Why Utilities Should Push for Performance Regulation.

Written by Ronald Lehr, Director, Western Grid Group & Former Chairman & Commissioner, Colorado Public Utilities Commission

Ronald Lehr

Ronald Lehr

A lot of discussions right now focus on moving toward more use of performance regulation for electric utilities.[1]  As utility executives confront the many challenges facing their companies, there are a lot of good reasons why they should support movement toward more use of performance regulation.  Ten good reasons are suggested here.

Performance regulation, according to one recent report

“…rewards utilities…for achievement of specific performance targets, providing an opportunity to earn a higher return if the company is able to perform on the objectives identified.”[2]

While defining objectives, metrics, and measurements for rewarding performance, then tracking, reporting, and rewarding performance can have benefits, implementing performance regulations is not without its challenges.[3]  It is commonplace for skeptics and critics within utility companies to shoot down proposals for change, but our purpose here is to arm performance regulation advocates with the best reasons that support changes.  Here are those reasons:

  1. Better satisfy customers. Besides being just plain good business to leave each interaction with satisfied customers, performance regulation incentives can be based on customer satisfaction surveys.  If you want to be successful in business, give your customers what they want. [4]More value for money. One indicator of long term business sustainability is the extent to which customers receive value for their money.  Increasing its levels of customers’ perceived value suggests that a business will attract and retain customers over time.  Performance regulation offers electric utilities a method to demonstrate in quantified terms how they are increasing value for customers’ money.  Meeting and exceeding performance targets, particularly when accompanied by a visual score card, can help companies keep their efforts to deliver value for money in focus for their customers.
  2. More value for money. One indicator of long term business sustainability is the extent to which customers receive value for their money. Increasing its levels of customers’ perceived value suggests that a business will attract and retain customers over time. Performance regulation offers electric utilities a method to demonstrate in quantified terms how they are increasing value for customers’ money. Meeting and exceeding performance targets, particularly when accompanied by a visual score card, can help companies keep their efforts to deliver value for money in focus for their customers.
  3. Stakeholders as contributors. The common approach to electric regulation practiced today is to take sides in litigated dockets.   In addition to providing a poor approach to running the large scale benefit-creating machine that is the electric industry, there are detrimental incentives in this process for intermediaries (such as lawyers and adverse experts).  They have few reasons to do more than point out and magnify problems and concerns.  Performance regulation could change this dynamic, because stakeholders have to say what they want, and how what they want can be rewarded, if provided.  There are some interesting questions here.  Are stakeholders able to play constructive roles?  Are they equipped by training or habit to propose and support constructive options?  Do they see the political and policy change potential of odd alliances of utilities and their constant critics both supporting new performance outcomes and rewards?
  4. Legislators and commissioners in constructive dialogue. There’s a striking lack of communication between utilities and the policy makers who decide on what regulation to impose.  It is rare for legislators to be well informed about utility regulation.  Commissioners and utility executives feel constrained to speak through lawyers and contested proceedings, rather than have frank and open dialogues about what to do.  Constructing and implementing new schemes of performance regulation requires these communications.
  5. Gain odd allies. With political extremes and polarization in vogue, getting changes in policy and legislation that might be required to implement performance incentives could be difficult.  One good way to cut through polarized politics is to bring the extremes together:  the lion and the lamb.  If utility managers and their best, most able critics can settle on performance outcomes that they both support, then bring their odd alliance to policy makers, the middle ground can be captured:  “If those two (previously warring) parties can agree, then I can go along.”
  6. Reduce investment risks and costs. Performance incentives send a signal to Wall Street that the utility is serious about managing its investment risks.  This is one of the reasons why Ben Fowke, Xcel Energy’s CEO, told analysts in January, 2014 that his company supports a new Minnesota regulatory framework called the “e21 Initiative” that he hopes will moderate rate increases going forward.[5]  By clarifying their investment strategy, Xcel hopes to get stakeholder support for it.  That should reduce their regulatory risks, and make the risks that remain more transparent for analysts who run the numbers on the company.  If there’s more support for the company’s spending plans, better access for analysts to understand the remaining risks, and the potential for performance incentives and rewards (if the company performs) then the logical outcome should be lower capital costs.
  7. More efficient operations. Performance regulation involves benchmarking best practices to set performance goals, and managing to the objectives that are identified, implementing in regulation the common business wisdom that “you can’t manage what you can’t measure.”  By adopting good business practices as criteria in the regulatory system, utility managers can claim rewards in the form of more money, if they perform beyond minimum requirements.  Today, there’s little incentive for efficient operations if the regulators just take away any savings achieved in the next rate case.  Performance regulation can change these weird incentives:  add value for consumers, get paid from part of the savings.
  8. Change how to do business and make money. There’s a ton of concern about “new utility business models” particularly in response to mounting evidence that consumers have effective technology options that reduce or eliminate their need for utility services.  PV on rooftops, particularly on Oahu, has challenged the electric industry.  For those who see a need to evolve the industry forward toward new ways of doing business and making money by providing more of what consumers and policy makers want, performance regulation provides a setting in which both customer expectations and utility business realities can be accommodated.
  9. Clarify expectations. Utility managers complain about policy uncertainty.  They need to make both long term investments, as well as short term operational decisions, but their policy landscape keeps changing.  By leading toward clear expectations captured in measurable performance outcomes, utility executives can take a hand in getting the policy and market clarity they need to make good investment and operating decisions.  If clear expectations are necessary challenge for a utility to confront, then promoting more performance regulation is a good way to get all the utility’s stakeholders to be clear about what they want.  Utility managers can then organize their business to deliver those outcomes.
  10. Reduce regulatory burdens. Implementing performance regulation requires committing additional regulatory resources up front, but since most performance based systems include a “stay out” period, this upfront investment should be paid back with a defined period in which the new performance system is left to utility management to run until the review period occurs.

Like most things in life, there’s no free lunch.  Performance regulation isn’t a perfect world, there are both costs benefits.  If you want the benefits, you need to pay the costs.  But it doesn’t have to be perfect to be better than the flawed incentive system that’s in place now.

[1] Lehr, R., “New Utility Business Models:  Utility and Regulatory Models for the Modern Era,” America’s Power Plan, 2013.  Web link:  http://americaspowerplan.com/wp-content/uploads/2013/10/APP-UTILITIES.pdf

See also, “Utilities 2020” at:  http://www.rbinz.com/Utilities%202020.pdf

[2] Aggarwal, S., Burgess, E., “New Regulatory Models” March, 2014.  Web link:  http://westernenergyboard.org/wp-content/uploads/2014/03/SPSC-CREPC_NewRegulatoryModels.pdf  The report provides a range of examples of use of performance regulation approaches and outcomes.

[3] The challenges implementing performance regulation are well discussed in another recent analysis, also prepared for the Western Interstate Energy Board, Whited, M., Woolf, T., and Napoleon, A., “Utility Performance Incentive Mechanisms:  A Handbook for Regulators” Prepared for the Western

Interstate Energy Board,  March 9, 2015.  Web link: http://www.synapse-energy.com/sites/default/files/Utility%20Performance%20Incentive%20Mechanisms%2014-098_0.pdf Performance regulation has been gamed and manipulated, particularly in California.  These experiences are well documented in this report’s appendices, and a set of best practices for avoiding such excursions is provided in the document.

[4] Since they provide monopoly services, utilities are infamous for their treatment of customers.  As Ernestine the telephone operator famously said:  “We’re the phone company.  We don’t have to care.”[4]  Lily Tomlin as Ernistine on UTube at: https://www.youtube.com/watch?v=CHgUN_95UAw and https://www.youtube.com/watch?v=SvesMBkduQo

[5] http://www.betterenergy.org/projects/e21-initiative

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