It has been more than three years since Superstorm Sandy came ashore, creating massive storm flooding, gasoline shortages, and more than a week of power outages. Sandy’s devastation revealed critical gaps in New York’s utility infrastructure that inspired Governor Cuomo’s administration to launch New York’s Reforming the Energy Vision (REV) proceeding to better equip New York’s energy system for the 21st century. Already the nation’s leading electricity sector reform effort, REV reached another major milestone this week.
On Thursday, May 19, the New York Public Service Commission (NYPSC) issued a major REV Order, “Order Adopting a Ratemaking and Utility Revenue Model Policy Framework.” In it, the Commission confronts a critical question: What practical steps can be taken now and in the future to align: (1) the regulated distribution utility’s business model and revenue streams, and (2) the rates that customers pay, with New York’s evolving needs and policy goals?
Taking foundational steps to reform utility ratemaking and align a greater share of utility earnings with performance against policy objectives, the Commission provides greater resolution to the path that New York will follow as it evolves the business and revenue models of the state’s investor-owned utilities.
Recap: What Brings Us To Today
Launched just over two years ago under the leadership of Audrey Zibelman, chair of the NYPSC, REV has sought to proactively chart a new path for the regulation of New York’s electric utilities. As the NYPSC stated unequivocally in its first major REV Order:
The confluence of cost, reliability, and environmental concerns… lead to a conclusion that conventional utility and regulatory practices no longer represent the best approach to satisfying our responsibilities. In order to fulfill its statutory duty, the Commission must consider new approaches.
To do so, REV aims to empower New Yorkers to better manage energy via animated markets that incorporate distributed energy resources as integral assets of a resilient electricity system.
Since its launch, REV has moved the needle on a number of foundational topics. In the first major Order of the REV proceeding, issued in early 2015, the Commission adopted a regulatory policy framework that described the need to reform the utility business model and to align ratemaking practices with an evolving set of regulatory and policy objectives. It also set in motion the establishment of a distributed system platform (DSP) structure by which utilities will facilitate distributed resources; limited utility ownership of distributed resources to mitigate market-power concerns; required utilities to create distributed system implementation plans (DSIPs) outlining relevant system information and investment plans; and established interim energy efficiency targets.
In short, the NYPSC has made important progress in developing its vision of a transformed electricity system and setting the foundational policy direction. The release of the “Order Adopting a Ratemaking and Utility Revenue Model Policy Framework” represents the next step toward implementation.
RMI's Lena Hansen explains New York's Reforming the Energy Vision (REV) proceeding.
The Need to Align Utility Ratemaking and Revenue Models
Utilities in New York, as in most of the country, are managed under “cost-of-service regulation,” meaning that utilities are allowed to recover their costs and earn a reasonable return on the capital they invest. In its simplest form, utilities are compensated for selling more electricity and investing in more infrastructure. Although cost-of-service regulation worked reasonably well over the past century, when demand was growing consistently, the model has strained as energy efficiency and distributed generation have grown. Some important fixes, such as decoupling, have been adopted in New York and other states; however, the underlying misalignment between cost-of-service regulation and an efficient, optimized, clean, and innovative electricity system remain.
Further, several assumptions that undergirded the development of cost-of-service regulation no longer entirely hold. As described in the just-released Order, these assumptions include that: (1) customer demand is largely outside the influence of the utility; (2) economies of scale favor utility-scale investments; (3) large expenditures to create redundancies are necessary to support reliability; and (4) end-use customers are the only substantial source from which system costs can be recovered.
The NYPSC has boldly called into question each of these assumptions and, on that basis, made a set of decisions that begin to better align the revenue model of New York’s utilities with desired outcomes. At its core, this reflects the idea that utilities should make money by achieving outcomes that customers and society are demanding.
Recognizing the need to strike a balance between the growing need for action and the necessity for ongoing learning and retooling, the Commission aims to establish a gradual transition path that addresses the shortcomings of cost-of-service ratemaking while preserving investor confidence and supporting a smooth evolution. The Order released Thursday sets the overall trajectory for transitioning the utility business model and rate design, and implements important near-term decisions that represent initial steps on that trajectory.
Tying Utility Revenues to Performance: The Order immediately establishes several new Earnings Adjustment Mechanisms (EAMs), New York’s version of performance-based incentives, to better align utility financial incentives with priority near-term outcomes: system efficiency, energy efficiency, improved data access, and interconnection. Because performance incentives are necessary but insufficient to address the potential for capital bias that cost-of-service ratemaking could entail, the Order additionally creates mechanisms to put capital and operating expenditures on a more equal footing.
Allowing New Revenue Streams for Operating a Platform: The Order establishes Platform Service Revenues (PSRs) by which utilities can earn revenues from operating and facilitating distribution-level markets. In the near term, as the DSP market is being established, PSRs may come primarily from the utility’s ability to develop non-wires alternatives to traditional infrastructure investments, but over time PSRs may be available. The NYPSC makes clear that PSRs are available to monopoly-related services, and may be approved by the PSC "in limited areas of competitive services" as stipulated by specific criteria in the Order.
Moving Toward More Granular Rates: The Order moves New York toward more granular rate design, proposing changes to improve customer adoption of time-based pricing on an opt-in basis. To pave the way for improved price signals that encourage and reward customers for the value they can provide to the broader grid system, the Order also provides for Smart Home Rate demonstration projects. Although the Commission acknowledged the importance of more granular rates, they chose to order additional analysis for default rates, given the state’s lack of advanced metering infrastructure and need for thoughtful design and analysis of potential bill impacts.
Making Data Available and Tracking Outcomes: The Order requires that distributed energy resource providers be given access to customer data, with permission. In addition, a scorecard is established that will track at least ten measures of utility performance against REV’s desired outcomes. Over time, some scorecard metrics may become EAMs.
The NYPSC’s recent order represents a major step forward in realizing the future of New York’s electricity system. While New York is a national leader in comprehensive regulatory reform, many states are tackling similar questions at varying levels of scope and scale. The latest development in New York’s REV proceeding provides insights for regulators, utilities, and stakeholders in states and localities that are facing similar challenges and opportunities in today’s quickly evolving electricity system.
In the coming weeks, we will be releasing an insight brief that describes these decisions in greater detail and provides commentary on their applicability elsewhere.
Image courtesy of iStock.