Performance-based ratemaking (PBR), an emerging regulatory framework that ties utility revenue to performance rather than capital investment, is on the rise in the United States.
19 states and Washington D.C. have seen recent legislative and/or regulatory developments related to PBR. That's six more than a year ago, according to new data on PBR activity by utility commissions and utilities compiled by regulatory intelligence firm EnerKnol and analyzed by Wood Mackenzie.
Yet analysis of regulatory and legislative activity shows that while PBR is becoming more widespread, linking new performance metrics with financial consequences for utilities remains rare.
Performance-based ratemaking is a utility business-model shift that rewards utilities for performing well on key metrics, such as efficiency, customer service and greenhouse gas emissions reduction. PBR is a departure from the traditional utility model of reaping returns from capital-intensive investments (the cost-of-service model).
In the context of flat demand growth and the proliferation of renewables, storage and grid edge technologies, capital-intensive investments are not always the most beneficial investments for customers or overall grid health.
The rise of PBR activity indicates that more legislatures, utilities, regulators and stakeholders now believe that breaking the link between revenue and investment is a logical evolution of the utility business model.
"You're starting to see a groundswell of interest in performance-based ratemaking across the U.S.," said Jonathan Crawford, head of research for EnerKnol. "Utilities increasingly view the programs as critical for locking in more stable revenues in the face of declining power sales and costly environmental mandates."
“PBR is part of a larger regulatory evolution, as state utility commissions and utilities grapple with the changing nature of the electric grid,” said Fei Wang, senior grid edge analyst at Wood Mackenzie Power & Renewables.
Drivers Behind Performance-Based Ratemaking Activity
Source: Wood Mackenzie Power & Renewables and EnerKnol
The most common PBR mechanisms today among the 19 states experiencing PBR activity are multiyear rate plans, revenue decoupling and performance incentives for conservation programs. Yet significant financial incentives (defined in the report as potential financial gains or losses) are so far lacking, with Hawaii demonstrating the most progress toward an incentive-driven framework.
Incentives are a key element of the PBR regulatory framework that is notably absent in most states considering PBR. At a high level, performance mechanisms for PBR can be broken out into the following components, according to WoodMac:
- Metrics: Required reporting of quantifiable and verifiable metrics (greenhouse gas emissions, clean peaks, efficiency and customer satisfaction are typical examples)
- Scorecards: When metrics are associated with targets and utility performance can be scored to compare to its historical levels or with peer utilities
- Incentives: When scorecards are associated with financial incentives and/or penalties, giving performance mechanisms real enforcement power
Some states are having broad and extensive discussions about PBR regulatory options. However, most states’ PBR deliberations remain at a nascent stage, and a few have abandoned the PBR framework or specific PBR options.
Only one state — Hawaii — has set a deadline regarding the implementation of financial incentives and/or penalties, which will make its performance mechanisms enforceable.
“Hawaii is taking the accountability step that is missing, so far, from proceedings in other states. People will be paying a lot of attention to that,” said Wang. “Hawaii is a clear leader in terms of willingness to develop comprehensive performance metrics.”
Scope is key, noted Wang. Before the process kicked off, there were already some PBR incentives in place in Hawaii, but the potential gains and losses associated with compliance totaled approximately $6 million — a small sum relative to utility operating revenue.
Wang points to two other states to watch as PBR activity continues.
Massachusetts utility Eversource is moving the state toward PBR via a new approach to rate cases. The investor-owned utility filed a five-year rate case with PBR components, including performance mechanisms, but the metrics are not accompanied by financial incentives or penalties.
Massachusetts is progressive in that utilities will measure around peak demand and greenhouse gas reductions, but Wang emphasized that the lack of incentives for compliance mean that PBR in Massachusetts is not yet as advanced as in Hawaii.
National Grid, the state’s other major investor-owned utility, followed suit with a five-year rate case of its own. (National Grid had filed a PBR rate case in Rhode Island previously, which was also approved.)
Minnesota is another state to watch, and it's another case in which the utility played a key role in kicking off PBR discussions. However, in Minnesota, the public utilities commission responded to the rate case by opening up a larger proceeding, rather than just looking at PBR in the context of the rate case, as was the situation in Massachusetts. Minnesota’s investigation of performance metrics is still at a nascent stage.
The report also finds a correlation between states with strong renewable energy commitments and PBR activity. Among the 11 states and territories with 100 percent renewable or carbon-free goals either signed into law or being acted upon in the state legislature, nine of them have recent PBR developments at the state or utility level: Colorado, District of Columbia, Hawaii, Illinois, Minnesota, New Mexico, Nevada, New York and Washington.
For a more in-depth analysis of PBR activity since 2015 at state utility commissions and utilities, download the executive summary of Regulatory Evolution for a Future Electric Grid: State of Performance-Based Ratemaking in the U.S. The full report is available as part of WoodMac's Grid Edge service and examines the drivers behind PBR activity at varied stages, looks at regulatory tools for commissions, and analyzes the progress in determining performance metrics and incentives. Tracking of the proceedings is available on the EnerKnol Platform.