Whatever Happened to Customer Empowerment?

Written by: Sherman J. Elliott, Ablewatts, Inc., Advisory Board Member

Elliott, Sherman, Resized, April 2017 PoV

Sherman J. Elliott

The questions raised below may seem sort of mundane to the energy professionals that comprise the readership of the FRI Update.  However, we all know that these issues are still at the forefront of nearly every regulatory proceeding dealing with smart energy infrastructure.

Most consumers know how much it costs to fill their tank with gasoline every time they fill up.  They know how many miles per gallon (MPG) they get on the highway and in the city, and they’re aware of what factors affect the price of gas, such as the supply and demand of oil, refinery capacity, the operating condition of their car, OPEC, etc.

But do they have the same awareness of the cost of electricity?  Or natural gas to heat their home?  Do they know what a kilowatt hour is?  Or a therm?  Do they know how many kWh/therms they’ve used this month?  The answer is probably:  no.

Most consumers know how much they spend on gasoline per year and they pay attention to that number in making the choice for their new vehicle when the old one is beginning to cost more than it’s worth to maintain.  Can they say the same about their annual electricity or natural gas costs?  What makes the most sense to repair or replace in the home to save energy?  And when is the right time?  How much will I save?

One of the biggest problems with electricity and natural gas billing is the lack of information necessary to determine what it actually costs.  While you can see the cost of gas at the pump in real time and you know your MPG, if you have the old watt-hour or cumulative consumption meters you have no idea what your kWh or per therm consumption is until you receive your bill 30 to 45 days after you’ve consumed the electricity or gas.  Not exactly timely information.  And, to make matters worse, you have no idea what household usage is causing the most consumption.  Is it the lights?  The fridge?  The air conditioning?  Your water heater?  The furnace?  If your gas mileage declines and your cost goes up, you might need a tune up or check your tire inflation to get things back on track.  If your electric or gas bill goes up, why did it happen and what do you do?  And is that the right thing to do?

Aren’t these problems with delivering timely information to customers one of the things that Advanced Metering Infrastructure (AMI) is designed to solve?  But even with the delivery of real time or near real time consumption data, is that enough to solve some of these questions?

As a former regulator, I can sympathize with current regulators and other stakeholders who raise concerns about the lack of customer side education and energy management tools in AMI cases that come before regulatory bodies for approval, particularly for low income/low use customers.  Everyone seems to readily understand the utility business cases for AMI but utilities (and other energy retailers) have been lacking (so far) in providing, along with the new smart hardware systems, tools with which their residential and small commercial customers can better manage their electricity usage and carbon footprint now that real time, or near real time data, can be accessed.

Wouldn’t it be helpful to have a resource that can help to explain the cost to produce and deliver electricity and natural gas and provide information to help reduce your monthly cost?  Wouldn’t it be helpful to have a resource that can provide timely information on the negative environmental effects of electricity and gas usage and how they can be reduced?  And do so at your convenience, whenever you want the information 24/7, in real time and on multiple platforms?

This is one of the issues I’ve been engaged in since I left the Illinois Commerce Commission in 2012, trying to make sense of the disaggregated supply chain of electricity and searching for a portal for education, information and access to an unbiased suite of solutions that can increase efficiency, lower customers’ energy costs and improve their environmental footprint.

For the last several years, I’ve been advising a team of energy sector veterans headed up by Troid Edwards that have created a company called Ablewatts, who’s initial product is a personal energy advisor, available as an online tool or an app for Android and iOS.  Ablewatts intent is to provide unbiased information that an energy customer can act on, at their convenience and on their schedule. Ablewatts is a tool that lets them know where their energy dollar spend has the most value, such as a programmable communicating thermostat or home weatherization, or purchasing energy efficient appliances and HVAC systems.

I’m happy to say that Ablewatts launched in 2017 and currently provides direct click through purchase options for advanced communicating thermostats and direct access to a utility’s incentive programs for home weatherization; energy efficient appliances and HVAC systems, links that would be very helpful for low income/low use customers.

Since I’ve left the FRI Board and the ICC, I have benefited greatly by working with the team at Ablewatts as our intent is and always has been to improve consumers’ energy awareness and provide actionable information and access to energy products and services that can improve efficiency and the environment.  And that’s not a bad idea.  As Ablewatts progresses we will continue to enable new information, new functions, and more exciting ways to save and become more environmentally conscious.  Please look us up at Ablewatts.com or in the Android and Apple App stores, try the app and let us know what you think!

Valuing a Water System

Sponsored & written by: John Marciszewski, Director, Business Development, Echologics &  Anthony Festa, Senior Director, Alvarez & Marsal

PoV - Marciszewski

John Marciszewski

It is no secret that the U.S. water infrastructure is aging rapidly. In its latest 2017 infrastructure report card, the American Society of Civil Engineers gave an overall grade of D+ to America’s infrastructure, and graded drinking water a D.  Many water system assets, both vertical and buried, are in desperate need of renewal; many water systems have assets dating back to the late 19th century. Repairing and replacing crumbling infrastructure isn’t cheap; in its 2013 Drinking Water Needs Survey and Assessment, the U.S. Environmental Protection Agency estimated that $247.5 billion would need to be invested in transmission and distribution systems over the next 20 years.  Broken down, the price tag can easily be tens of millions of dollars for small townships, and into the billions for major cities.

Festa - PoV

Anthony Festa

“What’s it worth?” is a question many decision makers ask about their assets or business

prior to, during, and after a transaction or restructuring. Water systems are no different, given the climate of public private partnerships (P3) and private equity transactions combined with municipal restructurings, and state and local mandates to get an appraisal, e.g., Water Infrastructure Protection Act (WIPA) in New Jersey. The list of parties that need to know what water systems are worth is ever growing, including tax payers, sellers, buy-side investors, and lenders, including banks and bond issuers.  These parties want to have a comfort level that a credentialed, independent third party performed an appraisal that will withstand scrutiny and will provide a figure that makes sense.

So how are aging water systems valued, and how does their condition come into play? With any appraisal, an appraiser should consider three approaches to value: cost, market, and income. All three approaches are not necessarily required, in fact a combination of two (or even just one approach) may be quantified and applied given the needs of a specific transaction.

The cost approach relies on the principal of substitution; this assumes an investor would not pay more for an asset than the cost to reproduce or replace it with like-kind or similar utility, less adjustments for physical deterioration, functional, and/or economic obsolescence. The market approach analyzes comparable sales data found in the used marketplace, making adjustments as necessary to equate each comparable to the subject asset being appraised. Lastly, the income approach determines the value of an asset by discounting future cash flows to a present value, using an appropriate discount rate at a required rate of return.

With a water system, it would be typical to primarily apply the cost approach, as these assets are uniquely constructed and configured, and current costs to replace operable assets, such as pipes, pumps, and hydrants, are readily available to extrapolate across the footprint of the system. Due to the uniqueness of the asset, the market approach typically would not be applied. As an example, think of a car – there are many comparable cars to yours…but for a water system? Lastly, an income approach can and should be considered and used, especially if the system has a customer base where the contracts have a quantifiable and measurable income stream. For purposes of this discussion, this blog will detail the cost approach to value.

The starting point of a cost-based appraisal is the cost to replace or reproduce the asset. When developing the valuation, the appraiser needs to ultimately develop the replacement cost, based on current, direct project costs. The appraiser may also need to develop the reproduction cost, based on historical cost indexing, or “trending”, as part of their procedures and then reconcile the two. The development of the replacement/reproduction costs must include all direct costs including freight, sales tax, installation and calibration costs, as well as indirect costs such as permits and architectural / engineering fees.

Once the replacement or reproduction cost is determined, adjustments are made to account for the loss in value due to physical deterioration and obsolescence. Physical deterioration is the loss in value due to normal deterioration, or “wear and tear.” Depreciation can be applied using a calculation based on the asset’s normal and remaining lives as determined from asset accounting lists, invoices, or purchase orders.

However, true condition can be quantified based on non-intrusive acoustical tests, such as Echologics’ ePULSE® condition assessment approach, that can quantify the deterioration level of buried pipeline assets. This is critical, especially as 75 percent of the total replacement cost of a system is buried. Knowing the condition of the pipes not only helps drive the valuation, but is crucial for planning future capital expenditure (CAPEX) investments.

Once physical deterioration is determined, adjustments are made for any forms of functional and/or economic obsolescence that are identifiable and measurable. In most water system valuations, buried assets are assumed that service life has expired.

The largest challenge in valuing a water system is understanding the inventory of assets, especially as most of the system is buried! It is important to perform an appropriate level of due diligence when conducting the appraisal, this would include meeting with system operators, engineers, CAPEX planners, and accounting personnel who understand the history, design, and operational capacities of the system. Also, it is important to collect additional data points such as maps, diagrams, current costing data, historical asset records, etc., and work with other third-party contractors with specialized areas of expertise that can provide critical inputs for the appraiser.

Is a Strong Regulator Anti-free Market?

Written by: Commissioner Scott Rupp, Missouri Public Service Commission

Commissioner  Scott Rupp

I am a free market loving person who generally believes that government regulation constrains economic growth. I also believe that utility commissioners in traditionally regulated states need to be strong, decisive, non-passive regulators to truly fulfill their designed roles.

As a PSC Commissioner, I’ve heard regulators voice concerns that being a strong regulator is micromanaging a company and I’ve talked with state leaders who believe a strong regulator is anti-free market. I’ve even been criticized for being too “hard” on some of the utilities that I regulate. I had to stop and ask myself, “Is it a bad thing to be a strong regulator?” To answer this question, I had to go back to why we have utility regulation in the first place.

The concept of the regulatory compact recognizes a set of mutual rights, obligations, and benefits forming, in effect, a relational contract between utilities and their customers. The utility is granted an exclusive service franchise/territory, and in exchange accepts the responsibility to serve everyone in the territory and submit to price (rate) regulation. The utility is obligated to supply service efficiently. However, it has the right to recover its costs, including an opportunity to earn a return/profit equal to its market-determined cost of debt and equity capital.

Without regulation, monopolies would participate in monopolistic pricing structures. The monopoly wants to set the highest price possible and control the level of output to maximize profits. Since there is no substitute for electricity and there are no competitors, monopolies can achieve this sweet spot at the expense of the consumer. Therefore, regulators then must assume the role of competition in a monopolistic market.

Competition in markets force companies to change their pricing strategies, find efficiencies, innovate, and cut costs. A strong regulator of monopolies, is in effect, providing the market forces of a strong competing company in a free market. Conversely then a weak regulator is providing the market forces of a weak competitor, allowing one company to dominate another, where the consumer ends up paying more, getting less service, or both.

No matter how valid the reason, whenever the government takes a free market and interjects pricing regulations, it stops the free market powers from working to their full potential and, consumers may end up with a disjointed system. The results of cherry picking elements of the free market and injecting them into the traditional regulatory compact could limit the regulatory compact’s effectiveness and may not gain the benefits desired.

I would argue that in traditionally regulated states, the urge to inject free market principles in a regulated monopoly service territory may, on the surface, appear to be promoting the free market. These principals must be thoroughly vetted as they may have anti-competitive results if not done well, or if they do not go far enough. That would be the same as half-heartedly running your company in a competitive market and allowing your competitors to gain a strategic advantage.

In the energy industry, there are pressures to bring free market principles into regulated markets. There are also movements to introduce more regulations in a competitive market. As a strong believer in the free market, I support many of these initiatives; however, I also see the benefits of traditionally regulated utility markets. I firmly believe that we need to make up our minds. It’s almost akin to being “kind of” pregnant. You either are, or you aren’t. Either we regulate utilities under the regulatory compact or we have a free market.

My concern is that regulators want to move toward competitive pricing structures and embrace new technologies, but are fearful of doing so. They want to tiptoe into the water, but their apprehension may trigger a full-scale retreat at the first ripple. By not having a clear direction of where they’re headed, they may wake up to a regulatory structure that is disjointed, not competitive, not effectively regulated, languishing in some regulatory purgatory. Are we going to embrace the free market principles or are we going to regulate utilities traditionally? Whatever we decide, we need to have a well-articulated plan with a vision of where we want to end up, and then enact policies and procedures that stand behind that desired regulatory model. To accomplish this task, we need strong regulators.

To learn more about Commissioner Scott Rupp, read his weekly blog and listen to his podcasts, go to his website SimplifyingEnergy.com, where he attempts to help consumer better understand the energy industry.

Comprehensive Look at Minnesota Energy System Moves Forward

Written by: Doug Scott Vice President, Strategic Initiatives, Great Plains Institute and former Chair & Commissioner, Illinois Commerce Commission

Doug Scott Vice President, Strategic Initiatives, Great Plains Institute and former chair and commissioner Illinois Commerce Commission

Doug Scott

Minnesota’s e21 Initiative set out to look comprehensively at the state’s utility structure, and remains an important dialogue.

The diverse set of e21 stakeholders have reached another milestone, concluding Phase II of their work with the release of three white papers (http://www.betterenergy.org//e21-phaseII) addressing key issues in Minnesota’s energy future, and a phase II report, which is intended as an overview of the highlights of the white papers. Each white paper is designed to relate to and support the other papers.

In the first phase, e21 set forth two overarching goals, a number of guiding principles, and a high-level blueprint for evolving Minnesota’s regulatory framework and the utility business model. At a high level, two goals were to:

  1. Shift toward a business model that offers customers more options in how and where their energy is produced and how and where they use it; and
  2. Shift toward a regulatory system that compensates utilities for achieving an agreed-upon set of performance outcomes that the public and customers want.

The purpose of e21’s second phase has been to develop the next level of detail necessary to begin implementing consensus recommendations (http://www.betterenergy.org/e21-Phase1-Report) from phase 1. Toward that end, at the beginning of Phase II, e21 participants set out to:

  1. Inform the Minnesota Public Utility Commission’s grid modernization process and increase transparency in distribution planning;
  2. Formulate principles and identify best practices for transitioning a portion of utility revenue to a performance-based approach; and
  3. Evaluate the pros and cons of the current integrated resources planning process and potential improvements.

Thus, the Phase II reports address grid modernization, performance-based compensation, and integrated systems planning. The report provides key information and guidance for decision-makers that can be further developed as Minnesota addresses how the electric system and utility sector evolve.

The paper on performance-based regulation outlines the rationale for a gradual shift to performance-based utility compensation, a continuum of reform along which Minnesota could travel, principles for selecting performance outcomes and metrics, and nine potential performance outcomes with detailed explanations and sample metrics for each. The paper does not specifically recommend where Minnesota’s regulatory framework should end up, other than toward a performance-based system.

With respect to integrated systems planning, the report sets forth an explanation of the current regulatory process and traditional integrated resource planning process, and then describes thirteen potential modifications. The group believes that by encouraging greater upfront collaboration on the resource planning side, it will be easier to implement the changes proposed in the other white papers.

The grid modernization report proposes a set of objectives for modernizing the grid and the functions and technologies needed to achieve those objectives. It also lays out an overall approach to grid modernization and makes a series of recommendations, organized into three categories: distribution-level grid planning; customer services and engagement; and operation of the distribution grid. The e21 group wishes to complement and inform the grid modernization effort underway at the Minnesota Public Utility Commission.

E21’s co-directors, Rolf Nordstrom at the Great Plains Institute, and Mike Bull at the Center for Energy and Environment, are in the process of designing the next phase of e21. The goal is for Phase III to begin in early 2017, with a shift toward implementation and a repeatable process of “learning by doing” while maintaining e21’s role as a valuable platform for mutual learning and information-sharing among utilities, regulators, and other interested parties. This will further the e21 Initiative’s goal of helping Minnesota continue to lead in shaping an electric system for the 21st century.

And, while every state will not initiate an e21-type process, every state and utility is grappling with the issues that e21 is addressing. As a result, e21 can help inform other state’s deliberations, in the same way that states can also look to New York’s Reforming the Energy Vision, or to the other states that have comprehensively looked at the issues surrounding a more customer-centric utility system that embraces new technology and a cleaner energy platform.

Diversity of Attributes: What’s needed for reliability?

Sponsored and Written by: Amy Farrell, Senior Director, Market Development, American Petroleum Institute

Amy Farrell

The electric sector has been evolving dramatically over the past two decades due to policy changes at the federal and state level, technology advancement, and fundamental shifts in underlying fuel markets.  With these changes, reliability of the electric grid has become a focal point.  From the implementation of the federal Mercury and Air Toxics Standards rule to the polar vortex of 2014 to the finalized Clean Power Plan, electric grid reliability continues to be called into question despite continued performance.  Diversity of fuel is often cited as an answer to maintaining grid reliability, especially in restructured markets.  However, upon closer inspection, diversity of fuel is not the appropriate solution to maintain grid reliability; rather, the solution is a diversity of attributes.

The electric system resource adequacy framework has been designed to ensure that system operators have access to sufficient capacity to maintain grid reliability under peak load conditions. Traditionally, this has focused on procuring enough capacity, in the form of megawatts (MW), to meet peak load plus a reserve margin (generally set near 15% of peak load). Additionally, system operators procure operating reserves that are tied to the value of the system’s largest single possible “contingency” event, which has historically been seen as the loss of the largest single generator on the system. These MW are considered fungible and homogenous, and system reliability measures are based on the ability to meet peak demand during a small subset of hours during the year, irrespective of the capacity sources’ operating capabilities during the remaining hours.

This approach was appropriate when the electric system consisted of relatively stable and predictable loads served by large, centralized generators. This is no longer the case.  The grid today is characterized by an increasing amount of both variable and distributed energy resources (VERs and DERs) that are rapidly making the current electric system operational models obsolete. The changes will only accelerate as VERs and DERs continue to grow into the future. A new model of resource adequacy — one that focuses on the capabilities and attributes of supply sources, rather than just the amount of capacity — needs to be developed and adopted.

A potential solution is to value attributes and services, rather than just energy and capacity, thus increasing the revenues that supply resources gain from ancillary services markets. Measuring reliability through services and resource capabilities can result in a resource adequacy model that is able to adapt to a changing world, yet still provide sufficient revenue to supply resources needed to maintain reliability. Policy discussion and implementation should focus on the “diversity of attributes” needed for reliability, rather than promotion of specific resource types based on fuel source.  This change in focus will lead to a more reliable and cost-effective generation mix.  Put simply, the conversation around capacity and energy resources should concentrate on what these resources do, where they do it, and how they do it, not what they are.  In a recent paper on investment in competitive markets, PJM wrote:

…[I]t is true that certain fuel-type generating facilities might naturally provide a particular attribute valued by an ISO/RTO. Other factors being equal, a coal facility with coal in the yard offers greater dependability than a natural gas peaking facility with non-firm fuel supply. Likewise, a coal or nuclear facility will provide greater inertia to the bulk power system than a solar panel, and a battery will provide faster and more controlled frequency response than a natural gas combined-cycle facility. However, from the perspective of the ISO/RTO, it is the attribute (e.g., dependability, inertia or frequency response) that is needed in the correct proportion, not necessarily a certain ratio of fuel type, even if that fuel type may be closely associated with the desired attribute.[1]

The types of attributes that could be considered as adding value include the following:

  • Able to be dispatched when called upon
  • Able to provide load following to support integration of VERs
  • Able to provide reactive power and voltage support
  • Able to be located close to load centers
  • Able to provide blackstart service
  • Ability to cycle on and off in a timely manner.
  • Able to start up and ramp to full power quickly
  • Able to operate 24/7
  • Scalable to the amount needed in any particular location
  • Cost-effective to construct and in a timely manner to facilitate system planning

Other attributes that could be of importance from a public policy perspective include:

  • Domestically sourced fuel
  • Fuel storage capability (either on-site or virtually through offsite storage and transport contracts)
  • Fuel flexibility

A few of these attributes (e.g. regulation energy) are already procured through market mechanisms in some regions, providing a value to those services. But most are not included in any type of model that assigns a value to the specific attribute being sought.  Some regional operators have started to think about what additional attributes could be included in resource adequacy models and market constructs, especially in California where the level of VERs and DERs is reaching significant percentages and volatility is high. These efforts are to be applauded but should only be considered as a good beginning. Much work remains to examine what services are truly needed to maintain grid reliability and to identify the best market mechanisms to induce the necessary  investment for supply resources to provide those services.  Similarly, where identified attributes are not conducive to being procured through a market, we should explore pricing through some form of administrative system that reflects the value the attribute contributes to keeping the lights on.

With our nation’s resource mix and electricity grid rapidly evolving, our conversation around reliability must also evolve.  Although my time on the Financial Research Institute’s (FRI) Advisory Board has been brief, I believe it is well-suited to provide a forum for this conversation.  I see value in the organization’s efforts to recruit diverse perspectives though its membership recruitment and in its effort to drive decision makers and stakeholders alike to think about the pressing policy questions of the day though its  Hot Topics, Points of View and Annual Symposium.

[1] PJM Interconnection, Resource Investment in Competitive Markets, May 5, 2016, at 42.

Why should Republicans support renewable energy?

Written by: Commissioner Scott Rupp, Missouri Public Service Commission

Commissioner Rupp

We know Republicans advocate for principles like personal responsibility, smaller government, and free market capitalism. It seems like a natural link between these principles and the innovative nature of the renewable energy industry (wind, solar, etc.). So I wonder why more Republicans don’t embrace renewables with open arms?

I’ve attended a number of energy conferences and noticed a trend among the renewable energy people – they are young. The renewable energy sector attracts young entrepreneurs who want to make a difference. Innovative energy solutions open up the highly regulated utility industry to more competition. This should be a target rich audience for the Republican party’s message of limited government and free market capitalism, but we’re missing the mark.

First: There’s room for everyone! Many of my fellow Republicans need to realize that if you embrace renewables, you aren’t turning your back on oil, gas, coal, nuclear, etc. You simply understand the economics of affordability of new technology, and the impact it is having on the marketplace.

Second: Renewable energy is not a leftist movement.  Too many elected officials of my party have made that assumption in the past. Here’s an example:  When I was first elected to the Missouri House of Representatives, an issue came up that dealt with individuals with disabilities. I was told by party leadership “Don’t waste your time. Those aren’t people that support us; you will never get their support. All they want is more and more government”.  I was shocked that this mindset was rampant among my colleagues.  When did disabilities become partisan? Well flash forward to the end of my political career and we saw numerous programs for kids with disabilities reformed, and serving the population better. I passed landmark autism insurance legislation, and today Missouri is considered by many one of the best states for how we serve individuals with disabilities. And this was accomplished mostly by Republicans. Today, disability issues in Missouri are not partisan, and I think the same thing can be done for renewable energy.

Third: Green = $.  When you hear green energy, don’t let your mind immediately go “Green = green peace. Green peace = protestors. Protestors = 1960’s hippies with their free love and organic food. Organic food = Jolly Green Giant. Jolly Green Giant = men in green tights. Men in green tights = the far left agenda” and so on and so on. Instead, think Green = money. It is fiscally prudent to support renewable energy. Think of it this way – energy efficiency saves you and your business money. Having renewables as part of your energy mix, is the same as having a diverse portfolio. You would never have 100% of your retirement plan in one or two stocks.  Why not diversify your energy mix as well. It is smart, it is prudent, and if you look at the numbers, it makes economic sense.

Finally: Focus on Jobs. The family trying to pay for their kids’ education and make the house payment doesn’t care if the latest study about global warming is wrong. They care about their family and keeping or getting good paying jobs. As republicans, we love jobs, especially family supporting jobs. The last time I looked, the new technologies in the energy industry around wind and solar and smart metering were creating jobs and new third party cottage industries.  The new modernized grid will have third party vendors and entrepreneurs popping up to fill niche markets we haven’t even thought of yet. Self-starting, risk taking, smart people are looking to start and grow a business, hire people, make money and impact the community in which they live, work and play.

I do want to digress and point out that there are many republicans that are very supportive of renewable energy. When he was Governor of Texas, former President George W. Bush pushed through legislation requiring utilities to buy renewable power, leading to widespread development of wind farms.

In an article in Bloomberg news by Joe Ryan, there was a great info graphic which I inserted below:

It seems that the support for renewable energy will have to start coming from within the rank and file of the Republican Party, and based on where that energy is being created, it will come from the heartland of the country.  Jobs associated with renewable energy are growing, and the stats are getting the attention of some Republican lawmakers.

For too long the left has dominated the renewable energy issue. It is time that we Republicans embrace the economics and new technology and welcome renewables into our energy mix along with coal, natural gas, and nuclear. It is time that we made renewable energy a non-partisan issue.

Comm. Scott Rupp has been on the Missouri Public Service Commission since 2014.  You can follow him on Twitter @Scott_Rupp.

Take Heed of the Law of Unintended Consequences

Sponsored and Written by: Ross Hemphill, President, RCHemphill Solutions, FRI Advisory Board Chair

Ross Hemphill

One of my stops on a vacation drive this past summer was to Flathead Lake, about 100 miles due north of Missoula, Montana.  This is the largest freshwater lake in the contiguous U.S. west of the Mississippi River – and it is gorgeous.  The water is deep, crystal clear and surrounded by beautiful scenery.  As we floated around the lake with an entertaining and informative guide, I could not help but start thinking about the challenges in the utility industry and the difficult decisions ahead.  “Whoa,” you say, “what is it about Flathead Lake that would make you start thinking about utility issues?”  Well, even this beautiful piece of nature has its challenges.  And there are similarities with the utility industry in terms of how they developed.

The guide told us that Lake Trout (a non-native species) is crowding out native species of fish like the Westslope Trout and the Bull Trout.  From what I heard and read, this didn’t happen naturally.  Way back in 1905 someone (or some agency) decided it would be a good idea to introduce Lake Trout into Flathead.  Several decades later, Possum Shrimp (also non-native) was introduced to help feed all the fish.  It turns out that the native fish don’t much like Possum Shrimp, which, by the way, started devouring organisms that the native fish like to eat.  Thus, the population of Lake Trout exploded because they love to eat Possum Shrimp.  And the fish native to Flathead are sparse.

There are many, many stories around the world like the one above where challenges to the ecosystem are created by some type of human action.  They are all examples of the law of unintended consequences, which states that actions frequently lead to one or more outcomes that were not intended.  This law is ever present in all types of actions, not just with the ecosystem.  It is particularly relevant in our economic systems where there are ample opportunities to make decisions that create far-reaching repercussions.

In doing a little research on unintended consequences, I was amazed to learn how much has been written about it with even scholarly interest.  It was eighty years ago that Robert Merton published a systematic treatment of this phenomenon.[1]  In this article, Merton discusses five reasons why it occurs: (1) limitations of knowledge, (2) unforeseen changes in technology or the environment, (3) errors in evaluating the situation, (4) imperious immediacy of interest, and (5) basic values.  Every one of the reasons cited by Merton deserve strong consideration; however, it’s the fourth one that I will call out as being particularly relevant to utility regulation.  In Merton’s words, “the ‘imperious immediacy of interest’ refers to instances when the actor’s paramount concern with the foreseen immediate consequences excludes the consideration of further or other consequences of the same act.”  In my words, sometimes a policy decision is made with a sole purpose in mind that is viewed to be of such high importance that other potential outcomes are not considered.

This can and does happen in the regulatory arena from time to time.  When I first started my career, some 37 years ago, an issue upon us in several jurisdictions was that residential customers were not paying full cost of service and commercial/industrial customers were paying more than costs (known as a subsidy).  This happened over a number of years when costs were rising and C&I customers saw a larger than share increase in rates to mitigate the rate impacts on residential customers.  But ultimately the utilities and regulators realized that placing more burden on the job-creating C&I sector was not in the best long-term interest of households.

Lately, there is a lot of attention regarding transformation in the electric utility industry, with growth in distributed resources and such.  This has put the spotlight on net metering rules and residential rate design.  There are many facets to these issues with stakeholders from all sides providing reasoned arguments worthy of consideration.  My point here is that policy-makers should step back and carefully consider not only the intended outcomes but potential unintended consequences of any action or, for that matter, inaction.

There are many recent writings on these issues, of which I will mention only two.  There is a recent article in Public Utilities Fortnightly by three experts representing historically diverse perspectives in the regulatory forum discussing unintended consequences of net metering. The authors point out that net metering was originally designed to encourage alternative forms of energy for residential customers, which provides an opportunity for those participating to lower their bills.  But the combination of growth in distributed generation with highly volumetric rates has led them to conclude that net metering is regressive in nature.  “The subsidy, in the aggregate, constitutes a regressive wealth transfer from lower-income customers to high-income customers.  Solar power is typically installed by higher-income customers.” [2]  I also encourage you to read a report released earlier this year by Lawrence Berkeley National Laboratory (LBNL) that provides a balanced presentation of the issues by authors representing a broad range of perspectives. [3]

Finally, I will use this opportunity to plug the value that the Financial Research Institute adds to critical debates in our industry such as this.  You can see from the make-up of the advisory board that all perspectives are sought in their agenda for Hot Topics, Points of View and the annual symposium.  FRI provides a very valuable platform for sharing information, ideas and alternative approaches to addressing pressing issues in utility regulation so that we can make decisions that minimize the unintended consequences.

[1] Robert K. Merton, “The Unanticipated Consequences of Purposive Social Action,” American Sociological Review, Volume 1, No. 6 (December 1936).

[2] Barbara Alexander, Ashley Brown and Ahmad Faruqui, “Rethinking Rationale for Net Metering,” Public Utilities Fortnightly, Volume 154, No. 10 (October 2016), pp 28-33.

[3] “Recovery of Utility Fixed Costs:  Utility, Consumer, Environmental and Economist Perspectives,” LBNL-1005742, Report No. 5 (June 2016).  You can access this report at https://emp.lbl.gov/sites/all/files/lbnl-1005742_1.pdf.