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Results-Based Regulation

A more dynamic approach to grid modernization.

Fortnightly Magazine - March 2014
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Today's electric distribution companies face a dilemma. Increasingly, they are expected to modernize their networks: replace aging infrastructure, improve resilience during severe weather, integrate distributed and variable renewable generation, and secure systems against cyber and physical attacks. Yet these expectations arise at a time of slow-growing, flat, or even declining sales - a trend that discourages capital investment.

This problem is rooted in an outdated cost-of-service model of regulation that reviews costs as if the functions and activities of the modern distribution utility were little changed from those of yesterday. This model of regulation can slow the pace of innovation and defer investment that could otherwise deliver significant net benefits to customers. Yes, cost-of-service regulation helped support the 20th-century expansion of electric service, but it did so largely during periods of falling costs and increasing sales.

Building a 21st-century power system that's affordable, resilient, and environmentally sustainable will require a regulatory model that enables investment in new technologies and supports business models that deliver greater value to customers. However, cost-of-service regulation offers little incentive for utilities to improve performance beyond minimum levels required by regulators and may delay the pace the grid modernization.

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. Yet rarely have these models simultaneously supported both objectives.

An alternative is emerging in the form of a new forward-looking regulatory and incentive framework: Results-Based Regulation. This regulatory model supports utility business plans that deliver long-term value to customers, rewards utilities for exceptional performance, and maintains affordable rates by encouraging operational efficiencies and sharing the cost savings with customers. One example of this new approach is the United Kingdom's recently adopted "RIIO" model, or "revenue set to deliver strong incentives, innovation and output." ( See, Peter Fox-Penner, Dan Harris, Serena Hesmondhalgh, " A Trip to RIIO in Your Future? " Fortnightly, October 2013 .) 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.

Creating the Modern Grid

Across the economy - from aircraft to automobiles and from manufacturing to entertainment - industries have adopted digital controls and technologies to drive down costs and, in many cases, improve the quality of products and services provided to customers. Electric utilities are starting a similar transition: from delivering power produced in distant facilities to a model that integrates resources located closer to the customer and provides enhanced levels of service.

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