Today's electric distribution companies face a fundamental dilemma as they plan for the future design and operation of their networks. Increasingly, these utilities are expected to improve their resilience during severe weather events, replace aging infrastructure, integrate greater quantities of distributed and variable renewable generation, and secure their systems against cyber and physical attacks. Yet these expectations arise at a time of slow growing, flat, or declining sales - a trend that impedes a utility's ability to recover its fixed costs and discourages much-needed capital investment.
This dilemma is rooted in the fact that the rates of most electric distribution utilities continue to be set under a model focused on reviewing utility costs. Utilities face a regulatory lag between when they make an investment and can recover their costs in rates, which can negatively impact cash flow. During a period of rising costs but slowly growing sales, this lag can impair a utility's earnings and compel it to defer discretionary investments that could benefit customers. Moreover, cost of service regulation can slow the pace of innovation and may offer little incentive for utilities to improve operational efficiency or service quality beyond the minimum levels set by regulators.
Some regulators have experimented with alternative models - including capital trackers or multi-year revenue caps - to provide either greater support for new investments or stronger incentives for utilities to reduce costs. However, such alternatives may not effectively integrate incentives for efficiency, innovation, and service quality. A new regulatory model may be needed to create a twenty-first century power grid and enable utilities to deliver greater value to customers.
An Emerging Regulatory Model: Results-Based Regulation
As regulators look for a means to meet industry challenges without discarding the traditional objectives of regulation, a results-based model offers an attractive alternative. Results-based regulation is designed to support investments that deliver long-term value to customers, reward utilities for exceptional performance, and remain affordable by encouraging operational efficiencies and sharing the cost savings with customers.
One example of such an approach is the United Kingdom's newly-adopted "RIIO" model, or "Revenue set to deliver strong Incentives, Innovation and Output. "Its major components include:
- Revenues set based on the regulator's review of a forward-looking utility business plan;
- A multi-year revenue cap that provides an incentive for cost reductions;
- An earnings-sharing mechanism that enables customers to benefit from utility cost savings;
- Clearly defined performance metrics and incentives for delivering value to customers; and Funding set aside for innovative projects.
The goal of this paper is to advance conversations on the design of forward-looking regulatory models that can meet today's challenges. It examines the benefits of modernizing the power grid, the development and limitations of cost of service regulation, the incentives provided by alternative approaches to regulation, and how a results-driven regulatory model could support the transition to an efficient, reliable, and sustainable power system.