Pathway to a 21st Century Electric Utility Ef!ciency Solutions

Load Management Solutions November 2015

Distributed Resources

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Ef!cient All YOU NMeighyb orDs aNesighbobrsoard Acknowledgements About the Author Ceres would like to thank the Energy Foundation for a grant Peter H. Kind, that helped make this work possible. Ceres and the author Executive Director—Energy Infrastructure Advocates LLC. would like to extend their deep appreciation to the experts Peter is the Executive Director of Energy Infrastructure who generously agreed to review a draft of this report: Advocates LLC, a strategic advisory consultancy focused • Diane Munns, Environmental Defense Fund on public policy supportive of utility and energy sector • Steven Nadel, American Council for infrastructure development in a changing energy an Energy Ef!cient Economy industry landscape. • Rich Sedano, Regulatory Assistance Project Prior to the founding of EIA in 2012, Peter worked for over • Devra Wang, Energy Foundation 30 years in investment banking, with a specialization in utility and power sector !nance. Peter’s banking experience Dan Bakal, Meg Wilcox and Sue Reid of Ceres made includes capital markets advisory and transaction execution important contributions to this report. and strategic advisory services, including merger and Graphic design by Patricia Robinson Design. acquisition and corporate !nance advice. Peter’s M&A experience includes all sectors of regulated utility and non- © Ceres 2015 regulated power businesses. Throughout his career, Peter has been actively involved in outreach to regulators and About Ceres policymakers, including work as an expert witness in Ceres is a nonpro!t organization mobilizing business regulatory proceedings and forums, presenting at industry leadership on climate change, water scarcity and other and regulatory conferences on !nancial issues impacting global sustainability challenges. Ceres directs the Investor utilities and power producers and in direct outreach Network on Climate Risk (INCR), a network of more than on regulatory matters. In 2013, Peter authored a paper 110 institutional investors with collective assets totaling on Disruptive Challenges to the utility industry published more than $13 trillion. Ceres also directs BICEP, an advocacy by the EEI. coalition of 36 businesses committed to working with policy Peter’s investment banking experience, includes prior makers to pass meaningful energy and climate legislation. experience at Macquarie Group, Bank of America, where For more information, visit www.ceres.org or follow on he lead the Power and Utilities Corporate and Investment Twitter: @CeresNews Banking effort, and Citigroup and Kidder Peabody, where he co-directed the Power & Utilities industry teams of each of those !rms. Prior to investment banking, Peter worked for Arthur Andersen & Co. Peter is a Director of the general partner of Enable This report is available online at Midstream Partners, LP, a midstream energy services www.ceres.org provider and a Director of NextEra Energy Partners GP, an owner of renewable power generation. Peter is also a Director of Southwest Water Company, an infrastructure fund owned water and wastewater utility. For questions or comments, please contact: Peter holds an MBA in Finance from New York University and BBA in Accounting from Iona College. Peter practiced Ceres, Inc. as a Certi!ed Public Accountant until 1981. During 2008 Dan Bakal to 2011, Peter was Co-Chairman of EEI’s Wall Street Director, Electric Power Advisory Group. 617-247-0700, ext. 113 [email protected] Table of Contents

Foreword...... 4 Executive Summary ...... 5 The Case for a 21st Century Electric Utility Model ...... 8 Disruptive Forces–A Quick Overview ...... 8 Value and Future of the Electric Grid...... 10 The Stakeholders in a 21st Century Electric Utility Sector ...... 11 Key Stakeholder Issues ...... 13 Energy Efficiency–A Growing Opportunity ...... 15 A Vision for the 21st Century Electric Utility ...... 17 Foundational Principles to Support a 21st Century Electric Utility...... 21 Planning to Accelerate and Coordinate Industry Evolution ...... 22 The Clean Power Plan ...... 23 The Pathway to a 21st Century Electric Utility...... 24 Experiences in Selected States and the UK ...... 25 Developing an Accountability and Incentive Framework ...... 27 Engaging Utilities to Adopt a 21st Century Electric Utility Model ...... 27 Vertically Integrated vs. Restructured Utilities ...... 29 Ratemaking and Tariff Design...... 29 Tariff Design Principles for a 21st Century Electric Utility...... 31 Financial Issues ...... 32 The New 21st Century Electric Utility...... 33 Concluding Comments: Transitioning to the New Utility Model ...... 33 Foreword

Pathway to a 21st Century Electric Utility

Commissioned By: Ceres Authored By: Peter Kind

As a banker serving the U.S. utility industry for In reviewing the constantly evolving landscape, over 30 years, I have long questioned the impact I felt that it was important to provide an updated, of policy actions and regulatory mandates that more holistic perspective that aligns society’s threaten the revenue base of utilities and the needs with the interests of utilities and their industry’s !nancial health. In 2013, I authored customers. In 2010, Ceres made an important “Disruptive Challenges: Financial Implications contribution to the dialogue with the release of and Strategic Responses to a Changing Retail “The 21st Century Electric Utility: Positioning for Energy Business,” published by the Edison a Low-Carbon Future,” and it seemed a natural Electric Institute (EEI). That paper presented !t to collaborate with Ceres on this new paper. my views, looking through the lens Utilities do an excellent job of of an investor, of the challenges what they are mandated to do— confronting the long-term Utilities are not going provide safe, reliable and !nancial viability of the electric affordable energy. Utilities are utility industry given its away, because we require them not going away, because we present business model. to operate the electric grid, so why require them to operate the Since the release of not expand the scope of their mandate electric grid, so why not “Disruptive Challenges,” to manage an environment in which expand the scope of their the forces outlined therein mandate to manage an have continued to develop, consumers use energy and electricity environment in which particularly the pace of more ef!ciently to create customer consumers use energy and technological innovation electricity more ef!ciently to and cost-curve improvements. value and optimize the electricity create customer value and Importantly, electric customers system for the bene!t of all? optimize the electricity system and the policy community have for the bene!t of all? In this continued to foster key disruptive environment, utilities will be incented forces by con!rming their support for to maximize customer and system value, customer energy supply choice, net energy as opposed to simply building infrastructure. metering and opposition to increased !xed utility Given the importance of revising the utility industry charges. My positions have evolved in order to model for the bene!t of customers, society and !nd solutions that can promote collaboration and utility investors, this paper is an expression of my alignment of interests. evolved views in an effort to !nd common ground that will support a robust 21st Century Utility model.

Foreword 4 Pathway to a 21st Century Electric Utility Executive Summary

Challenges Facing the Electric Utility Business Model

Over the past decade, a con"uence of challenges facing align interests and behaviors or facilitate the policy goals the electric utility business model has stimulated active and customer dynamics that exist in 2015. To create the discussion among utility industry stakeholders. The clean, ef!cient and sustainable energy future that all challenges are the result of economic, demographic, stakeholders seek, we must revisit the industry model to behavioral, policy and technology trends, and are not ensure alignment with customer and policy goals, while expected to reverse. In fact, they are continuing to gain also ensuring that utilities and third-party providers are momentum, particularly the development of new properly motivated to support their customer, societal and technologies, continued reductions in renewable energy !duciary obligations. costs, and policymaker support for a revised vision of Policy and industry stakeholders in most states are utility service that supports customer choice. neither proactively addressing industry model Utility sector investments, however, continue challenges from a comprehensive policy to trade close to all-time high valuations The current 100- perspective, nor seeking the collaboration based on low interest rates. Threats to of all stakeholders to !nd a solution the utility sector are still in the early year-old utility business model that bene!ts all parties. In New York, stages because customer adoption of does an excellent job of keeping a closely watched initiative has new energy technologies remains policymakers de!ning a future in low, but are growing. Furthermore, the lights on, but it often does not which the utility role involves customers, rather than investors, align interests and behaviors or managing the grid and acting as a are bearing the near-term cost of platform provider for third parties. disruption through increased utility facilitate the policy goals This role is not as investor friendly as rates, somewhat offset by lower fuel and customer dynamics utilities would desire. In many states, costs. despite customer and policy opposition, that exist in 2015. electric utilities are proposing increases in Once investors begin to experience these !xed charges, which discourage energy challenges as a direct impact on the economic- ef!ciency and impact low-income customers. return potential of their investments, however, the This lack of progress in stakeholder collaboration is cost and availability of capital to fund the utility sector will not in our collective best interests. suffer. Given that the industry relies on 30-plus-year investment recovery cycles, it is essential that capital While the cost structure of electric distribution utilities is deployed today be planned and rationalized to avoid predominantly of a !xed nature (i.e., not meaningfully future stranded costs, or investments that are no longer impacted by volumes or operating variability), utility rate economical. structures have typically authorized a small !xed-charge component. Pursuing an increase to !xed-charge recoveries The current 100-year-old utility business model does an is a tariff design tool that utilities have actively pursued since excellent job of keeping the lights on, but it often does not 2013 to mitigate revenue risk from the challenges they face.

Executive Summary 5 Pathway to a 21st Century Electric Utility However, there has been meaningful opposition on the part The vision proposed for the 21st Century Utility model is of customer interests and policymakers to utility proposals relatively straightforward, and includes: to signi!cantly increase !xed charges. The policy of adopting ! enhanced reliability and resilience of the electric grid monthly !xed-charge increases has several "aws— while retaining affordability; principally that such increases would remove the price signals needed to encourage energy ef!ciency and ef!cient ! an increase in cleaner energy to protect our environment resource deployment—that need to be considered when and global strategic interests; assessing alternatives through a lens by which all principal ! optimized system energy loads and electric-system stakeholders bene!t. This paper proposes several solutions ef!ciency to enhance cost ef!ciency and sustainability; to address the utility revenue challenge as an alternative to and increased !xed charges, such as inclining block rates, ! a focus on customer value, including service choices reforming net energy metering, use of bidirectional meters, and ease of adoption. time-of-use rates, accountability incentives and identifying Instead of maintaining our current policies, which encourage new revenue opportunities for utilities. increased electric consumption and capital investments, More broadly, this paper proposes a new pathway the objective of the vision is to develop a model that to a 21st Century Electric Utility system enables customer value and service and that creates bene!ts for customers, achieves policy objectives to position us for policymakers, utility capital providers This paper proposes the certainties of the future—particularly and competitive service providers. several solutions to address that the current concentration of fossil fuels in our energy mix poses The key differentiators proposed in the utility revenue challenge as an signi!cant risks to our economy the pathway toward a new utility and environment. model are as follows: alternative to increased !xed charges, such as inclining block rates, reforming Because there is no reasonable a) engage the distribution utility to threat over the foreseeable future of be at the center of integrating net energy metering, use of bidirectional signi!cant customer grid defection, a resources and stakeholder meters, time-of-use rates, accountability robust electric grid is a key collaboration to achieve customer component of a 21st Century Electric and policy objectives through incentives and identifying new Utility, and thus, !nancially healthy accountability and incentives; revenue opportunities utilities will be essential to maintaining and b) shift regulatory oversight to focus on for utilities. operating the grid. integrated distribution system planning and development of transparent accountability metrics; The foundational principles or ground rules to support the achievement of this vision are as follows: c) ensure that utility revenues will re"ect incentives (or penalties) earned for accountability of results and ! !nancially viable utilities are essential to fund and new energy management services sourced through support an enhanced electric grid; new resources, such as an energy management ! policymakers must promote clear policy goals as part applications store; and of a comprehensive, integrated jurisdictional energy d) pursue cost-effective planning to identify the most policy or 21st Century Utility model; ef!cient technologies to be employed, and cap ! commitment to engaging and empowering customers customer incentives based on the most economical can help them make intelligent energy choices, including alternatives to achieve policy goals. third-party engagement and access to necessary data; The paper !rst sets the stage by identifying the and stakeholders and potential participants in a new industry ! equitable tariff structures promote fairness and model, summarizing the objectives and considerations of policy goals. stakeholders, and reviewing the debate that is playing out, The pathway proposed is one wherein policymakers task including actions by several of the more proactive states. utilities with the responsibility for being at the center of It then lays out a vision for the 21st Century Utility and coordinating and accelerating the re!nement of our model identi!es foundational principles to support this vision for a 21st Century Electric Utility, and holds them accountable before proposing the pathway. Given that we have over with penalties and incentives. On this pathway, policymakers 50 states and districts that regulate our utilities, there will will collaborate with stakeholders to develop and authorize be no one-size-!ts-all solution.

Executive Summary 6 Pathway to a 21st Century Electric Utility the vision for the industry’s future for customers and in adopting such technologies. Because increased providers. Policymakers will then outline a comprehensive ef!ciency strikes at the revenue base of utilities, the plan to realize their 21st Century Electric Utility model. proper incentives must be adopted so that utilities will be The proposed pathway shifts regulatory oversight from at least indifferent to the loss in electricity sales and ideally, being administered primarily through periodic rate cases be motivated to encourage energy ef!ciency. to a forward-looking focus on planning, accountability and In order to realize the societal bene!ts of a clean and !nancial incentives for results achieved. Tariffs will be ef!cient electric industry, each state should move forward re!ned to address fairness, policy goals and provide price now on a pathway to a 21st Century Utility model. Each signals, consistent with enhancing system wide ef!ciency state will have different challenges to confront, but the and environmental protection. goal would be to develop several robust models that can Regulators will create incentives and penalties to be tested, compared and re!ned over time. encourage and hold utilities accountable for achieving The Environmental Protection Agency’s newly released transparent goals and metrics to be outlined for measuring Clean Power Plan (CPP) provides an excellent opportunity progress and success. Technology innovators and third- for states to consider their utility model as a component of party service providers will collaborate with customers their CPP compliance plan !lings. The CPP sets standards and utilities to create and re!ne products and services for reducing greenhouse gas emissions from existing and that support policy goals, engage customer interest and new power plants, and calls for each state to provide its integrate ef!ciently with the grid. Utilities will partner with compliance plan by September 2016. The CPP will enable third-party providers and customers to provide reliable, each state to reconsider its energy future and align state affordable, clean energy in the most ef!cient way possible. compliance plans with a pathway to a 21st Century Utility. Customers will be educated as to opportunities to deploy Longer-term, customers, society and utility investors will new services to enhance the value of their electric service bene!t from proactive solutions. and achieve societal bene!ts, such as reducing their environmental footprint. Utilities have remained committed to their historical obligation to provide customers with safe, reliable and Energy ef!ciency and system optimization, for example, affordable service. As dynamics have evolved, society now have been an area of focus since the 1980s, and while expects that utilities will confront new priorities, such as progress has been made, the majority of customers have protecting our environment and assisting customers in not taken advantage of the opportunities that can be realized. being more ef!cient with their energy usage. These new The American Council for an Ef!cient Energy Economy priorities challenge utilities’ revenue and pro!tability levels (ACEEE) estimates that a 40 to 60 percent reduction and, thus, utility !duciary obligations to their of electricity sales could be achieved by 2050 investors. A new industry model will need to by harnessing the full suite of opportunities. provide opportunities for utilities to earn a On a pathway to a 21st Century Utility, we reasonable return while providing society must redouble our efforts to achieve The proposed pathway and customers the services they seek. these savings by increasing customer shifts regulatory oversight education and giving utilities incentives to engage their customers from being administered primarily through periodic rate cases to a forward-looking focus on planning, accountability and !nancial incentives for results achieved.

Executive Summary 7 Pathway to a 21st Century Electric Utility Chapter 1

The Case for a 21st Century Electric Utility Model

Disruptive Forces—A Quick Review Over the past several years there has been active discussion ! public-policy goals seek to increase energy-ef!ciency among utility industry stakeholders as to the con"uence adoption and clean-energy production and to reduce of challenges facing the industry business model. These environmental emissions; challenges are considered long-term forces that are not ! price in"ation and costs to deploy new grid technologies expected to be reversed, and they encompass economic, are increasing utility capital budgets and requiring demographic, behavioral, policy and technology trends. increased electric rates (although rate increases have The principal challenges facing the utility model can be not in general outpaced in"ation); summarized as follows: ! customers now have enhanced options to save on their ! slowing demographic (U.S. population) and economic energy bills through programs that reward adoption growth opportunities have reduced electric consumption of clean technologies (e.g., solar distributed energy growth and customers’ disposable income levels; resources combined with net energy metering ! customer interest in reducing energy usage and programs); and environmental impact has gained attention and ! U.S. regulatory models that are energy-usage based, interest, particularly among Millennials; regardless of load or time of day, constrain prospects for utility revenues and !nancial health.

Figure 1: Disruptive Forces—Impact and Feeding of the Vicious Cycle

Behavior Change ! L/T Economic Fundamentals ! New Technologies/DER ! PV—Declining Costs; 3rd Party Finance ! Distributed Resources ! Energy Ef!ciency/DR UTILITY RATE$ ! Energy Ef!ciency ! Volumetric Tariffs ! Microgrids ! Utility Mandates ! Behavior Modi!cation ! Grid Modernization

VICIOUS

CYCLE!

A con"uence of factors are posing disruptive threats to the traditional utility business model.

Chapter 1 8 Pathway to a 21st Century Electric Utility All of these dynamics are at play while distributed energy an increasingly smaller group of customers. And yet the resource (DER) economics continue to improve, due to grid is essential for DER technologies, particularly rooftop improved technology, market competition and the advent solar, because it allows customers to sell their surplus of attractive customer !nancing options (see Figures 2 energy back to the utility. A 2013 study commissioned by and 3, below). Left unattended, these challenges encourage the California Public Utilities Commission found, in fact, a vicious cycle in which customers are motivated to self- that due to net energy metering, residential DER customers generate (such as by rooftop solar) to avoid increasing utility in California paid approximately 50 percent less toward the prices, thereby leaving the cost to fund the electric grid to !xed cost of providing utility service.1

Figure 2: PV Cost Improvements—Innovation and Scale Drive Opportunities

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Figure 3: Average USA Price Per Watt for a New Solar System

Ⅵ Soft Costs Ⅵ Engineering, Equipment, Other Ⅵ Modules

Soft cost estimate to fall by more than 85%

Source: Bloomberg New Energy Finance.

1 Energy and Environmental Economics, Inc., “California Net Energy Metering Ratepayer Impacts Evaluation,” Prepared for the California Public Utilities Commission, October 2013.

Chapter 1 9 Pathway to a 21st Century Electric Utility Clearly, the electric grid will continue to be essential to Value and Future of the Electric Grid virtually all customers for the foreseeable future. In fact, the viable solar rooftop market—after factoring in home While the “Disruptive Challenges” paper and others have ownership, credit scores, locational positioning and drawn parallels between landline telephone deregulation suitability and NEM favorability—is currently projected and the electric utility model, there are important to be approximately 20 percent of US households.2 distinctions between the two. First, there is no known Thus, utilities must retain their !nancial viability to attract technology today by which electricity can be transported the capital required to support the grid. Most investors from location to location without a wire. Second, for many are not focused on these issues today due to low, though customers, installing the technology to disconnect from increasing, penetration of DERs and allowed cost recovery the grid would be prohibitively expensive, and/or they are of “lost revenues” in future rate cases. not in the proper location or lack the ownership control (i.e., rent their homes) to deploy Other disrupted industries have reached current DER technologies. In addition, the tipping point at which new products industry experts believe there is great and services attain a penetration level Other disrupted industries societal value created from the and trajectory that challenge the have reached the tipping point development of a robust grid and that viability of an old-line business and grid defection creates barriers to its access to capital. At that point at which new products and enhancing and maintaining the in those challenged industries, electric system we require. !nancial access and viability services attain a penetration level are forever threatened. Kodak and and trajectory that challenge the While industry discussion, including Polaroid are prime examples of how “Disruptive Challenges,” gives disruptive forces (primarily technology viability of an old-line business examples of a scenario whereby in those cases) can destroy a company’s and its access to capital. certain customers could disconnect !nancial value and capital access. Given their access to the grid, or new the essential nature of utility services, construction could be grid independent however, a death spiral for the electric utility (e.g., DER customers with storage), there is no industry is not expected in the foreseeable future. reasonable scenario for signi!cant customer exit Stakeholders must nevertheless be proactive to protect from the grid for the foreseeable future. The only way to utilities’ !nancial viability, given the industry’s vital sell power back to the grid is to be connected to the grid. importance to our energy future. For DER customers, as an example, every time a new

Figure 4: Examples of Technology Disrupting Main Line Industries

Pre-1990 Post-1990 Post-2007

2 GTM Research and Vox

Chapter 1 10 Pathway to a 21st Century Electric Utility customer installs rooftop solar, he or she is likely basing low-income residents and seniors by creating a progressive that economic decision on the ability to sell surplus rate tariff: the more you use, the more you pay per unit. renewable power back to the grid for at least 20 years. From an environmental policy perspective, inclining block rates provide an incentive to conserve energy usage by The grid acts to enable the bene!ts of distributed charging higher rates to the higher energy users. resources through the sale of electricity to others and to enable commercial opportunities and transactions through Commercial and Industrial Customers the powering of our entire economy. In addition, the grid provides needed backup support for DERs and storage Although large commercial and industrial customers lack when renewable resources are not functioning or when voting clout, they are active voices in the development of demand exceeds system capacity. Thus, the electric grid energy policy. Policymakers need to be aware of large is, and is expected to remain, the backbone of our electric customers’ impact on the economic growth and vitality of energy system. a region; low utility rates will retain and attract them. While energy prices and availability are not the only factors in A robust electric grid is therefore required to achieve the the drive for corporate competitiveness, large businesses greater reliability sought by all customers and to enhance can relocate when the local policy environment does not access to additional bidirectional power inputs for DER support their competitive position. In addition, large customers. A study by Brattle Group, commissioned by commercial and industrial customers (including General the EEI in 2009, projected that the U.S. electric utility Electric, Procter & Gamble, Microsoft, Coca Cola and industry will need to invest between $1.5 and $2 trillion Walmart) are increasingly focusing on their sustainability between 2010 and 2030 to maintain current levels of pro!les, including procurement of renewable energy. Thus, 3 reliable electric supply. To maintain a robust, responsive as stakeholders consider how to retain current business and resilient grid, we must have a structure in place that customers and develop and attract new industries, energy supports !nancially healthy utilities capable of attracting prices, reliability and access to clean energy will be the signi!cant capital required. Thus, the question of key factors. structuring tariffs to support the grid and other valuable services provided by utilities must be considered (see Policymakers Ratemaking and Tariff Design, page 29). Policymakers and regulators tend to be attuned to their most vocal customers, because their voting power controls the ongoing “seat” of the policymakers. It is clear from the The Stakeholders in a 21st Century wide array of state-mandated renewable portfolio standards, Electric Utility Sector energy-ef!ciency programs, net energy metering tariffs, and inclining block rates that policymakers are focused on It is critical that any attempt to develop 21st century clean energy, consumer choice, ef!ciency and price approaches seek as much alignment as possible among signaling. One question this paper seeks to address is the key stakeholders involved in electric utility planning. whether policymakers are doing all they reasonably can The stakeholders in electric utility debates continue to to accelerate programs to optimize these objectives. evolve as priorities and key issues are re!ned or emerge, and today include residential, commercial and industrial Technology Sector Participants customers, technology sector providers, utilities and A recent entrant into the energy policy debate is their shareholders. technology sector participants, particularly renewable- energy providers. These entities are selling their products Residential Customers to customers directly and, as a result, customers use less Residential customers continue to have signi!cant clout in electric service from the utility. While many of these the evolution of policy due to their voting power and large providers understand that they need to cooperate with numbers. Groups representing low-income residents utilities to provide customers the bene!t of their product and seniors (who often live on a !xed income) tend offering, there is typically no clear, approved path for these to have in"uence because service cost is a high priority. competitive providers to partner with utilities to promote Another prominent voice in the residential class debate their offerings in a way that bene!ts both the technology is environmental advocacy groups that seek a focus on provider and the utility. The interaction between environmental stewardship and sustainability. Between technology and utility providers is often adversarial, with these groups, there is alignment that aims to avoid high the technology provider seeking to sell products that will !xed charges for utility services and supports well- limit electric sales and thus adversely impact utility designed inclining block rates. Inclining block rates aid revenues. Utilities have therefore been hesitant to partner

3 Brattle Group, “,“In Transforming America’s Power Industry, The Investment Challenge 2010–-2030,” ( 2009).

Chapter 1 11 Pathway to a 21st Century Electric Utility with these third-party providers, which have built For example, while California has been proactive in strong policy advocacy efforts and industry organizations providing incentives to utilities for encouraging energy because such activities are essential to their ef!ciency, the incentives reported in 2014 were less than future viability. 1.25 percent of pre-tax operating income for the largest California utilities, or less than 0.1 percent in additional Utilities and Their Investors return on equity (ROE), after tax. Locating the disclosure Utilities have many masters, but their principal obligations of earned incentives in the California utilities’ SEC !lings is are to provide safe, clean, reliable and affordable electric like !nding a needle in a haystack. That makes it hard for service to customers and to earn a fair return on capital investors to re"ect in their valuation assessment a material, invested. Electric utilities generally do an excellent job of recurring, transparent and timely (in California there is meeting customer-service expectations. A comprehensive a several-year lag in calculation) incentive mechanism. study, “Exploring the Reliability of U.S. Electric Utilities,” While incentives should align behaviors, insigni!cant showed that reliability, despite extreme weather events, and nontransparent levels of incentives will not drive averages above 99.9 percent.4 However, extreme weather behavioral change and realization of optimal results. events, such as hurricanes Katrina (2005), Irene (2011) While utilities are interested in and impacted by the and Sandy (2012) and devastating tornadoes such as debate on regulatory models, their interactions are Joplin (2011) are examples of the need for enhanced challenged by a skeptical policymaker environment, which electric grid “hardening” and resilience to protect our often presumes that any position by an electric utility citizens and economy. re"ects a self-serving bene!t. Thus, utilities are in a Achieving an adequate return on capital, in particular challenging position when it comes to leading or proposing in the short term, depends upon selling more energy, solutions. As a result, utilities tend to be defensive in their because that is how tariffs tend to be structured. Utility approach and often lack the vision or motivation to identify boards of directors typically structure utility management areas where the business model can be enhanced for the compensation programs based on achieving reliability bene!t of their customers and investors. Instead of factors and a larger weighting to !nancial returns. This arguing for incentive mechanisms, many utilities have is more customer friendly than other industries, in which been seeking to increase !xed charges, while customers executive compensation is based solely on market share and policymakers are vehemently opposed to such action. and pro!t goals. While 25 states offer incentives for An evolved approach would focus on common ground ef!ciency results,5 these programs tend to offer limited with win4 (i.e. bene!cial to customers, policy, competitive !nancial incentives to utilities for promoting energy- providers and utilities) opportunities. ef!ciency services or clean technologies.

Figure 5: Utilities Are Valued Above 15-year Averages and Comparable to S&P 500

UTY/SPX 15 Year Average 1 Year Average

Source: BofA Merrill Lynch Global Research, Bloomberg

4 Larsen, Sweeney, LaCommare and Eto, “Exploring the Reliability of U.S. Electric Utilities,” (2012). 5 ACEEE Economy, “Beyond Carrots for Utilities: A National Review of Performance Incentives for Energy Ef!ciency,” June 2015.

Chapter 1 12 Pathway to a 21st Century Electric Utility Figure 6: Credit Rating Agency Actions Suggest Improving Credit Quality

100% - 97.2% Ⅵ Total Rating Activity ⅷ Percent of Upgrades - 300 83.7% 75.0% - 250

75% - 253 r e

y 65.0% b

t 60.9%

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- 100 t P 121 121 110 110 a 106 R 25% - 13.8% 80 76 80 - 50 57 60 50 43 0% - - 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: Edison Electric Institute, Fitch Ratings, Moody’s, Standard & Poor’s

Utility investors as a group are not interested in change, term dynamics should be a key consideration in order to because the results they have realized from their avoid disruption to the utility industry, its customers and investments in the sector have provided stable returns. our economy. Investors fear that any change could lead to an adverse Utility investors, individually or as a group, are not often impact on short-term results and that the defensive at the table in discussions on energy policy. Many investment attributes they have sought—low price volatility, institutional investors prefer the current utility business stable economic returns and cash dividend yields—may model and deal with change by selling the sector or be compromised. As stated above, boards have structured certain investments when it starts to evolve in a way that the bulk of utility management compensation appears more risky. While some investors, such as on achieving pro!t objectives, in addition those in the $13 trillion Investor Network on to reliability performance. Investors Climate Risk (INCR) have become involved are generally comfortable with the in clean-energy policy advocacy, it is still transparency of the utility model, So, while short-term rare to see major institutional investors despite the argument that the industry dynamics are the current show up to address a state regulatory model may no longer be appropriate policy issue or to support a utility or viable in a changing environment. focal point of the investment rate case. In fact, utility stock prices today are community, longer-term dynamics near all-time highs on a price and valuation multiples basis. Current should be a key consideration in valuation metric levels (See Figure order to avoid disruption to the Key Stakeholder Issues 5) suggest that investors continue to Although unanimous agreement on view utilities as an attractive place to utility industry, its customers the objectives for a 21st century deploy capital. and our economy. electric utility industry model is not likely If a material change in business !nancial to be achieved, there appears to be solid performance were to be realized, investors customer, policymaker and utility support for would likely become less sanguine about deploying key foundational objectives for the future industry. capital in the sector. But the majority of utility-sector Key objectives include improved reliability and resilience investment analysts and rating agencies see little to be of electric service, a cleaner sustainable electric supply concerned about as long as the penetration rate of and customer cost stability. ef!ciency and clean-energy resources is low and Customer cost stability is dif!cult to achieve in a regulatory regulators allow utilities to recover lost revenues in the construct that seeks (i) usage-based pricing, (ii) customer near future. In fact, utility credit ratings have solidi!ed choice for self-generation of electric supply, compensated over the past several years, particularly distribution utilities, by non-DER customers, and (iii) limits on utilities’ ability to as the economy has stabilized and industry restructuring serve and earn revenues from new 21st Century Utility volatility from the 2000 - 2005 era has been resolved. services. Moreover, the investment required to harden the (See Figure 6) So, while short-term dynamics are the grid to improve reliability and resilience and provide a current focal point of the investment community, longer- cleaner mix of energy resources will increase the cost of

Chapter 1 13 Pathway to a 21st Century Electric Utility Figure 7: Unsubsidized Levelized Cost of Energy Comparison—September 2017

Alternative Energy(a) Conventional Energy

Source: Lazard estimates. Certain Alternative Energy generation technologies are cost-competitive with conventional generation technologies under some scenarios; such observation does not take into account potential social and environmental externalities (e.g., social costs of distributed generation, environmental consequences of certain conventional generation technologies, etc.) or reliability-related considerations (e.g., transmission and back-up generation costs associated with certain Alternative Energy generation technologies). Diamonds typically represent expected cost in 2017, wind is for offshore, for more information see https://www.lazard.com/media/1777/levelized_cost_of_energy_-_version_80.pdf

providing service. Despite improving economics, the cost ef!ciency and optimization, and regional economic growth. of clean energy, excluding externalities, will likely be more But without encouraging ef!ciency (via technology, price expensive than the current embedded cost of existing signals and targeted incentives) it will be quite dif!cult to generation, because investment and backup capacity optimize the primary objective of enhanced price stability, are required to support renewable supplies, which are given that incremental resources and investment would be intermittent. Given current utility pricing policies that do required to support incremental consumption. not consider externalities, the cost of electric service is J.D. Power, a leading global market-research !rm, evaluates expected to increase over time. However, as shown in industries to understand what drives customer interests, Figure 7, clean energy is expected to become increasingly loyalty and retention. In J.D. Power’s recent rankings of competitive with traditional fossil energy sources, even utility customers, their analysis prioritizes customer before considering carbon costs. attributes as follows: One of the key disputes in the discussion of a 21st Century Utility is the value of clean energy resources. Currently, Customers neither the cost of carbon nor the system wide bene!ts Residential6 Business7 of a clean-energy strategy, such as reduced system losses and transmission needs, are fully factored into the price Power Quality and Reliability 1 1 of electric power. When the cost of carbon and other Price 2 4 externalities are re"ected in the cost of energy, the cost to Billing and Payment 3 2 customers will likely prove the long-term bene!t of a clean- Corporate Citizenship 4 3 energy strategy. With the appropriate policies and alignment Communications 5 5 of interests, the value of electric service can be enhanced. Customer Service 6 6 For instance, optimizing our system and the use of energy can reduce the need for new peaking capacity and related incremental infrastructure. Residential customers are primarily focused on power quality, reliability and price. Interest in new technologies Additional objectives, of policymakers and engaged and environmental stewardship does not re"ect separate customers, include system and energy-ef!ciency categories but rather contributing factors in the price and optimization, price signals to encourage economic

6 J.D. Power and Associates, 2015 Electric Utility Residential Satisfaction Survey. 7 J.D. Power and Associates, 2015 Electric Utility Business Customer Satisfaction Survey.

Chapter 1 14 Pathway to a 21st Century Electric Utility corporate citizenship scores. Industry data show that a on intelligent ef!ciency advances, zero-net-energy relatively low percentage (less than 1 percent nationally)8 building standards and improved ef!ciency of appliances of utility customers are currently seeking new technologies and technology. The study also noted signi!cant progress and choosing to self-generate from renewables. Customers’ in the energy intensity of our economy from 1980 to 2014 primary focus today is on reliability and price. A much due to structural changes (e.g., the reduction of our smaller subset of customers are proactive in initiating manufacturing base) and improved ef!ciency of the adoption of energy-ef!ciency and clean-energy appliances, new buildings and electric infrastructure.11 technologies, but it is a group that is growing rapidly and Thus, the opportunity to increase energy ef!ciency is is expected to increase dramatically in the coming years. substantial, but will require the focus of stakeholders to overcome the barriers to adoption. Large (commercial and industrial) customers, being Energy Ef!ciency—A Growing Opportunity focused on pro!t, are savvier than the residential class as One of the most signi!cant opportunities to enhance both to their awareness of cost-saving opportunities. Given customer value and environmental bene!t is the capital availability constraints, however, commercial expansion of energy ef!ciency. Presently, however, customers tend to demonstrate high return-on- customer adoption rates are low. Policy investment hurdle rates (i.e., short payback frameworks need to develop incentives for periods) to invest capital in activities not overcoming the barriers to adoption. directly related to their core product or service offering. This factor limits A study by the Edison Foundation on The opportunity to implementation of investments that the impacts of energy ef!ciency at a would be of long-term bene!t to the national level shows that energy increase energy ef!ciency is customer speci!cally and for ef!ciency is increasing, but society overall. amounted to only 3.4 percent of substantial, but will require the total 2012 electric energy sales.9 focus of stakeholders to Policymakers and regulators are Another study prepared for the clearly intent on promoting customer Edison Foundation found that when overcome the barriers choice of energy supply and energy-ef!ciency savings are to adoption. increased renewable energy output. combined with enhanced building Twenty-nine states have Renewable codes and standards, such savings will Portfolio Standards (RPS), 24 states have increase by 2035 from current levels to 5.6 energy-ef!ciency resource standards and 43 12 percent of total electric energy use.10 While any states have net energy metering. Yet the increase in the adoption of energy-ef!ciency tools is a approach to realizing this objective has primarily relied positive development, economic studies indicate that on customers taking the initiative to investigate new much more is achievable and would bene!t both opportunities or responding to utility mailers regarding customers and the environment. pilot programs, which are adopted by a very low percentage of customers. While there are many providers Leading factors in the low adoption rates for energy in various markets that are seeking to sell their ef!ciency include a lack of general awareness of technologies and services, customers often don’t know opportunities (particularly because customers cannot whom to trust in this complex arena and are not familiar price-shop for another utility provider), lack of trust in with the alternatives. third-party providers (due to ongoing “junk” mailings and cold calling), the cost to implement new technologies or Why not engage utilities and offer them incentives to services when up-front investment is required, and the assist in accelerating these objectives? Utilities are well fact that customers are too busy to learn about positioned to assist their customers in learning about and opportunities that may be consistent with their long-term deploying energy-saving technologies, but they need both economic and environmental interests. increased incentives and accountability for doing so. What we see from the success of smartphone applications A recent study by the ACEEE, for example, found that (“apps”) is that customers want “low-touch” solutions that energy-ef!ciency opportunities could reduce electric sales can be implemented and monitored with ease. While that by 40 to 60 percent from current 2030 forecasts, based may not be possible for all services, the smartphone app

8 Solar Electric Power Association, 2014 Power Statistics 9 Edison Foundation Institute for Electric Innovation, “Summary of Electric Utility Customer-Funded Energy Ef!ciency Savings, Expenditures and Budgets”, (2014). 10 EnerNoc Utility Solutions Consulting, “Factors Affecting Electricity Consumption in the U.S. (2010–2035),”), (2013). 11 ACEEE, “Energy Ef!ciency in the United States: 35 Years and Counting,” June 2015. 12 ACEEE website, State Energy Ef!ciency Planning.

Chapter 1 15 Pathway to a 21st Century Electric Utility is today’s gold standard for engaging customer interest. fair economic return on the capital employed in the The exciting news is that the advancement of sensor business. In most jurisdictions, utilities earn revenues technology and automated controls is creating new based on capital invested, and such revenues are possibilities for low-touch ef!ciency applications in the recovered through customer usage. By promoting energy sector (e.g., Nest, a learning, programmable activities that reduce usage, utilities are working against thermostat). one of their core missions and their !duciary duty, which is to earn a fair return on invested capital. Thus, achieving Many observers believe that there is a meaningful aversion stakeholder objectives regarding energy ef!ciency and on the part of regulators to determining how utilities clean-energy technologies may be best accomplished by should be compensated for providing such new services. providing incentives to customers and providers. In most Thus, the utility role is neglected in favor of competitive business models, businesses are motivated to sell new industry players, who are not well known by customers, to services because this enhances revenue. In our present drive this important objective. In fact, there is a logical utility business model, utilities realize a “penalty” to their scenario, to be outlined later, in which competitive third- revenues by encouraging the deployment of our current party providers collaborate and partner with utilities to policy objectives, such as energy ef!ciency. This creates accelerate the adoption of their products and services. an inherent con"ict that requires logical solutions, such as Finally, although utilities are interested in providing “revenue decoupling,” described later, which breaks the excellent service to customers, they also have a !duciary link between energy sales and revenue, to align utility and obligation to support their investment value by earning a customer interests.

Chapter 1 16 Pathway to a 21st Century Electric Utility Chapter 2

A Vision for the 21st Century Electric Utility

If we could start with a clean sheet of paper, how would seek a business that offers growth potential as well, because electric utility services be structured? We would want to a business without growth offers only a bond-like investment. ensure that there was alignment of policy, customer and Competitive service providers would partner and collaborate investor goals in order to structure a product offering that with utilities to re!ne their products, optimize customer- satis!ed the best interests of all major stakeholders, a acquisition costs and increase their share of market. In other win4. Such a service offering would maintain and build on words, they would partner with utilities to enhance their the high electric reliability we have today; allow customers collective pro!t potential. To aid in identifying opportunities, to bene!t from the latest, most economical technologies competitive providers might avail themselves of de!ned, to optimize the ef!ciency of their energy service; be non-customer-sensitive electric system data. environmentally friendly; and seek ef!cient Policymakers would decide what information economic deployment of resources and, This ef!cient could be provided without compromising thus, capital investment. deployment of renewables, customer and system security. Policymakers would seek optimal How would a 21st Century Utility economic deployment of the system consistent with a utility cost- operate? It would target optimal use of to ensure reliability and capital effectiveness plan, would seek diverse (hydro, solar, wind, biomass, ef!ciency. They would expect ef!ciency, demand response, storage deployment of resources consistent the most economical and location- and Combined Heat and Power (CHP) with local, regional and national ef!cient technology to provide renewable or low-cost electric energy environmental policy goals. They resources that would be backstopped would ensure that price signals be the best resource base for and supported by other clean, baseload provided to customers so that the system the bene!t of the energy sources. This ef!cient deployment was used ef!ciently to manage systemwide of renewables, consistent with a utility cost- costs (both embedded and future entire system. effectiveness plan, would seek the most deployment). Finally, policymakers would want economical and location-ef!cient technology to to see fairly stable customer prices, to provide provide the best resource base for the bene!t of the entire customers more certainty and help realize a competitive system. For example, in addition to residential rooftop PV solar cost of service that promoted economic growth in the region. systems, which do not consider optimal location or technology Utilities in this optimal environment would aim to offer ef!ciency, the resource base would include a signi!cant a suite of products and services to achieve customer and component of DER, community or utility-scale solar, policymaker objectives, and they would earn at their cost of intentionally located to enhance grid and system ef!ciency. capital (as deemed appropriate by the marketplace), or be The system would look to include ef!cient deployment of given incentives to earn above it, for meeting these objectives. demand response and microgrids in those areas where In a transparent and predictable business environment the reliability was of paramount importance (e.g., regions with high cost of capital is lower, and the availability of capital is greater, concentrations of hospitals, senior centers and schools) to than for less transparent, less stable businesses. Investors protect them from weather and other emergency events.

Chapter 2 17 Pathway to a 21st Century Electric Utility Energy Management Applications Store Over the past several years we have witnessed time-of-use products that could be operated from of increasing customer adoption of new explosive success and customer interest in their smartphone or other device. “My Dashboard” technologies, utilities appear best positioned software applications that integrate with icons could support “shadow billing” to assess to be a logical host of this application store. smartphones and tablets to provide easy and the potential savings from ef!ciency applications They have the ability to provide usage data fun access to powerful software tools. These and other service opportunities. Customers’ and objectively present information on services. apps provide an array of services and ability to arrange for the installation, operation In addition, utilities are best positioned to track information at the touch of a button. Why not and oversight of these services would be as easy and aggregate results of products and services create a customer-focused energy management as the touch of a button. Their total savings would to present to current and potential customers. application page, or “store,” that would allow be presented on the app so that they could see Policymakers would have to decide how to customers to explore a range of product and the bene!t of their actions and understand how compensate utilities for providing this service. service alternatives to save energy and money? their usage and savings opportunities compare The Apple model is worthy of consideration. Apple The objective of such a store would be to: to their neighbors. This vision is not futuristic, hosts the App Store on its system and earns a fee 1) introduce an available product or service because such tools and products exist today. from application developers (e.g., competitive alternative; The 75 percent of Americans with smartphones energy solution providers) when users download (expected to reach 80 to 85 percent by December 2) provide information to educate the customer; apps. In the energy management model, third- 2015) or 87 percent with Internet connections party providers could compensate utilities for 3) highlight quality vendors to provide the 13 would be able to access these services easily. each customer click or purchase of a product service, as appropriate; The question remains: Who is best positioned or service. This model would likely result in a 4) provide click-through to order the product, to host the energy management app store—the cost-effective tool for third-party providers to arrange for an estimate or get further government, the utility or some other sponsor? reach customers. information; and There is no reason that such an approach need Importantly, the energy management application 5) monitor results from using the product. be exclusive to one provider. The challenge is how store by itself will not be suf!cient to drive Ease of access to robust information and service to achieve the most traction from such an effort results without continued efforts by third-party ordering would be effective in engaging and and create an environment in which customers providers to develop new ef!ciency technologies empowering customers. Customers could be have con!dence that the information is and by policymakers and utilities to design offered demand response, load management and objectively presented. Given an objective programs and customer education initiatives.

Figure 8: Energy Management Applications Store

Ef!ciency Lighting HVAC Appliances Solutions

Load Management Centralized Demand Response Time of Use Programs Solutions Controlled Solutions

Distributed Rooftop Solar Community Solar Storage Solutions Resources

93 63 84 therms Usage vs. Comparable My Dashboard Savings Realized Community Footprint Opportunities to Save

Ef!cient All YOU Neighbors Neighbors

13 comScore, “U.S. Smartphone Market Share Report,”, February 2015.

Chapter 2 18 Pathway to a 21st Century Electric Utility Incentives would optimize expenditures and thereby to an economic-value-driven incentive model; moderate customer rate increases to help reform the utility ! enhancing customer engagement in pursuit of optimal model and manage behaviors. By realizing ef!ciency and use of ef!ciency resources through continued focus system-load optimization, and considering tools such as the on awareness, education and customer incentive UK’s Totex (see Experiences in Selected States and the UK, programs; and page 25), we should be able to moderate capital investment ! regulatory reform to align interests, incentives and levels. For utilities, these incentives will offset reduced growth metrics for achieving accountability of results. opportunities for investors and, most important, encourage the achievement of customer and policy objectives. In order to achieve these goals, we need to create a transition plan that embraces the end-state vision. For that we need The challenge is that we are not starting from a clean policy leadership, clear goals, alignment of interests and slate, and while we have an excellent quality of essential accountability. utility service, the shift to the 21st Century Utility model requires complex transitions that will be heavily debated The vision for the 21st Century Utility can be summarized by stakeholders. in four simple points: Examples of such transitional issues include: ! enhanced reliability and resilience of the electric grid while retaining affordability; ! phasing in new clean-energy resources while phasing out less clean resources; ! an increase in cleaner energy to protect our environment and global strategic interests; ! phasing out current subsidy structures for DER users

Technology Game Changers Although it is a mature industry, the electricity sector has become ! Combined heat and power standards for all large, continuously increasingly dynamic. New forms of technology are in development deployed energy loads (hospitals, hotels, prisons, etc.) optimize that will signi!cantly shape the future of the utility business. Given BTU consumption by leveraging waste heat into electric energy the large capital investment required to fund this sector, and its and steam-heating loads. This is a policy-driven game changer essential and pervasive involvement in our communities, an important using incentives. consideration to factor in to the development of the 21st Century ! Enhanced building standards can promote energy ef!ciency and Utility industry framework is how customers and utilities will deploy strive to reach net-energy-neutral status. This requires policy to and address new technologies, including those on the horizon that mandate that new construction and remodeling achieve higher have not yet achieved commercial viability. ef!ciency standards. According to a study prepared for the IEEE , Policy will be an enabling driver of many of these game changers. aggressive building codes and standards would achieve a 17 14 Policymakers should be proactive in considering how best to accelerate percent reduction in electric usage by 2035. each of these opportunities in a 21st Century Utility model to maximize ! Appliance standards can compel all new major energy-using their potential economic and environmental bene!ts. Potential game- appliances to operate at best-in-class ef!ciency levels and changing technologies such as the following could dramatically reshape support Internet adoptability for purposes of controlling technology the utility business. use. This is a policy-driven game changer. ! Grid scale and customer-owned battery storage units allow electricity ! Big data analytics can be leveraged to enable intelligent ef!ciency to be stored when not required for immediate use and thereby technologies. This is a technology- and policy-driven game changer. dramatically enhance the value of intermittent resources, such as ! Cost-effectiveness planning protocols can be applied, both for solar and wind power. They also allow customers to buy power from resources and systemwide, including renewable adoption, promoting the electrical grid when prices are lowest and use their own energy the most ef!cient resources to provide systemwide bene!ts. This at more expensive times. This is a technology-driven opportunity. is a policy-driven game changer. ! Electric vehicles create potential for substantial additional electric Most of these game changers will allow for more ef!cient deployment demands (expected to be off-peak) for charging batteries and of system resources (e.g., storage, CHP, building and appliance could discharge energy back into the system when the charge has standards). While electric vehicles will increase off-peak electric more value as a pure electric energy source. This is a technology-, consumption, they offer the opportunity for storage optimization. policy- and customer-preference-driven game changer that could All of these listed items will require incremental capital investment, signi!cantly reduce pollution from the transportation sector. either on the grid or behind the meter.

14 EnerNoc Utility Solutions Consulting, “Factors Affecting Electricity Consumption in the U.S. (2010–-2035),” (2013).

Chapter 2 19 Pathway to a 21st Century Electric Utility ! optimized system energy loads and electric-system ef!ciency to enhance cost ef!ciency and sustainability; and Con Ed's Brooklyn-Queens Program ! a focus on customer value, including service choices An interesting example of deploying innovative solutions to and ease of adoption. achieve the goals of a 21st Century Utility is Con Ed’s Brooklyn- Reliability and Resilience Queens Demand Management Program (BQDM). The BQDM seeks to reduce demand by 52 megawatts via customer-side and utility- Few question the priority and importance of enhancing the side solutions in order to avoid spending $1 billion on a new reliability and resilience of electric service. While our electric substation and related electric infrastructure. This initiative will system is highly reliable, recent weather events and the provide incentives to participating customers and to Con Ed and reliability needs of our increasingly technology-dependent will result in lower utility rates for all customers. economy are ample proof that we require exceptionally high reliability and resilience to fuel our economy. As in most areas of strategic importance, we cannot just maintain the status quo, but must be committed to continuous improvement of our electric system to support new technologies and the individual customer energy loads. For example, if there competitiveness and growth of our economy. are better ways to enhance the ef!ciency of the grid (vs. behind the meter), all customers bene!t equally from this Increased Clean Energy investment. Examples include community solar and grid- level storage, as compared with customer DER application Most Americans believe that preserving a clean environment of such technologies. This is not to suggest that we and addressing climate change are essential priorities. mandate one renewable resource over another, but that Gallup polling shows that only 24 percent of Americans we pursue the most cost-ef!cient energy sources, either have no concerns as to the quality of the environment through new-construction plans or by capping incentives (which is down from 29 percent in 2010).15 Opposition to on DERs consistent with the most cost-effective clean- developing a cleaner energy mix tends to highlight the energy options. near-term economic impact (jobs and costs to customers), but momentum is clearly building Customer Value toward a cleaner energy mix. In support of a clean energy future, (i) 36 states plus This is a new area of focus for utilities. D.C. have either renewable portfolio Optimizing the use of Prior to DER and ef!ciency applications, standards (29 states plus D.C.) or utilities were responsible for meeting renewable portfolio goals (7 states), our energy infrastructure system needs, and customers were (ii) 23 states have energy ef!ciency will enhance our economic viewed as “ratepayers.” When resource standards, and (iii) the US customers have alternatives, service EPA recently released the Clean growth potential by increasing providers must focus on providing Power Plan (which aims for a 32 customer discretionary income customer value. Utilities are in the percent reduction in greenhouse gas process of transforming to customer- emissions by 2030).16 and reducing costly focused organizations with an energy emissions. expanding choice of energy technology Optimized Energy System options. This is a work in progress, and many utilities may not understand the Optimizing the use of our energy signi!cance of this change. The focus on infrastructure will enhance our economic growth customer value also includes ease of product potential by increasing customer discretionary income adoption. We live in a complex world in which many interests and reducing costly energy emissions. Optimization of compete for our time. Value to customers is not just about resources includes ef!cient energy consumption, product quality and cost of service, but includes making it spreading usage to off-peak periods and reducing the easier for customers to learn about and, if appropriate, need to invest in incremental energy infrastructure. In adopt alternatives. doing so, current and future costs of electric service can be proactively managed to enhance value for customers. To build such an industry, we will need foundational System energy loads should be optimized, not simply principles to support the vision and a pathway to reach it.

15 Gallup, Gallup Social Series: Environment, March 2015. 16 ACEEE website, State Energy Ef!ciency Planning.

Chapter 2 20 Pathway to a 21st Century Electric Utility Chapter 3

Foundational Principles to Support a 21st Century Electric Utility

A durable building or organization requires a strong component of a 21st Century Utility model. Importantly, foundation to support its structure. The prior section !nancial health is built over many years of experiencing outlined the vision for a 21st Century Utility industry, but a transparent and durable operating environment, with we cannot create this without solid foundational principles, consistent policies and !nancial performance. which are as follows: Clear Policy Goals ! !nancially viable utilities are essential to fund and support an enhanced electric grid; The utility industry cannot evolve without rules and regulations that support the desired evolution. Thus, ! policymakers must promote clear policy goals as part policymakers must assess the landscape and create, of a comprehensive, integrated jurisdictional energy through active interaction with key stakeholders, clear policy or 21st Century Utility model; policy goals and a program to achieve them. Each ! a commitment to engaging and empowering customers jurisdiction will need to fully explore the interests of can help them make intelligent energy choices, including stakeholders, the policy objectives already in place and third-party engagement and access to necessary data; the impacts of proposed policy shifts on their stakeholders. and The objective is to develop a comprehensive and integrated ! equitable tariff structures promote fairness and set of policies that drive toward the desired outcomes while policy goals. accounting for constraints to reaching the vision. Although several states are exploring the opportunity to re!ne their Financial Viability utility model (see Experiences in Selected States and Enhancing our electric grid to achieve our reliability the UK, page 25), no state to date has implemented an objectives will require signi!cant investment. The Brattle integrated, comprehensive set of policies, with a timeframe Group estimated that $75 to $100 billion per year (in 2009 and plan to reach an objective. Without a comprehensive dollars) will be required to maintain reliability levels. The set of policies and a plan, a jurisdiction may have a variety industry, however, has operating income of $30 billion per of programs, some mandated and others aspirational, to year before paying dividends, which means it needs access re!ne utility services. But such plans require appropriate to external capital to raise the signi!cant funds (in excess incentives and accountability as a comprehensive package of $50 billion per year) to support the existing business and to drive reform. make the required future investments. Accessing capital of this magnitude requires investment-grade credit ratings Customer Empowerment (BBB- or above, using Standard and Poor’s parlance). The A commitment to empowering customers to make intelligent better the !nancial health of the utility, the larger its potential energy choices may seem obvious, but it requires proper audience for capital and the lower the cost of capital realized. alignment of stakeholder interests. Traditionally, utilities Thus, !nancially healthy utilities are a key foundational have been motivated to sell electricity, not support reduced

Chapter 3 21 Pathway to a 21st Century Electric Utility consumption or investment. We need to remove the model and accelerate the ef!ciency of activity, and thus mitigate bias that promotes traditional utility !nancial value and create any waste of energy and capital through the transition an environment in which all stakeholders are aligned and of the plan to the desired end state. The components of bene!t from behaviors consistent with the vision. When a statewide energy or 21st Century Utility plan would include: shared interests are recognized, we have an opening for ! vision—how we expect customers to use and manage an environment that supports customer value creation, their electricity needs in the future; including promoting actions and tools for customers. ! objectives—comprehensive, integrated policy positions Equitable Tariff Design to achieve the vision, including the approach to deploying renewables, storage, DER and microgrids; Utility tariff structures will be a key component of the strategy to achieve a 21st Century Utility. Tariffs are central ! de!ned goals—providing metrics and timeframes for to both customer value decisions and recovery of revenues achieving progress toward the realization of the vision; to support utility !nancial health. The development of tariff ! clear participant roles—who will be held accountable structures that support policy-driven objectives and that for driving the vision, and how customers, policymakers, are fair to all customer classes is a key area of debate. utilities and competitive service providers will interface In a model that focuses on ef!ciency and cost of service, and cooperate; inclining block rates have been a favored tool to mitigate ! incentives—quantifying the appropriate level and excessive energy use. The problem for utility revenues is approach to allocating !nancial incentives to stakeholders that this rate structure feeds customer choice dynamics to accelerate and realize the vision; that reward DER selection and transfers costs to non-DER ! accountability—ensuring the realization of the vision customers. In the discussion of tariffs that follows, a package through metrics, incentives and penalties; and of solutions is proposed that is intended to encourage policy goals, fairness to all customer classes, systemwide ! feedback loop—how often the plan will be evaluated to cost optimization and utility !nancial stability. re"ect changing market dynamics and opportunities. Given their scale, presence and interaction with all stakeholders, particularly customers, utilities appear to be Planning to Accelerate and the only logical entity to coordinate and be held accountable for the execution of a 21st Century Utility model and the Coordinate Industry Evolution realization of milestone goals. The U.S. has more than 50 state/district regulatory Essential to the evolution and acceleration of a 21st Century authorities overseeing investor-owned utilities, which Utility is the education of customers on the opportunities represent over 70 percent of the U.S. electric industry.17 and bene!ts of optimizing their energy use (reducing To enable the industry to evolve, states have generally taken use and/or moving load off-peak), deploying alternative the approach of setting goals (e.g., RPS) and programs technologies to optimize usage and offering assistance but rely on utility mandates or the competitive marketplace in adopting such new services. The more effective the to innovate and provide solutions directly to customers, with education and ease of effort to adopt and utilize new the expectation or hope that customers will engage in these services, the more likely that customers will be receptive. products and ef!ciency behaviors. If we rely on the marketplace to support the future of electric services, the While utilities have offered energy-ef!ciency programs most successful competitive market participants will win, but and services for years, the Internet and smartphones are they may not be the most ef!cient for customers or society accelerating customer education and energy optimization. overall, as evidenced by the relatively low penetration of and Smartphone apps turn what used to be low-priority chores energy savings from ef!ciency technologies. into fun ways to be productive and share success and opportunities with friends. So although utilities have been To drive our electric energy future so as to optimize our involved with ef!ciency in the past, technology is driving !nite resources (energy and capital), it seems appropriate exciting new products and services, and smartphone for policymakers to proactively develop a comprehensive deployment is making it easier to adopt and manage these vision and plan for each jurisdiction’s energy future. The new technologies. objective would be for us to take charge of our direction

17 EEI, EEI website.

Chapter 3 22 Pathway to a 21st Century Electric Utility The Clean Power Plan as a compliance option. States can also join together to develop multistate solutions, such as the Regional The EPA’s newly issued CPP offers states an excellent Greenhouse Gas Initiative. The rule calls for state plans to opportunity to develop their energy strategies for achieving be !led by September 2016, with the potential to seek a 21st Century Utility business model. Issued in August extension until September 2018. 2015, the long-awaited rule governs performance standards for greenhouse gas emissions from existing and new While the CPP provides signi!cant "exibility to states, the power-generation sources. The CPP outlines the !rst rule will likely lead to reduced coal-!red power generation national standards for CO2 emissions from power plants and a signi!cant expansion of renewables to achieve the and seeks to reduce emissions from the power sector by targeted CO2 emission reductions. For renewable power 32 percent in 2030 from 2005 levels. Among its bene!ts, generation to grow from 13 percent of our power mix in the CPP aims to improve health by reducing pollutants, 2013 to 28 percent in 2030 will require a dramatic increase supports clean-energy innovation and provides the foundation in renewable-energy capacity and investment. for a national climate change strategy. Compliance States will likely consider multiple strategies to encourage commences by 2022, with phase-in completed by 2030. an increase in renewable energy, including expansion of While lawsuits have already been !led against the rule, RPS mandates to support their CPP implementation plans. when implemented the CPP will be based on three building Based on projections developed from Energy Information blocks: (i) improved performance of existing coal-!red Administration (EIA) data, the renewable capacity required power plants, (ii) substitution of natural gas power to generate the 2030 goal could stimulate up to 350GW generation for coal-!red capacity; and (iii) increased of incremental renewable capacity. This level of capacity renewable generation to an estimated 28 percent of our expansion will require all forms of renewables to be energy mix by 2030. adopted, but utility-scale renewables will likely be a very large component of the compliance requirement, given Each state is responsible for developing and implementing their scaling potential and economic advantages. a plan that ensures compliance through the phase- in. States have the option to implement The timeframe set for state CPP compliance plant-speci!c performance plans or a plans provides an excellent opportunity for statewide portfolio approach. While end- The timeframe set for each state to develop its energy strategy user energy ef!ciency is not a formal in alignment with the 21st Century building block in the rule, it is allowed state CPP compliance plans Utility model proposed in this paper. provides an excellent opportunity for each state to develop its energy strategy in alignment with the 21st Century Utility model proposed in this paper.

Chapter 3 23 Pathway to a 21st Century Electric Utility Chapter 4

The Pathway to a 21st Century Electric Utility

Stakeholders will likely agree on the vision and foundational ▪ multiyear rate proceedings to target customer focus principles to support a 21st Century Utility model, but the and shift of resources from regulatory administrative way to achieve it will be more heavily debated. This paper proceedings to planning and results accountability; and introduces a pathway for accelerating the realization of a 21st ▪ structure of utility revenue potential for integrating Century Utility by setting clear policy direction, assigning new customer services and potential for ownership of accountability for results and shifting the focus of regulatory DERs, including revenue requirement implications. oversight from litigated rate proceedings to forward planning and accountability with incentives and penalties. The ! Tariff structures are re!ned to support price signals following pathway points are not an á la carte menu of and !nancial viability requirements, including: choices but are intended to be a combined package of ▪ inclining block rates to encourage ef!ciency and actions to support and integrate realization of the vision. signal incremental cost of new resources; ! State policymakers pursue legislation to outline the ▪ bidirectional meters installed for all DER customers; model for a 21st Century Utility, to include: ▪ transition to highest economic value renewable rate: ▪ providing environmental, RPS, energy-ef!ciency, - most economical option to meet RPS, adjusted for demand response and peak-load management transmission and distribution investment, line losses, objectives, including transitional targets; system reliability and emissions avoidance value, and ▪ re!ning building standards to address new construction - timing of transition and grandfathering of existing and major modi!cations to support ef!ciency and DERs; environmental footprint goals (e.g., California Zero ▪ demand response to be bid into capacity planning Net Energy Plan for new construction); to encourage load resource optimization; and ▪ accountability metrics for managing the transition to ▪ time-of-use rates to be implemented to manage the vision; peaks and enhance system optimization. ▪ reform of the regulatory oversight approach to focus on planning and accountability oversight; and ! Utilities are empowered and accountable for managing the transition, and are: ▪ outlining the role by which distribution utilities will be authorized to participate, including the potential for ▪ held accountable for controllable results in achieving service revenue and behind-the-meter asset ownership. a 21st Century Utility; ! Regulatory reform is enacted to support ef!cient ▪ encouraged to lead the integration of new technologies resource deployment and accountability: and given incentives to achieve results, as deemed appropriate; ▪ multiyear integrated transmission and distribution system planning process, including de!ning the value ▪ responsible for educating customers on new energy and cost-effectiveness of renewable options; management alternatives; and ▪ transparent and sustainable accountability metrics to ▪ the potential owners of renewables, new technologies, be set, based on customer and policymaker objectives; or DERs, as addressed in statewide energy or 21st ▪ transparent and sustainable incentives (and penalties) Century Utility plans. for accountability as to realization of policy objectives;

Chapter 4 24 Pathway to a 21st Century Electric Utility Experiences in Selected States and the UK States with high electric prices, locational DER opportunities developed a comprehensive framework for engaging the or grid reliability challenges will likely take the lead in utility of the future. California and New York have been the pursuing 21st Century Utility proceedings and, hopefully, most proactive in leading change in their markets. Also implementation programs. Clearly, states will develop worthy of note is the Revenue = Incentives + Innovation + policies and strategies that re"ect their unique circumstances Outputs (RIIO) model in the UK and how it has addressed regarding policy, system resource issues, locational the alignment of customer, policymaker and utility interests. opportunities and energy costs. Many states will learn In Minnesota, policy advocacy and utility interests have from !rst-mover jurisdictions that are pursuing a 21st proposed an interesting paradigm to develop the electric Century Utility model in a comprehensive manner. utility model and are in the process of collaborating with state policymakers to discuss the proposed framework, While practically every state has addressed speci!c issues referred to as the e21 Initiative. related to energy supply and ef!ciency programs, few have

Figure 9: Responses to Evolving Electric Utility Models

e21 Great Plains Institute, CEE, Xcel Energy, MN Power et al.

State of MA: Grid Modernization Working Group

NY: Reforming the CA: Energy Vision (REV) AB 327 on Distributed Generation Tariffs

HI: Power Supply Improvement Plan

Source: Great Plains Institute, July 2015.

California has led efforts to reform its utility model, dating Currently, California is mandating that distribution resource back to an aggressive Public Utilities Regulatory Policy Act plans be provided by each utility, with a focus on better implementation program in the 1980s and its groundbreaking integrating DERs into the grid. However, California has not 1994 industry-restructuring docket. However, the California gathered its array of programs into a comprehensive 21st energy crisis of the summer of 2002 illustrated that not all Century Utility model, and is only beginning to unleash the that has been tried in California has met with success. full power of its nearly statewide advanced metering Still, California has led with its aggressive implementation infrastructure, including meaningful residential customer of renewables through its RPS (now seeking a 50 percent application of time-of-use rates. Policymakers are renewable mix by 2030), attracting both rooftop and utility- facilitating change through mandates, due to California’s scale renewables, and energy-ef!ciency spending (about high electric prices and their willingness to allow cross- 30 percent of U.S. spending).18 California also leads on subsidies among and between customer classes. Such incentive programs for utilities to achieve ef!ciency savings mandates raise questions as to the fairness of bene!ts to and programs to enhance energy-storage technologies, all customers, given the small but growing percentage of though the incentives for ef!ciency adoption are modest customers who take advantage of market opportunities, relative to the amount needed to drive signi!cant such as rooftop solar rewarded with high net energy organizational focus and strategy. metering buy-back rates.

18 Edison Foundation Institute for Electric Innovation, “Summary of Electric Utility Customer-Funded Energy Ef!ciency Savings, Expenditures and Budgets”, (2014).

Chapter 4 25 Pathway to a 21st Century Electric Utility New York has been the most active in pursuing a ! reward utilities for delivering customer value with reduced comprehensive solution to a reformed utility model. The New reliance on a capital investment–driven model; York state proceeding Reforming our Energy Vision (REV) ! align the utility model with state and federal policy goals; intends to promote more ef!cient use of energy, including ! enable the delivery of services that customers value; increased penetration of renewables and DERs. It also intends to promote markets to drive greater use of new ! fairly value grid and DER services; technologies for energy management. The objective is to ! focus on economic and operational ef!ciency of the empower customers by providing more choices for managing entire system; their electric consumption. Utilities, under REV, will be tasked ! reduce regulatory oversight–related administrative costs; with operating the grid and acting as the distribution-service and platform provider, integrating market solutions into the grid. ! facilitate innovation and implementation of new The New York Public Service Commission (NYPSC) is technologies. considering tariffs and incentives to better align utility interests with achieving the commission’s policy objectives. e21 proposes performance-based ratemaking as an The Staff of the Department of Public Service issued a white incentive to utility performance, consistent with multiyear paper19 in July 2015 proposing future incentive opportunities integrated system plans that focus on DER deployment and for New York utilities, including market-based earning reducing costs through system wide ef!ciency measures. opportunities from new grid-related services and incentive The initiative seeks to establish multiyear rate programs to mechanisms for performance consistent with goals. shift the regulatory oversight focus from rate-case The REV initiative is a work in progress. preparation and deliberation to forward planning. Neither California nor New York has yet created The e21 Initiative, while in its early stages, material, timely or transparent incentive If the system can represents a comprehensive and frameworks to move utilities to revise their bene!t from ef!ciencies collaborative approach to pursuing a approach to customer engagement, or 21st Century Utility model. Unlike otherwise taken a leadership position to related to operating versus New York’s REV, this initiative is encourage large percentages of the capital expenditures, the utility more robust in that it provides a customer base to more proactively larger role for utilities to engage with optimize energy consumption. In New will earn a return on a component customers and it outlines how York, that is starting to change. Con of such ef!ciency savings while regulatory oversight should evolve. Ed’s BQDM Program, discussed earlier, For the initiative to move forward, is a recent example of the NYPSC the customer bene!ts policymakers will need to endorse the approving an innovative solution that does from a lower cost. framework outlined. How this initiative provide for incentives to the utility. is ultimately received by Minnesota policymakers, and the full range of public In California, the incentives available two years process participants that engage in the discussion, after the reporting period yield less than 1.25 will shed light on the prospects for policy-led collaboration 20 percent of utilities’ operating income. This level of toward a new utility model, in Minnesota and nationally. incentive does not motivate major corporate strategic reassessment of operational, !nancial and compensation The United Kingdom’s RIIO model is encouraging to consider strategies. In addition, the programs in California and New for its impact on ratemaking solutions. The RIIO model builds York do not promote the most ef!cient use of DERs, but on the UK’s prior approach to determining revenue. It will encourage the marketplace to adopt DERs, at the same create eight-year periods for price review, under which utilities time discouraging the utilities from investing in them by have the opportunity to realize operational ef!ciencies, subject offering attractive net energy metering incentives. to accountability metrics, and given incentives to consider operating investments that replace or defer capital investment Minnesota’s e21 Initiative is an interesting and important (known as Totex, or total expenditures). Totex was structured collaborative effort to develop Minnesota’s 21st Century to address the inherent utility bias toward capital investment Utility. The effort is led by the Great Plains Institute, an (rate base) by capitalizing and allowing a return on, and of, energy policy advocacy group, and involves Minnesota’s investment of certain operating expenditures that avoid or investor-owned electric utilities and several national energy defer less economical capital investment. The concept is to policy groups. The initiative proposes a comprehensive focus on optimizing total system expenditures. If the system framework for a 21st Century Utility and regulatory can bene!t from ef!ciencies related to operating versus capital oversight approach. The Phase I report, issued in expenditures, the utility will earn a return on a component December 2014, includes the following recommendations:

19 State of New York Department of Public Service, "Staff White Paper on Ratemaking and Utility Business Models," July 28, 2015 20 SEC Form 10-K for Edison International and PG&E Corporation Chapter 4 26 Pathway to a 21st Century Electric Utility of such ef!ciency savings while the customer bene!ts from report on in a timely manner). To drive and align behavior a lower cost. The criticism of RIIO is that signi!cant change, signi!cant opportunity and dollars should be at risk regulatory proceedings, costs and ongoing oversight are for achieving on incentive performance, for example up to 10 required to approve and execute on a RIIO planning period. to 20 percent of pro!ts. A utility realizing a 10 percent ROE So, while the RIIO model may not be appropriate for many would be able to earn up to 12 percent for meeting its U.S. states due to the signi!cant administrative burdens incentive targets. While there is no science behind that created for policymakers and utilities, components of RIIO, incentive number, it must be meaningful to encourage such as multiyear regulatory review periods and Totex, are changes in behavior, and less than 10 percent is unlikely to worthy of consideration for implementation. achieve that goal. In order to encourage the behavior and innovative spirit that are essential to achieving continuous performance improvement, incentives must be durable. They Developing an Accountability must be available and achievable on an ongoing basis and subject to revisions as market conditions evolve. For capital and Incentive Framework markets to differentiate between those states that provide The utility model we operate within today is highly regulated incentives and those that do not, durability will be an and mostly backward looking in its approach to regulation. In important component. an ideal world, policymakers would outline their policies and The bene!t of a multiyear regulatory plan is that utilities can develop accountability metrics to monitor and evaluate align their strategy with the implementation of their utility performance. Instead of mandating and integrated distribution plan, which will free up overseeing countless proceedings as to utility resources that can be deployed in effective performance, a strategy could be employed future planning because fewer resources by which reasonable accountability metrics The utility would not will be required to process rate cases. were tied to meaningful incentives and Transparent accountability metrics and penalties that would lead utilities to be responsible for developing resulting incentives and penalties will focus on achieving best-in-class new technology, but for assessing provide ongoing oversight of utility performance. Since U.S. utilities for the performance and progress in most part already provide best-in-class and working with technology reforming our energy future. reliability of service, new accountability providers to bring best-in- Policymakers, through their regulatory metrics would focus on achieving oversight, can ensure that the performance toward a 21st Century class technologies to integrated system plan responds to their Utility framework. Examples of potential the customer base. stated objectives. In particular, agreement accountability metrics, focusing on customer can be solidi!ed on deploying and valuing and policy goal realization and the transparency renewables, such as community solar and and sustainability of such goals, are as follows: rooftop solar. A robust integrated system plan ! reliability—percentage of hours of uninterrupted would provide utilities with an effective roadmap for electric service and percentage and number of annual operating over the planning period with improved clarity as to outages impacting customers; the path of utility rates over that period. Each new integrated planning cycle would provide an opportunity to re!ne the ! service—range of customer energy solutions offered, next plan, so as to continuously improve the process and number of customer calls, call wait times and number respond to customer and marketplace dynamics. of calls to resolve complaints; ! ef!ciency—weather-adjusted decline in energy usage due to ef!ciency adoption and peak load management and optimization; Engaging Utilities to Adopt ! clean energy mix—increase in renewables and DERs a 21st Century Electric Utility Model and decline in carbon footprint relative to RPS standard The pathway proposed in this paper looks to the utility transitional goals; and as the facilitator, integrator and nonexclusive distribution ! investment—capital and total spending below a channel to offer new products and services to its market. predetermined rate, subject to carve-out for critical The utility would not be responsible for developing new infrastructure investments. technology, but for assessing and working with technology providers to bring best-in-class technologies to the customer To be effective in driving change, incentives and penalties base. With the support of policymakers, utilities may be must be transparent (i.e., easy to understand, calculate and allowed to own and operate (either through the regulated

Chapter 4 27 Pathway to a 21st Century Electric Utility entity or an unregulated af!liate) assets behind the meter, with customers; or at a minimum, could leverage competitive providers to ! optimized investment and reduce costs and risks; offer the best price to customers. The advantage of utility ! enhanced regional economic growth through enhanced ownership is scale and cost of capital bene!ts. optimization of utility system and services; The following summarizes why utilities should be at the ! enhanced citizenship pro!le; forefront of leading, integrating and accelerating the ! potential to earn incentives for achieving accountability transition to a 21st Century Electric Utility, from the goals; and perspective of key stakeholder interests. ! ability to earn additional revenues from participating in ᮣ Benefits to Customers facilitating and integrating realization of a 21st Century Utility, thereby creating potential to offset rate-increase ! high level of recognized trust in utility providers versus needs and earn incremental returns for investors. a large group of unknown vendors of competitive energy services and technologies (including ef!ciency, demand Those opposed to utilities owning behind-the-meter assets response, load management and DER providers); within the regulated business fear that it could: (i) complicate ! access to customer and electric system information the regulatory model and ratemaking, (ii) increase potential that supports a program for system optimization !nancial risk to customers for un-creditworthy decisions and regarding future investment (subject to strong standards (iii) freeze out competitive industry players. Policymakers/ to protect consumer privacy); stakeholders would have to evaluate these issues when considering whether and how to allow utilities or utility-af!liated ! increased quality control oversight of third-party entities to participate in behind-the-meter infrastructure. competitive energy service providers and products, given their scale, system knowledge, resources and lack of We now have an array of competitive entities seeking to offer incentive to promote one new technology over another; new electricity products and services to both residential and ! enhanced information analytics based on customer large commercial and industrial customers. This is a positive usage experience to support customer decision making development, but there is little, if any, oversight of the quality regarding innovative energy-optimization product of the services offered, including the economic ef!ciency of alternatives; and these new inputs to the energy delivery system. Third-party entities partnering with utilities should create the right type ! lowest systemwide cost of deploying optimal located of checks and balances by which utilities can oversee the investments with scale technologies. development of new technologies that impact their system, ᮣ Benefits to Policymakers invest as appropriate to support the grid needs and enable best-in-class technologies, and act as a distribution channel ! acceleration of de!ned policy objectives (ef!ciency, system to assist in deploying new technologies. However, competitive optimization, environmental) through properly structured service providers may seek utility system data to support their incentives and accountability for realizing results; initiatives, and policymakers will need to resolve issues ! ability to enhance accountability via regulatory oversight regarding data control, sharing and privacy protection. of utilities; and Regulators in this paradigm would be able to drive utility ! opportunity to mitigate the level of utility rate increases accountability through appropriate and transparent required by allowing utilities to earn additional revenues customer and policy performance standards, consistent related to facilitating, integrating or owning new services, with the objectives of economic provision of reliable, clean including behind-the-meter assets. and affordable energy services. In addition, regulators ᮣ Benefits to Competitive Marketplace Service Providers would determine how utilities would be compensated for their role in facilitating change and customer adoption ! endorsement of best-in-class providers and technologies; through incentives, as well as penalties when performance ! partnering with utilities can facilitate increased adoption standards are not met. They could further offer commissions of new value-add technologies; and for utilities facilitating sales of new products offered by ! partnering with utilities can reduce customer acquisition vendors, and structure compensation and returns allowed costs and thus enhance pro!tability (through reduced on utility (or utility af!liate) ownership to allow for behind- cost and increased volumes). the-meter assets. ᮣ Benefits to Utilities Utilities have been timid in claiming a role in accelerating and executing a 21st Century Utility model. Several factors ! enhanced customer service by increasing interactions

Chapter 4 28 Pathway to a 21st Century Electric Utility have likely caused a less than aggressive posture: skepticism it appropriate. In fact, the e21 Initiative was developed on the part of regulators, who often suspect that utilities for adoption in Minnesota, which is a vertically integrated may earn outsized pro!ts from future activities and, thus, utility market. have sought to encourage the competitive marketplace Utilities in restructured states have less at risk in moving without providing rules for how utilities can participate; forward with a 21st Century Utility sector. While these a strong lobbying effort by competitive market providers utilities may still be exposed to kWh consumption-based to prevent utilities from participating in new services; and tariffs, the impact can be more easily managed by utility compensation programs aligned with !duciary duties decoupling or other mechanisms to mitigate any drag on that do not encourage development of new markets but return on invested capital. Importantly, the highest-cost focus on reliability and near-term !nancial performance. markets that are seeing the most interest in ef!ciency and new technologies tend to be in restructured regions. Thus, we expect that these markets Vertically Integrated vs. will tend to be at the forefront of driving Restructured Utilities Importantly, the highest- industry change. cost markets that are seeing Given the restructuring of U.S. electric utility markets and utilities’ the most interest in ef!ciency Ratemaking and roles in 17 jurisdictions during the and new technologies tend to be 1990–2005 period, the industry is Tariff Design no longer a homogeneous group in restructured regions. Thus, we Important components of the of vertically integrated (distribution, expect that these markets will evolution to a 21st Century Utility transmission and generation) utilities. industry model are the topics of In most restructured markets, tend to be at the forefront of ratemaking and tariff design. For distribution utilities own no meaningful driving industry change. purposes of this paper, ratemaking is level of power generation and thus are de!ned as the process by which regulators less exposed to threats to the economics determine the appropriate aggregate annual (and value) of the power markets. The volatility revenue collection (or revenue requirement) utilities and pro!tability of power generation in restructured markets may recover from customers to cover costs and earn a fair is borne by competitive generation companies (whether return on invested capital. Tariff design refers to the independent from utility ownership or in unregulated structure of customer rates (or prices charged) to recover utility-af!liate entities). However, to the extent utilities the revenue requirement allowed. in restructured markets collect tariffs based on energy usage, these transmission and distribution utilities remain Ratemaking, which is grounded in legal precedent as to exposed to "uctuations in customer energy usage. Thus, the utilities’ right to recover prudent costs, is not a hotly not all utilities will be impacted by the same set of factors contested issue in the 21st Century Utility debate. The in the transition to a 21st Century Utility sector. ratemaking discussion has often focused on structuring a system whereby utilities have no incentive for (or are Because vertically integrated utilities own power generation, indifferent to) increased capital investment (aka rate base) they are more exposed than transmission ad distribution to provide service, such as in the UK’s RIIO model. utilities to the electricity consumption impacts of DERs and various forms of energy ef!ciency. Declining consumption Tariff design is the tool that regulators use to promote for these companies results in lower revenues to recover policy objectives, such as equitable distribution of cost, generation investment and the related adverse impact on customer usage and consumption behavior. “Disruptive market power prices (due to lower demand and increasing Challenges” highlighted the con"uence of factors challenging supply from DERs). Thus, all other factors aside, it is likely the long-term !nancial viability of our traditional utility that electric generation owners, including vertically integrated regulatory model. The strategies proposed to address utilities and competitive generators, will be less interested and mitigate the disruptive forces outlined were primarily in moving toward a 21st Century Utility until the level of regulatory solutions. Looking through an investor’s lens, unrecovered investment in power-generation assets becomes several tariff-restructuring alternatives were proposed. less meaningful. This does not suggest that a transition may Those alternatives, which could be implemented individually not occur prior to recovering greater levels of generation or in combination, included increasing monthly !xed investment, since regulators can approve structures, such charges on all customers, monthly service charges for as transition charges, to accelerate change if they deem all distributed energy resource (DER) customers and/or

Chapter 4 29 Pathway to a 21st Century Electric Utility Figure 10: Mandatory Fee Proposals Timing Map

Current !xed charge Ⅵ proposal/!ght (21 states) New proposal expected within Ⅵ 12 or 24 months (4 states) Proposal expected (uncertain Ⅵ timing), or possible due to recent activity (e.g., NEM debate) that could spur a proposal (13 states) No current or near-term Ⅵ expected activity (12 states)

Source: NRDC, NCLC and Vote Solar.

revising the net metering buy-back rate to be based on mandatory !xed charges (or demand charges), a solution the wholesale value of the energy provided by the DER proposed in “Disruptive Challenges,” is a tariff design tool customer to the utility (versus the retail rate, as re"ected that utilities have actively pursued since 2013 to mitigate in the majority of net energy metering programs). revenue risk from disruptive forces. According to the Environmental Law and Policy Center, Marketplace dynamics since the release of Adopting meaningful 24 utilities have recently proposed “Disruptive Challenges” suggest that two increases to their !xed fees.21 However, important factors were missing from that monthly !xed or demand signi!cant increases have met with 2013 assessment: (i) the customer and charges system-wide will reduce strong opposition from customer policymaker view that it is not in the !nancial risk for utility revenue interests and policymakers. best interest of customers or society overall to slow the pace of technology collections for the immediate future, Adopting meaningful monthly !xed innovation or adoption (a likely result but this approach has several "aws or demand charges system-wide will of increased customer !xed charges), that need to be considered when reduce !nancial risk for utility and that over the long term, revenue collections for the immediate technology advancement cannot be assessing alternatives through a future, but this approach has several deterred by regulatory rulemaking; and win4 lens, by which all principal "aws that need to be considered when (ii) customer and policymaker actions stakeholders bene!t. assessing alternatives through a win4 through 2015 that have demonstrated a lens, by which all principal stakeholders clear policy opposition to meaningful increases bene!t. Fixed charges: in !xed charges, as evidenced by low !xed charges in ! do not promote ef!ciency of energy resource demand place throughout the investor-owned utility industry, as well and capital investment; as recent actions in several states that approved nonmaterial !xed charge tariffs (e.g., Arizona Corporation ! reduce customer control over energy costs; Commission adopting a $5/month charge, not the ! have a negative impact on low- or !xed-income $50/month charge proposed by Arizona Public Service). customers; and While the cost structure of distribution and transmission ! impact all customers when select customers adopt of electric utilities is predominantly of a !xed nature (i.e., DERs and potentially exit the system altogether, if high not meaningfully impacted by volume variability or short- !xed charges are approved and the utility’s cost of term business issues), utility rate structures have typically service increases. authorized a small !xed charge component. Increasing While DER customer charges can be structured to re"ect

21 Environmental Law and Policy Center Foundation, June 2015.

Chapter 4 30 Pathway to a 21st Century Electric Utility the value of the grid connection that is maintained by the economic and policy bene!ts commonly associated practically all DER customers, such charges will need to with PV solar. If, as the study shows, there are meaningful consider whether and at what level a DER buy-back rate cost differentials between residential and utility-scale (the price paid for energy by a utility to a DER supply systems, it is important to recognize these differences, customer) should be set. Through a win4 lens, it is clear particularly if utilities and their regulators are looking to from recent regulatory actions recon!rming support for maximize the bene!ts of procuring solar capacity at the DERs and net energy metering that policymakers are lowest overall system costs.”22 interested in DER development and customers want the Given the signi!cant net cost bene!t of approximately option to choose their own energy supply. 45 percent for utility-scale solar (due to capacity costs It is therefore in the long-term best interests of utilities to and power output optimization), pricing of rooftop solar support such choice, consistent with regulatory policies and related subsidies, and other energy technology that support !nancial viability and avoid meaningful alternatives, should be determined by the most ef!cient monthly !xed charges. By instituting monthly DER alternative opportunity, after factoring in grid-related costs customer grid fees or reducing buy-back rates, it is likely and bene!ts. Tariff fairness can be structured, such as that rooftop solar activity will be slowed, and this must be by adopting renewable grid charges or adjusting DER considered in the policy debate. This is consistent with the buy-back rates (i.e., net metering), in a way that factors in early experience of the Salt River Project (SRP), the economic value of adding renewables to the grid which is not regulated by the Arizona and creates an opportunity for all customers to Corporation Commission and implemented bene!t equally from the adoption of a $50/month renewable customer grid Given the new tools renewables, not just homeowners who charge for all new rooftop installations. available to enhance system can deploy solar on their rooftops. Since that announcement, one major Without increased demand for rooftop supplier reported a 96 wide ef!ciency, including peak load electricity sales, !xed charges to all percent decline in new solar management, time-of-use rates can be customers, or DER grid charges, applications in the SRP territory. an important tool in managing a dynamic utilities will continue to be exposed Besides the installed cost advantage optimization of resources as market to customer switching and under of utility-scale solar versus rooftop recovery of revenues. This is solar and system optimization demand and supply evolve in a especially true for utilities with considerations, community or utility- technology-enhanced 21st inclining block tariffs (i.e., the more you scale solar brings the advantage of use, the higher the rate for incremental renewables to all customers without the Century Utility model. energy consumed) that are in excess of the potential cross-subsidy issues associated with cost of DER alternatives. The result of ongoing rooftop solar. customer adoption of DERs in net energy metering states (43 of 50) is that future rate increases are required to offset the revenue lost from those customers adopting Tariff Design Principles for DERs. This scenario feeds a cycle of customer adoption of DERs and eventually results in increasing rates for non- a 21st Century Electric Utility DER customers. The advent of (i) bidirectional metering, As we consider fairness to all customers, we should provide (ii) most economical value of renewable buy-back rates incentives to fund the most cost effective renewable options. and (iii) revenue-decoupling mechanisms can assist in In October 2015, the Hawaii PUC halted its net energy mitigating this risk. metering program for new systems due to penetration Time-of-use (or real-time) pricing has the potential to in excess of 20 percent. This is the !rst signi!cant action be an important tool in optimizing system capacity and to slow the growth of rooftop solar penetration due to the moderating incremental capital investment in electric high cost that NEM programs shift to non-DER customers. energy infrastructure. While this type of tariff design has In a recent study prepared by the Brattle Group entitled, been discussed for years and is supported by smart-meter “Comparative Generation Costs of Utility-Scale and technology investment, policymakers have generally not Residential-Scale PV in Xcel Energy Colorado’s Service supported it. The lack of support from policymakers is a Area,” the !ndings demonstrate that “utility-scale PV system roadblock to moving forward on a 21st Century Utility model. is signi!cantly more cost-effective than residential-scale PV systems when considered as a vehicle for achieving Time-of-use rates have not been widely implemented due to technical constraints—a lack of smart-meter

22 The Brattle Group, “Comparative Generation Costs of Utility-Scale and Residential-Scale PV in Xcel Energy Colorado’s Service Area,” Prepared for First Solar, July 2015.

Chapter 4 31 Pathway to a 21st Century Electric Utility infrastructure—and a lack of public interest. Customer existing DER customers during the transition period, we concerns include lack of understanding, potential volatility should address the tariff issue now to de!ne the ultimate of bills, and impact on low- and !xed-income customers. transition period, provide fairness to all customers and Given the new tools available to enhance system wide mitigate !nancial risk to customers and utility investors. ef!ciency, including peak load management, time-of-use rates can be an important tool in managing a dynamic optimization of resources as market demand and supply Financial Issues evolve in a technology-enhanced 21st Century Utility model. Thus, we need to expand our efforts to educate The !nancial health of utilities has improved over the last and pilot these programs. While “opt-in” programs have several years, based on the support of regulators for often realized low adoption levels, another alternative to allowing recovery of revenue shortfalls due to declining consider is selected “opt-out” programs, where appropriate, consumption and customer growth, with increased use of to encourage realization of policy objectives. decoupling of revenues from consumption in some form now in over 28 jurisdictions. In addition, a decline in the Factoring in !nancial viability considerations and customer cost of fuel to generate power, lower merchant power prices and policy preferences, the following tariff principles are and lower interest rates have provided additional headroom components of a tariff design that can contribute to the for base utility rate increases. In this environment, and development of a 21st Century Utility model: re"ecting lower interest rates in the !nancial markets, ! introducing inclining block rates to promote utility credit ratings have stabilized from the ef!ciency of energy consumption; continuous decline experienced from the 1960s through 2010, and utility equity ! decoupling of revenues from However, below the prices have been at or near all-time volumetric usage charges to protect surface, lie foundational highs on a dollar price and multiples- cost-recovery shortfalls in the shifts that suggest the steady of-earnings basis. Investors are short-term, for example due to generally pleased with the utility customers switching to DERs or period of utility performance will sector’s performance, and likely declining usage due to new be challenged by customer choice, hope the current business model technologies; however, decoupling prevails for the foreseeable future. does not reduce the long-term the adoption of new customer-driven Unfortunately, hope is not a strategy. vicious cycle of increasing customer technologies and customer behavior adoption of DERs created by changes driven by social However, below the surface, as increasing rates; described in countless industry trade ! providing bidirectional meters to all and economic forces articles and in “Disruptive Challenges,” lie DER customers so that energy consumed foundational shifts that suggest the steady from utilities would be charged based on utility period of utility performance will be challenged tariff schedules, and buy-back rates for DER-produced by customer choice, the adoption of new customer-driven energy at a value of renewable rates; technologies (e.g., Nest) and customer behavior changes driven by social and economic forces (e.g., smaller ! setting the value of renewable rates at the higher of homes). Investors have shown from prior experiences in competitive wholesale energy prices or the levelized other industries that they become noticeably concerned cost of the lowest incremental cost to deploy ef!cient about disruptive challenges when the loss of sales and renewables (e.g., lower of rooftop vs. utility scale, with revenues is re"ected in !nancial results. For utilities, this adjustments based on evaluation of system costs and can happen when serious rate-increase opposition bene!ts); and accelerates due to the impact of increasing penetration of ! establishing time-of-use rates to optimize system DER technologies. ef!ciency; time-of-use rates will enhance the value of new technology investment as customers optimize the Although these disruptive challenges are well outlined in value of this rate structure (e.g., using appliances with utilities’ SEC !lings, utility managements are managing time-of-use controls). their businesses based on the current framework and their !duciary duty to focus on quality service for customers With these principles in place, tariff economists can !ne- and growth in near-term earnings and investment value tune potential tariff structures to support a 21st Century for investors. As long as investment spending supports Utility model. Each jurisdiction will have its own unique growth through increased rate needs, the problems lurking issues and cost structures that will impact the ideal in the future are kicked down the road, although one could approach in its market. Since we are likely to grandfather argue that the problems are ampli!ed by increasing utility

Chapter 4 32 Pathway to a 21st Century Electric Utility rates in the short term. In addition, utility management new services to customers directly or through utility-run compensation is focused on near-term reliability and !nancial ef!ciency programs. In that environment, the utility is goals, creating a !duciary obligation and compensation relegated to grid provider, and policymakers have few incentive for management to focus on the near term. levers to oversee or in"uence the marketplace to achieve their vision. For the time being, all may appear well, but if one believes that risks are at play, when these threats become a !nancially The environment that this paper proposes is one in which reality, investment values will be impacted. Capital availability the utility is responsible for the development and operation will decline as investors focus on the potential for declining of the grid, but is also encouraged and accountable for pro!tability and the risk of stranded assets or cost levels that accelerating our progress toward a 21st Century Utility the remaining customer base may be unwilling to bear. Given model. The utility will be encouraged and accountable the importance of utility access to capital to support the grid, for promoting the adoption of new technologies, and for this is not an acceptable scenario. developing a cost-effective plan to deploy technology in the most ef!cient way to control customer costs. In this scenario, The objective is not to create fear or call for a death cost of capital on new investments might consider returns spiral, but to commence the transition now to a future on selected operational spending (similar to the UK Totex that customers support and in which utilities can play model) that mitigates less-than-optimal capital investment. a constructive role and access the capital required to build Utilities would also play a traf!c cop role by allowing only this future. As a point of reference, who would have thought proven technologies or vendors entry to their application store. that essential service industries in a growing economy such as the airlines and the landline phone business Utility revenues will be determined by regulators to would not support investment-grade quality ratings as encourage a return on invested capital, particularly for stand-alone entities? the legacy system in place, and transparent incentives to encourage accountability for accelerating change and policy realization. It may be a challenge to develop tariff The New 21st Century Electric Utility mechanisms and incentives, since there exists a distrust of providing utilities an opportunity to increase their returns The current transition of the electric utility framework into above currently allowed levels. But common sense and a new model is being led by economic and technological economic theory demonstrate that the best way to achieve forces that will ultimately drive change. This is particularly results is to provide economic incentives. Regulators will true given the support of policymakers for customer choice continue to regulate, and thus any midcourse correction of electric supply and new technologies to drive ef!ciency, deemed necessary can be implemented. The objective system optimization and the reduction of our environmental is to develop a formula by which customers are served, footprint through expanding our mix of clean energy sources. policy is realized, technology adoption and product offerings The actions by states to date in considering meaningful by competitive entities is accelerated, and utilities are regulatory change have been predominantly in support of motivated to achieve the objectives of customers and policy a free marketplace for competitive providers to offer their while maintaining !nancial viability to support the grid.

Concluding Comments: Transitioning to the New Utility Model

The transition to a new industry paradigm will require the the full suite of opportunities that can be created by a 21st proactive support of customers, policymakers and utility Century Utility. A mutual understanding of the bene!ts of regulators, competitive-market service providers, and collaboration and economic bene!ts to all parties is key utilities. In the ideal world this would be a collaborative to a productive process and for de!ning a clear transition process, driven by policymakers who understand that the and end state. industry model needs to be re!ned in order to promote

Chapter 4 33 Pathway to a 21st Century Electric Utility Figure 10: The Pathway to a 21st Century Utility Model Vision

Vision: Foundational Principles: Pathway: • Enhanced reliability and resilience of • Financially viable utilities essential to fund • State policymakers pursue legislation the electric grid while retaining and support an enhanced electric grid; to outline the model for a 21st Century affordability; • Policymakers must promote clear policy Utility; • An increase in cleaner energy to protect our goals as part of a comprehensive, • Regulatory reform to support ef!cient environment and global strategic integrated 21st Century Utility Model; resource deployment and accountability; interests; • Commitment to engaging and • Tariff structures re!ned to support • Optimized system energy loads and empowering customers to make price signals and !nancial viability electric-system ef!ciency to enhance cost intelligent energy choices; and requirements; ef!ciency and sustainability; and • Equitable tariff structures that promote • Utilities empowered and accountable • A focus on customer value, including fairness and economic and environmental for managing the Transition. service choices and ease of adoption. policy goals.

TRAFFIC RULES

21st Century Pathway

Utility Accountability Turnpike 21st Century Utility Tariff Reform Legislation Highway Interstate Regulatory Reform Parkway

To make progress, it is important to begin this transition ! de!ne a timeline for commencing the study process soon and oversee its continual evolution. The process to and transition to the end state; accomplish this transition is not regimented, but should ! identify a process to revise the utility model through include the following steps: the transition, as appropriate; and ! de!ne the objectives, vision and foundational principles ! de!ne the impact of the new model on the regulatory for a 21st century electricity market; oversight process. ! identify the transitional constraints and No two states will apply the same approach, but roadblocks to navigate to the end-state the goal is to develop several robust models market; that can be tested and compared against ! consider the roles and interactions of each other to re!ne into best-in-class key market participants, including The policies set forth models over time. The policies set utilities and competitive service for a 21st Century Utility model forth for a 21st Century Utility model providers; and the pathway for achieving ! de!ne utility tariff structure and the pathway for achieving results will create a signi!cant objectives and approaches to results will create a signi!cant opportunity for economic growth realizing objectives; and regional competitiveness. Over opportunity for economic the long term, these proactive ! identify alternative incentives and solutions will create shared bene!ts hold utilities accountable for growth and regional for customers, utility investors and accelerating and integrating competitiveness. society as a whole. system optimization;

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