Aligning Utility Performance with the Public Interest
- Oct 20, 2020 10:04 pm GMT
In 2018, the Rhode Island Public Utilities Commission rejected six out of seven performance incentive mechanisms (PIMs) included in a settlement agreement proposed by the state’s primary utility and a diverse coalition of stakeholder interests, from environmental groups to the state energy office. The joint proposal included new incentives for the utility to install energy storage, reduce CO2 through beneficial electrification, and improve the interconnection of DERs. What would lead a commission to reject the bulk of this proposal, which on its face had wide support and promoted attractive, forward-looking policy goals?
RMI’s new report, PIMs for Progress, reviews a selection of historical PIM examples and provides a simple taxonomy of their results to identify important lessons for future PIM development. By exploring why some PIM proposals are rejected by regulators and others are accepted, as well as what happens to PIMs after acceptance, we can learn how these regulatory tools can be best leveraged to support public interest goals in a shifting energy landscape.
What’s in a PIM?
Similar to Rhode Island, states across the country are examining the utility role in the energy transition. While we still rely on utilities to provide basic energy services, they now have an opportunity to advance state clean energy goals, mitigate environmental impacts, and empower customers to evolve from passive consumers of a commodity to active participants in a dynamic electricity system.
PIMs are a regulatory tool to help transition the utility business model to one where an increasing share of revenues relies on utility efforts to meet the customer, policy, and technological demands emerging from the transformation taking place in the power sector. PIMs can motivate utilities with financial rewards and penalties to deploy and utilize distributed energy resources (DERs), improve resilience, better engage customers, and deliver greenhouse gas (GHG) emissions reductions. As utilities and regulators try to balance these new expectations with existing responsibilities, PIMs provide utilities with the flexibility needed to meet both traditional and emerging demands, while still serving shareholder, customer, and broader public interests.
From a historical perspective, PIMs have a mixed track record in delivering effective and sustainable changes to utility performance. While there are plenty of success stories, there are also many examples of PIMs that did not motivate desired utility behavior, created perverse incentives, or either over- or under-compensated utilities relative to the customer benefits created. Given the great potential of well-designed PIMs, we need to understand their past results to identify what characteristics make PIMs successful.
To shed light on why PIMs produced the results they did, it is useful to consider the fuller context of underlying motivations, design processes, and unique features at play. For example, New York utilities have had rewards and penalties for basic service obligations and energy efficiency for years, but recently have attempted to develop more novel incentive mechanisms, with varying levels of success. The state’s utilities and stakeholders have confronted the hard reality of how complicated incentive design is in practice due to competing stakeholder visions for what outcomes to incentivize and at what price, as well as limited available historical data.
Both the New York and Rhode Island cases are emblematic of both the promise and the potential pitfalls of PIMs. As these and other cases demonstrate, PIM development, approval, and implementation are not always straightforward.
Eight Recommendations to Improve PIM Results
Based on our research and interviews with stakeholders involved in PIM development, we offer eight recommendations to regulators, utilities, and other stakeholders looking to integrate PIMs into their regulatory frameworks:
- Determine what role PIMs can play in supporting public policy goals
Where in the past US utility regulators primarily tied performance incentives to traditional service obligations, PIMs are now being considered as a tool to support new—or “emergent”—policy areas. However, as PIMs are only one tool available to regulators to advance policy priorities, it is also important to assess their interactions with other mandates and directives to ensure rewards or penalties complement, but don’t duplicate or counteract, existing rules.
- Evaluate how PIMs can work within current regulatory frameworks
Contemplating how PIMs function alongside other earnings opportunities can avoid PIMs being added to the existing utility revenue model in a piecemeal manner. Depending on states’ needs and priorities, PIMs may be used conservatively—narrowly applied to specific programs or services—or they can offer an opportunity to more fundamentally change how utilities make spending decisions to support regulatory objectives.
- Consider how PIMs can support utility growth into new service areas
PIMs are an effective tool to incent utilities to develop innovative programs and services beyond their day-to-day operations. By offering utilities a financial incentive to pursue new roles—for example DER integration or utilization of load from electric vehicles—they can evolve alongside new markets and technologies.
- Strive for outcome-based PIMs where possible
Outcome-based PIMs provide new opportunities to leverage utilities’ unique knowledge of the grid to benefit customers and can drive innovation in the power sector. While activity- and program-based PIMs have been used in the past to successfully motivate utilities, outcome-based PIMs provide utilities flexibility to choose which portfolio of programs and investments best produce desired outcomes most cost-effectively.
- Leverage data to better understand utility operations
PIMs can reduce information asymmetry between utilities and other stakeholders by making data on utility programs or services transparent. PIMs should be designed to motivate utilities to utilize the growing amount of data that now can be collected to achieve efficiencies and other improvements.
- Align incentive structures with expected benefits
PIMs should be designed to motivate different utility actions or decisions than what would happen under business as usual. Their benefits should outweigh the cost to customers in terms of both the potential reward paid to the utility and the spending needed to meet their requirements.
- Prioritize flexibility and learning
Given the complexity of utility operations, grid and market interactions, and ratemaking, PIMs will likely need to be adjusted over time to ensure customer rates are reflective of prudent utility costs. This is also important to ensure that PIMs deliver additional benefits to customers and market participants, as well as to the larger economy and society.
- Design effective approaches for stakeholder participation
If a wide range of stakeholders are not included in discussions, PIM development risks overlooking important dynamics or tradeoffs. Regulators should consider structuring PIM processes differently than traditional regulatory proceedings or more formal technical conferences to optimize collaboration, data sharing, and innovative thinking.
Whether the intent is a broad vision for utility transformation or a narrower exploration of how incentives can improve specific programs, PUCs and stakeholders looking to develop PIMs can learn from the range of historical PIM experiences across time and geography. And while it may be premature to make a final assessment of their results, important lessons are already emerging from ongoing PIM processes in states such as Rhode Island and New York, as well as Minnesota and Hawaii.
As more and more states attempt to update the traditional regulatory compact of yesteryear to reflect what is in today’s public interest, PIMs are a tool to remake how utilities are compensated for new services, while ensuring customers and the wider society benefit as well.