revenue model is all about how the utility makes money, then rate design is about how it collects money. Increasingly, rate design is also about sending the right price signals to customers, so they can make investments in DER and adjust their behavior in ways that benefit the entire system. This really is the essence of REV. Thus, the Track 2 Order also directs development of rates that better reflect the time-varying nature of electricity generation and delivery. This includes making improvements to existing rates for large customers who are already exposed to real-time energy prices, improving existing optional time-of-use rates that are available to mass-market customers, and developing a “Smart Home Rate,” where prosumers (actively engaged customers) and utilities can begin to tinker with highly granular pricing. Initially, mass-market customers will be able to opt in, but these time-varying rates will also be studied for future application on an opt-out basis, as technology is deployed that enables mass-market customers to respond to time-varying rates.

Access to Data

The last major topic covered by the Order is access to data, which is critical if customers are to have the information they need to become more engaged in an active energy marketplace. The Order specifically lays out what types of data will be provided free of charge, and when utilities can charge for data. Basic data, which the PSC defines as all of the data used as billing determinants, will be offered free of charge. As advanced metering is rolled out, granular time-interval data will also be provided to customers and their designated third-parties free of charge.

The Track 2 Order ends with a short section on implementation, laying out a series of deadlines out to October 2017. The profound changes in the order must be implemented gradually and deliberately. This is necessary to ensure smooth transitions for utilities, customers, and DER providers alike, all of whom are being asked to do things differently. Yet the pace of technological change, coupled with other imperatives, means that time is of the essence. We believe the PSC has struck the right balance in its most recent, and perhaps most significant, order in the REV proceeding.

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Topics: State Policy