It’s odd the way we pay utilities, especially in an era when saving energy is so important.
Utilities earn revenue based on their electricity sales. Yet we ask – or even demand – that they encourage customers to buy less electricity by using smart thermostats, efficient lighting, and the like. Few businesses find themselves in such an odd predicament.
Unless we fix the problem, some see a ‘utility death spiral’ ahead, where utility profits increasingly decline, service falters and consumers suffer.
General Electric stepped into the debate this week with a possible solution. Why not compensate utilities based on their ability to meet specified goals agreed upon in advance with regulators?
The technology giant outlined the idea in a white paper co-authored with the Analysis Group: ‘Results-Based Regulation: A Modern Approach to Modernize the Grid’.
How we regulate utilities contributes to the problem, says the paper. Investor-owned utilities serve about 70 percent of US consumers. An IOU’s spending and return on equity is subject to approval by state regulators. Unfortunately, this is often a backward looking process. The utility makes the investment first and then afterward regulators review it and decide if the utility did right and can recover costs.
The fallout from risk aversion
Fearful that regulators won’t let them recover their investments, utilities shy away from risk and innovation. That’s a bad thing, especially now when the aging grid needs so much improvement and new efficiency technologies abound to help.
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Henry Yoshimura, ISO New England’s director of demand resource strategy, pointed out a real-world example of how this utility risk aversion limits consumer choice in a presentation at the recent National Summit on Integrating Energy Efficiency & Smart Grid in Washington, DC. Lacking incentive, New England utilities have been slow to offers customers smart meters. As a result, consumers lack the ability to tap into related dynamic pricing products that could save them money and ease strain on the electric grid. Only 11 percent of New England ratepayers had advanced metering in 2012, compared with 70 percent in California and 23 percent nationwide.
How bad are things for utilities?
It turns out that utilities are doing some investing, but it is hurting them when it comes to cash flow. Utilities saw a net cash deficit of more than $132 billion from 2007 to 2012.
“Although utilities have been able to finance this deficit during a period of relatively favorable interest rates, it is unclear whether the industry will be able to sustain the required pace of investment,” said the GE white paper. “Currently, 58 percent of electric utilities have a Standard and Poor’s credit rating of BBB or lower. Twenty years ago, only about one in five electric utilities had such low ratings.”
Meanwhile, electricity sales are abysmal. Despite economic recovery (albeit small), US electricity sales fell 1.8 percent in 2012 and have fallen in four of the last five years, GE said.
The trend is likely to continue. Energy efficiency, distributed generation and fuel switching are expected to offset a majority of electric load growth through 2025, according to the white paper.
“As a result, our country faces a fundamental question: how to structure a regulatory model that supports needed investment and expenditures, drives efficiency improvements so that service remains affordable for customers, and creates a sustainable business model for the utilities,” the white paper said.
What’s the solution?
GE calls for national discussion of “results-based regulation,” where the utility agrees to achieve specific objectives. In return, the regulator provides incentives for the utility to achieve the goals efficiently and with only limited backward-looking review.
“A results-based model could be based on regulators approving: multiple year revenues to support a forward-looking utility business plan; a mechanism for sharing any cost savings with customers; and output-based performance incentives,” the white paper said. “These performance incentives can be selected to reflect different consumer preferences and public policies in each jurisdiction.”
What kind of savings might the utility and customer share? The white paper gives several examples. Savings might come from avoiding power outages because of grid upgrades, reducing emissions, or optimizing voltage on the distribution system. Or they might share the benefits accrued from dynamic pricing and energy efficiency.
The white paper also sees the approach helping utility vendors and competitive companies. The results-based model “could include competitive solicitations that allow third parties to propose innovative projects and funding for the demonstration and implementation of new technologies that reduce costs, improve performance, or advance policy objectives,” the white paper said.
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