By Jim Kennerly
PV Solar Report guest contributor
In the coming years, distributed energy resources (DER) (solar PV, energy storage, efficiency and demand response) will very likely continue on a rapid path toward broad-scale deployment. Despite much of the escalating controversy surrounding net energy metering and solar PV, few C-suite utility and DER industry executives would dispute the need for utility regulation to adapt to these changes.
However, there currently is an absence of clear, affirmative answers as to what the role of state-regulated utilities will be. Without that, it is unlikely that customers will be able to access the full potential of DER to reduce their utility bills and partially mitigate the impacts of climate change.
In a very brave step, New York has set out to change that.
“The regulatory compact,” and the end of its era
The simple agreement that forms the foundation of the relationship between public utility regulators and their utilities is known as “the regulatory compact.” While some states allow for competition in buying and selling wholesale & retail power, all states grant an “exclusive franchise” (read: monopoly) to a utility in a certain area for the obligation, at a minimum, to deliver electricity to all customers at rates and prices that reflect the average cost of providing electricity to each and every customer.
In short, utilities are allowed to charge rates that reflect their “cost of service.” Regardless of whether a utility operates in a fully regulated or partially deregulated state, rates are arrived at using a relatively simple formula:
Cost of Service = Annual Operating Expenses + A (Pre-Set and “Reasonable”) Rate of Return on Assets
Rates = Cost of Service ÷Total Expected Annual Electricity Sales
This approach made sense for a fast-growing, mid-20th-century economy in which manufacturing represented America’s main competitive advantage. During that time, the fully integrated utility value chain (centralized power plants, as well as the transmission and distribution network that served them) was a natural monopoly, providing “least-cost” power that fueled rapid economic growth. The regulatory compact thus truly did transform the lives of millions, if not billions, for the better.
However, the events of the first two decades of the 21st century have emphatically driven home the point that consumer spending now drives America’s economy, and that increases in utility rates are a feature, not a bug.
Thus, a regulatory compact that assumes the existence of a natural monopoly and drives perpetually increasing marginal costs (and thus rates) will erode America’s economic strength. In contrast, a distributed energy system enabled by advanced technology will provide added benefits over a “natural monopoly” that no longer exists. As New York Public Service Commission chair Audrey Zibelman puts it, “business as usual just doesn’t cut it anymore.”
Two potential visions of a new regulatory compact
While America’s changed economic circumstances suggest that the regulatory compact no longer meets its needs, it isn’t clear to all parties involved what should modify or replace it. In his outstanding (but criminally under-appreciated) book Smart Power: Climate Change, the Smart Grid, and the Future of Electric Utilities, Peter Fox-Penner of the Brattle Group lays out two competing visions of what a new regulatory compact (and thus a new utility role and business model) could look like.
Vision One: The Energy Services Utility: In short, the “energy services utility” concept is predicated on the idea that existing regulated electric utilities can begin slowly shifting their focus from being regulated monopoly providers of centralized power to regulated monopoly providers of DER services. Fox-Penner’s example of this model is of the vision former CEO Jim Rogers had for Duke Energy – one in which Duke would earn a regulated profit from expanding customer-focused DER programs. The “energy services utility” approach is also closely mirrored in the recommendations of groups such as the Solar Electric Power Association, or the GridWise Alliance. In this way, this vision is an evolutionary, not revolutionary, change – plugging in DER, but leaving the original essence of regulatory compact unchanged.
Vision Two: The Smart Integrator: Fox-Penner’s outstanding book also offers a second, and starkly different, vision for a utility – one in which it becomes an open-access platform with the customer at the center. In this vision, customers would manage their energy with full-spectrum awareness of their energy usage and the location-specific cost of that energy. Thus, customers would be well-positioned to select the best and most cost-effective mix of DER technologies for them. As an example, Fox-Penner describes Northeast Utilities’ smart grid pilot program that provides customers with real-time energy information.
Marrying the two visions: New York and the role of “distribution service provider”
In the wake of Superstorm Sandy, New York’s leaders have made it clear that they do not want to choose between the two “Smart Power” visions – they want both. By kicking off the “Reforming the Energy Vision” process (REV), they have begun the process of transforming their utilities into “distribution service providers” (DSPs). In addition to their responsibility to deliver reliable service, the Public Service Commission’s staff made clear that the Commission will likely expect utilities in a DSP role to:
- Allow customers to benefit from third-party owned and operated DER products and services, but also claim ownership of microgrids and DER infrastructure;
- Reduce their market power by providing more open and less discriminatory access to its grid and distribution system;
- Respond to new and different regulatory and cost incentives; and
- Make utility cost and system data (as well as DER cost and system data) more freely available to allow for proper pricing and cost-benefit analysis of these products and services.
What does it all mean?
There is no question that New York’s DSP innovation changes essentially everything about the regulatory compact with its utilities, and thus creates numerous sources of initial uncertainty. Nevertheless, this hybrid approach (as applied in other markets) is likely to have profound and lasting advantages for customers of all income levels, and all participants in future DER markets.
Benefits for solar PV (and DER as a whole): DER providers will probably benefit the most from a more open market and regulatory platform, given that the purpose of a DSP is to provide open access and interconnection of DER, as well an appropriate platform to fully value (and incentivize) DER services.
Benefits for utilities: Even though many utilities that own generation assets will likely resist becoming a DSP, it could also provide greater certainty as to their future role, and would allow them to incorporate smart grid-related investments into their rate base, while finding ways to offer DER in without abusing their market power.
Benefits for regulators: While setting up the DSP model will make being a utility regulator more complex at first, a more transparent and customer-centered approach will allow regulators to use market-based approaches to set rates more frequently. In addition, retaining the option of creating a distribution system operator independent of the utility (as New York has) can beneficially increase a Commission’s independence from the utilities they regulate, minimizing the risk of regulatory capture.
Of course, customers (especially low-income customers) have the most to gain from REV, which is why, according to Audrey Zibelman, they embarked upon the process in the first place. Currently, ConEd customers pay some of the highest average utility rates in the nation, and the U.S. Energy Information Administration projects that residential rates in New York City will rise by 3.3% each year through 2040.
This process is being watched very carefully, and could influence other similar processes beginning in California, Massachusetts, Minnesota, Arizona, and elsewhere. While REV will not likely produce a “one-size-fits-all” solution, it will likely move the regulatory compact forward in several long-overdue ways.
Jim Kennerly is a senior policy analyst at the NC Clean Energy Technology Center at NC State University, where he works on the Department of Energy’s SunShot Solar Outreach Partnership (SolarOPs) and the Database of State Incentives for Renewables and Efficiency (DSIRE). He will present at Solar Power International 2014 on how minimum bills, time of use pricing and decoupling can allow states to raise net metering caps.
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