The Resurgence of Performance-Based Ratemaking

Over the last year, there appears to be a resurgence in the consideration of performance-based ratemaking (PBR) in utility regulatory proceedings across the country. As advanced technologies are deployed by electric utilities pursuing broad smart grid initiatives, there is an increasing realization that traditional regulatory policies and ratemaking may be inadequate when it comes to striking the right balance between the risks associated with utility investments in smart grid technologies and the need to modernize what is clearly an aging energy infrastructure. According to a number of state utility commissions, PBR—which has been around for decades in various forms—may once again provide a solution.

For those who may be unfamiliar with the term, PBR is a fairly generic term that becomes more defined when it is applied in a specific regulatory proceeding. Although PBR can take many different forms and the application of it will be unique in each state jurisdiction, essentially PBR refers to a process by which energy utilities’ revenues are adjusted based on their performance. Under PBR, rates are set on a utility’s performance on various measures, such as reliability and customer service as well as costs. Typically, a target baseline for rates is set by a utility’s regulator and then, based on a set of established performance metrics, if the return on equity (ROE) achieved by the utility exceeds this target then the utility would provide its customers with a credit defined by an agreed-upon sharing mechanism; if the ROE falls short of the target then it would be able to seek a rate increase or other surcharge. If a utility does not meet its performance goals, the regulatory commission may seek to reduce the utility’s ROE.

There appears to be a consensus in the Energy & Utilities industry that PBR will become more prevalent and performance results will be contested more frequently as utilities continue to deploy advanced technologies. Regulators will likely seek to ensure that rates and rate increases are directly tied to measurable performance metrics, such as the reduction of frequency and duration of outages and the number of estimated billing statements. Other performance metrics might include theft detection and minimizing energy usage from inactive meters.

Last year, Illinois became the first state to approve a comprehensive PRB structure directly associated with utility investments in smart grid, through the state’s Energy Infrastructure Modernization Act (EIMA). The logic behind the legislation is to create a value proposition for sharing risks and benefits between Illinois’ utilities and their customers, while modernizing the grid. There are specific set of metrics on which Ameren and ComEd will need to demonstrate performance in future regulatory proceedings that will impact the level of their potential earnings.

In addition to Illinois, the apparent resurgence in PBR is evidenced by activities in other states:

  • Maryland: In October 2012, Maryland Gov. Martin O'Malley unveiled a four-part plan designed to speed up investments that will strengthen the state's distribution grid. Part of that plan would set a ratemaking structure that aligns customer and utility incentives by rewarding reliability that exceeds established reliability metrics and penalizing failure to reach those metrics. A task force appointed by the governor has encouraged the Maryland state regulatory commission to implement a PBR process for IOUs in the state such as Baltimore Gas & Electric, linking a utility's progress or failure to meet certain reliability metrics with its authorized rate of return.
  • Oklahoma: A PBR regulatory platform has been put into place for  Oklahoma Natural Gas (ONG), which sets up a range of acceptable revenue for the utility that is also tied to performance metrics. If infrastructure improvements or other factors push the company below an established range, ONG can ask for an increase. If higher revenue pushes it above that range, most of the excess is shared with customers. Separate riders are currently used to cover unanticipated costs will reportedly be phased out in favor of an annual PBR review.
  • California: Although forms of PBR have been in existence in California for a number of years, a new initiative by the California Public Utility Commission (CPUC) is exploring how to elevate the importance of safety in gas and electric utility rate cases, which would be supported through a PBR platform. Following the deadly 2010 explosion of a Pacific Gas and Electric (PG&E) pipeline in San Bruno, California, a state review panel found that CPUC staff was not keeping adequate track of how PG&E was prioritizing and spending money allocated to safety improvements. The panel has suggested the CPUC move to a PBR scheme, in which the state’s utilities would adopt a system of safety standards, with rate incentives and penalties enforced by state regulators

 

West Monroe Partners has been following this regulatory trend closely and will be hosting a Webinar on the topic on Wednesday, March 27. The focus of the Webinar will be on the potential ineffectiveness of traditional, cost-of-service ratemaking as it pertains to current smart grid and energy efficiency projects; the primary drivers for reconsidering PBR as an alternative; regulatory and legislative PBR initiatives that have emerged in specific states; and the design and tracking of performance metrics that have become the new basis for cost recovery and earnings sharing in PBR-based regulatory proceedings.

For more information or to discuss this topic further, please contact me directly at wmcnamara@westmonroepartners.com or at 505-206-7156.

Here is a link to register for our Webinar on PBR that is being held March 27, 2013.

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