1 PERFORMANCE- BASED REGULATION SONIA AGGARWAL NATIONAL GOVERNORS’ ASSOCIATION JULY 28, 2015
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PERFORMANCE-BASED REGULATIONSONIA AGGARWALNATIONAL GOVERNORS’ ASSOCIATIONJULY 28 , 2015
2WWW.AMERICASPOWERPLAN.COM
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1.WHY
2.HOW
3.EXAMPLES
4.NEXT STEPS
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THE POWER SECTOR HAS EVOLVEDOld Goals: Meet growing demand Build new infrastructure Build to deliver universal service Affordability, reliability, safety
Old Options: Centralized power plants Transmission lines Distribution system
COST OF SERVICE REGULATION
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THE POWER SECTOR HAS EVOLVEDOld Goals: Meet growing demand Build new infrastructure Build to deliver universal service Affordability, reliability, safety
Old Options: Centralized power plants Transmission lines Distribution system
New Goals: Build Maintain Reliability Resilience Clean power Customer satisfaction Affordability, safetyNew Options: All the old stuff, plus: Innovative distributed energy
resources (EE, DR, PV, EVs, etc.) Advanced IT
COST OF SERVICE REGULATION PERFORMANCE-BASED REGULATION
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COST OF SERVICE REGULATION Utilities spend prudently to maintain and operate the
power system Utilities recover capital expenses plus a rate of return Operational expenses are recovered at no risk to the
utility
This incents capital investments and sales volume A great structure for 20th century goals
(meet growing demand, build new infrastructure, build universal service)
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NEW GOALS FOR THE POWER SYSTEM
Resilient
Affordable, Safe
Clean
Customer-oriented
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ALIGN FINANCIAL INCENTIVES OF:
UtilitiesCustomers
Independent Power Producers
3rd party service providers
$Resilient
Affordable, Safe
Clean
WITH THESE GOALS:
PERFORMANCE-BASED REGULATION CAN ALIGN FINANCIAL INCENTIVES
Customer-oriented
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PERFORMANCE-BASED REGULATION
Works (for the residual monopoly) in both vertically-
integrated & restructured
markets!
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From: “Did we pay the right amount for what we got?”
To: “Are we paying (the right amount) for what we want?”
Utility and Regulatory Models for the Modern Era
by Ron Lehr
PBR changes the central question…
PERFORMANCE-BASED REGULATION
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1.WHY
2.HOW
3.EXAMPLES
4.NEXT STEPS
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COST OF SERVICE REGULATION, SIMPLIFIED
Revenue = Operating Costs + (Capital Costs) *
ROR…As utility investment increases
Revenue increases…
(Rate of Return)
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Revenue = Operating Costs + (Capital Costs) *
ROR
ELEMENTS OF COST OF SERVICE EQUATION
Often recovered at no risk to the utility Reviewed by regulators for
prudence and public interest
Greatest opportunity for affecting overall shareholder value creation
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Regulators
Set quantitative performance goalsEstablish reward & penalty structure
Utilities
Meet goalsReceive rewards and/or penalties
Reliable service Customer satisfaction Equity Innovative third-party
services
System-wide least cost
Resource diversity Effective facilitation
of open access Reliability Innovation
Retail Level, e.g.:
Wholesale Level, e.g.:
OutcomesPolicymakers
Establish policy prioritiesWork with regulators
POLICY SOLUTIONPERFORMANCE-BASED REGULATION Already
a standards driven industry
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Revenue = Operating Costs + (Capital Costs) *
ROR
PERFORMANCE-BASED REGULATION, SIMPLIFIED
± Performance …As utility investment increasesperformance improves
Closer to the cost of capital
Revenue increases…
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MOVING FROM COST OF SERVICE TO PERFORMANCE-BASED REGULATION
Opex (including
depreciation & taxes)
Opex (including
depreciation & taxes)
ROR ROR
Reve
nue
Incentives available for
value-creating activities*
ILLUSTRATIVE
Traditional Modelvalue derived from all investment activities
Performance Value Model
value derived from both investments and
performance
*Overall costs may actually decrease; but potential returns to shareholders should grow commensurate with the additional risk shifted to utilities
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1. Return on Equity (ROE) Adjustments: Basis point adjustments applying to the whole ratebase
e.g. IL, UK Incentive ROE for projects that meet performance criteria
e.g. CA: nuclear performance
DELIVERING THE INCENTIVETWO METHODS
* Shares may change over time
2. “Direct incentives” Shared savings / shared profits*
e.g. CO: Xcel off-system sales Shareholder incentive mechanisms
e.g. CA: efficiency performance
PREFERRED
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1. Work with stakeholders to clearly define goals and outcomes in quantitative terms.
2. Include incentives for exceptional performance and penalties for missing the standard.
PRINCIPLES FOR DESIGNING PERFORMANCE-BASED REGULATION
3. Use a transparent and consistent methodology for measuring performance. Define it clearly at the outset of the program.
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PRINCIPLES FOR DESIGNING PERFORMANCE-BASED REGULATION4. Shift an appropriate amount of performance risk to the utility in exchange for longer-term regulatory certainty and the opportunity to earn incentive compensation. Reward entrepreneurialism.
5. Establish a long enough time horizon for the utility and third-parties to make investment decisions with certainty, and to innovate to meet performance targets.
PLANNING TIME HORIZONMONTHS YEARS DECADES
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PRINCIPLES FOR DESIGNING PERFORMANCE-BASED REGULATION6. Consider revenue sharing to align utility performance with customer benefits.
7. Build on the existing framework, but look for holistic solutions that go far enough to truly align incentives and simplify the regulatory process.
8. Consider provisions for mid-course correction—any changes should be announced well in advance of implementation to minimize uncertainty.
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1.WHY
2.HOW
3.EXAMPLES
4.NEXT STEPS
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EXAMPLE 1 OF 2: FIRST STEPS
O.38% of total utility revenue at stake Penalty-only structure Three primary output categories tied to revenue, more being tracked:
1. Reliability2. Reduction of system uncertainty3. Affordability
Performance targets set for 10 years, assessed annually, with increasing stakes
Incentive delivery: ROE adjustments to all cap expenditures
Illinois
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EXAMPLE 2 OF 2: GOING (A LOT) FURTHER
3% of total utility revenue at stake Penalties and rewards offered Six primary output categories tied to revenue:
1) customer satisfaction, 2) reliability and availability, 3) safe network services, 4) connection terms, 5) environmental impact, 6) social obligations
Eight years to adapt and perform, opportunity to review at year 4
Incentive delivery: ROE adjustments applied to all capital and operational expenditures
United Kingdom
“Utility investors agree RIIO is a paradigm of success.”
Julien Dumoulin-Smith, UBS
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1.WHY
2.HOW
3.EXAMPLES
4.NEXT STEPS
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NEXT STEPS TO CONSIDER1. Agree on top goals for the state’s power sector. What value
can utilities deliver to citizens and customers?
2. Identify appropriate quantitative performance metrics under each goal. Work with the Commission to establish a transparent methodology for calculating performance on each metric.
3. Begin to measure and track performance. Support pilots.
4. Grow the share of utility revenue tied to performance once the metrics and methodologies are well understood.
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THANK YOU
@USPOWERPLAN@ENERGYINNOVLLC
WWW.AMERICASPOWERPLAN.COMWWW.ENERGYINNOVATION.ORG
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