Performance Based Rates

Affordability, Current Articles, Leadership

Summary

Performance Based Rates (PBR) provide a promise and opportunity for investor-owned utilities to seek a higher rate of return from the traditional cost of service model. The concept and implementation have evolved over the past two decades in adding value for utilities and consumers. When used effectively, they promote state policy objectives and utilities have an opportunity to receive a higher return for their shareholders. Their use can also promote adoption in other utility models such as municipalities, coops, and others.

At the present time, 171 states have implemented PBRs to advance their state policy objectives. These states are seeing mixed results in effectiveness. States encouraging early adoption of renewables, battery storage, electrification, and addressing disruptive events to accelerate deployment of technology in states like California. The implementation of PBRs has run into challenges, such as being over-subscribed and creating a bottleneck because too many participants are acting on claims and inadvertently delaying policy objectives2.

PBRs include evaluation and monitoring programs with key metrics and benchmarks to measure against regulatory approved PBRs. One recent example metric is monitoring for wildfires with “wires down” and “ignition” that utilities, such as PG&E, are using and reporting to the public utility commission, California Public Utilities Commission (CPUC)3. When these metrics are combined with PBRs, this provides opportunities to encourage utilities to take risks on emerging technology and non-wire alternatives (NWA). When the risk pays off, the utilities share the rewards with shareholders and rate payers. As the metrics, PBRs, new technology, programs and processes gain maturity, the source of high costs such as wildfires (claims and insurance premiums) are identified and reduced. These reductions are used to make a dent in affordability, reliability and resiliency indexes for communities.

Background

Performance based rates (PBR) emerged in the 1980s with early adopter states Massachusetts and California. PBRs emerged to address what lowest cost to serve models were not addressing in changing policy objectives and societal costs. These states initially focused on energy efficiency and customer bills. Energy efficiency objectives dominated the last 2 decades and now are evolving to address newer technologies associated with renewable energy, batteries, disruptive events (fires, storms), affordability, equity and economic development objectives4.

Electrification and disruptive events require innovation to mitigate the risks and costs to expanding use of variable renewable generation resource’s reliability. In addition, the expanding load growth in AI technology is part of supporting those changes. PBR is also emerging as a tool to foster this innovation by increasing appropriate risk taking to solve these issues. The challenges are new and complex so PBRs can cause unintended consequences such as oversubscribing by participants, burdening ratepayers or delaying policy objectives. Developing thoughtful strategies and discipline steps are needed to build effective PBRs.

Opportunities

The utility industry has had unique lowest cost to serve models that adapted over time. We are now encountering a period of emergent new technologies in renewables, battery storage, and software working together to provide affordable, clean and resilient energy. The challenge is the variability in renewable energy to match supply with demand. Innovative policy design can create a new path for how we create, distribute, and use energy. Policy changes can increase and encourage new configuration and non-wire alternatives to provide the precision currently required to orchestrate the supply and demand. They can also be used to encourage suppliers to work together to solve integration points across multiple software and grid-edge intelligence offerings. This provides a path to increase our use of existing variable renewable generation, transmission, and distribution assets without adding to the existing generation, transmission and distribution capabilities. In other words, reward our utilities who utilize their assets more effectively.

PBRs provide an innovative mechanism and regulatory tool to encourage risk taking for utilities to solve these complex problems. By solving these problems, they can increase rates of returns for the shareholders and keep affordable, clean and resilient energy for ratepayers. As an example, localizing storage with local governments facilities combined with Non-Wire Alternatives software solutions allows sending a demand signal to charge during non-peak times which typically includes renewables such as wind. Behind the Meter (BTM) energy management solutions (EMS) then send demand signals to grid operators so they will use this localized energy during peak times. This gives grid operators a tool to balance the energy needs they can count on. In return this provides economic development (local jobs to serve the asset), community ownership (equity), bill savings, clean energy and assets that can be used for resiliency during disruptive events.

Aligning the right metrics and benchmarks to monitor participation is instrumental. The use of metrics to measure adoption and corresponding usage behaviors is key in determining policy effectiveness. The information is also used to adapt and optimize returns for shareholders and savings for ratepayers. Finally, the gathered information can be expanded to improve equity and opportunities for underserved communities and ensure these communities receive their fair share of the benefits.

Challenges

The coordination of these tools is complex and requires new solutions. This complexity is the number one challenge due to increased coordination required to receive the full value of the implementation of new technology, regulations and rate structures. The complexities can be broken into three areas of focus that have a high chance of resolution. The primary complexities are as follows:

  1. Regulatory implementation
  2. Potential in increasing customer costs
  3. Challenges in designing incentive mechanisms

Regulatory Implementation

Many states lowest “cost to serve models” have evolved over decades and support legacy policy objectives for states. Introducing PBRs inherently contradicts the established policies and require experience and data for development of mature policies. Utilities also need to adapt to the recent policy shifts in reshaping and innovating processes and explain why these policy shifts will provide community benefits. Communications must address how community and individual rate payers will benefit. In addition, communications should include estimates on the timeline for the benefits to be seen. This communication requires precise metrics that are evaluated, monitored and reported on in a consistent and transparent fashion to the community and ratepayers.

States and utilities focused on adapting, and applying lessons learned in gathering these metrics will yield the greatest success. The metrics must be designed to focus on tangible results and tied to real indicators that are understandable by the rate payers. As an example, comparing customer bills in relation to inflation indexes demonstrate how the consumer is gaining improvements for affordability in spite of ongoing inflation. While bills may not appear lower, the rate payer can see they are receiving savings and getting more value for their payments.

Potential In Increasing Customer Costs

lean energy can generate higher costs due to the new technology and emerging NWA orchestration tools to deliver variable renewable energy reliably. Utilities and other suppliers have not had time to create mature, fully cost-effective energy sources and so costs may end up more than traditional energy sources.

Making subsidies available to rate payers can be used to overcome these costs and advance policy objectives. An example is California CPUC Self-Generation Incentive Plan (SGIP)5 . This subsidy targets distributed energy systems, such as battery storage, wind turbines, fuel cells and other methods of reducing the need for energy from the utility. For ratepayers in fire prone areas larger subsidies for them for this energy generation helps them to be independent in natural disasters and can be targeted to energy resources that reduce fire risk. In addition, metrics and appropriate risk taking to use existing renewable assets and utilization can also mitigate this challenge.

Corresponding metrics are instrumental in developing communication plans and providing success to programs and part of the overall PBR structure. Metrics measuring renewable and NWA solutions that look at the trade-off of higher cost clean energy, affordability metrics, reduction of fire risk and other meaningful benchmarks contribute to overall policy success.

Challenges In Designing Incentive Mechanisms

There are multiple configuration options available with technology, expertise, and services in the market today to design these incentives. Since these configurations are all new and possibly untried, finding the right experts with the right knowledge and expertise to map financial, technical, community value and processes is a challenge. Locating these experts leads to simplifying the complexities and to evolve the metrics and thus the policies faster. Good design will focus on the end user experience and work backwards from there in creating the right design with easy-to-understand risk and rewards.

Call To Action

Rocky Mountain Institute, industry thought leader, introduced a framework of pillars6 to identify and seize these opportunities and address the challenges. They propose the following as a foundation in good PBR design:

  • Incentivize cost efficiency
  • Remove the throughput incentive
  • Equalize capex and opex incentives
  • Incentivize targeted customers

These pillars can be implemented by bringing experienced thought leaders with extensive utility industry experience, to work together in a network to share their knowledge. This experience and knowledge can be used to accelerate achievement of these policy objectives in support of the pillars. Once policies are set in place, creating metrics and benchmarks to evaluate and monitor the objectives will support adapting and using lessons learned to improve communication and report status to the key stakeholders.

Conclusion

PBRs will become a critical component in advancing and modernizing the grid in an affordable, clean and resilient manner. Engaging early, analyzing the biggest problems with load growth and disruptive events will provide the data and information to define the requirements to deliver affordable, clean and resilient energy.

By seeking expertise to assist in this journey it will expedite and aid in building these new and exciting value propositions.

Glossary

BTM – Behind the Meter
Capex- Capital Expenditures
Cost to Serve Models – In Cost of Service regulation, the regulator determines the Revenue Requirement Requirement—i.e., the “cost of service”—that reflects the total that reflects the total amount that must be collected in rates for the utility to recover its costs and earn a reasonable return. costs and earn a reasonable return.
CPUC – California Public Utilities Commission
NWA Non-Wire Alternatives
Opex – Operating Expenditures
PBRs – Performance Based Rates
SGIP – Self-Generation Incentive Plan

  1. https://www.naruc.org/core-sectors/energy-resources-and-the-environment/valuation-and-ratemaking/performance-based-regulation-state-tracking-map/ ↩︎
  2. Navigating Business Model Reform: Practical Guide to Regulatory Design 2018, Rocky Mountain Institute, America’s Power Plan, AEE Institute ↩︎
  3. PG&E California Public Utility Commission 2024 Mid-Year SOM Report – September 2024 ↩︎
  4. National Association of State Legislature: Performance Based Regulation: Harmonizing Electric Utility and State Policy April 7, 2023 ↩︎
  5. Self-Generation Incentive Plan – https://www.cpuc.ca.gov/sgip ↩︎
  6. Rocky Mountain Institute How to Restructure Utility Incentives: The Four Pillars of Comprehensive Performance Based Regulation https://rmi.org/wp-content/uploads/dlm_uploads/2024/07/RMI_how_to_restructure_utility_incentives.pdf ↩︎