Improving Performance in Publicly Owned Utilities

Deck: 

Consistently setting, measuring, and updating quantitative performance metrics should be a central feature of any program.

Fortnightly Magazine - March 2016

Public priorities for the electricity sector have shifted in recent years as rapid technological development enables a cleaner, more affordable, reliable, and safe electric system. But many utilities are not keeping pace. 

Market forces are precipitously changing the role of utilities. Third parties are offering customers more choices and control over their electricity, through energy efficient products and services, demand management, self-generation like rooftop solar, smart electric vehicle chargers, and on-site storage. At the same time, the role of cost-effective utility-scale wind and solar is growing, as costs have plummeted in the last five years. New technologies and new grid configurations can increasingly deliver on traditional goals like affordability, reliability, clean energy, safety, and universal service. As a consequence of these new market forces and new options, the institutions governing the electricity system must also evolve.

A quarter of Americans are served by publicly owned utilities. Unlike investor-owned utilities, which are ultimately motivated by profits and shareholder value, publicly owned utilities are non-profit entities that are often owned by customers themselves, directly connected to public policy, and governed democratically. These utilities must also adapt to new customer demands and market forces, and this transition is just as challenging for public utility management and boards as it is for their IOU counterparts. The American Public Power Association and the National Rural Electric Cooperative Association submissions to the 51st State process, of the Solar Electric Power Association, both describe important ways to balance and achieve modern power sector goals. This article builds on that work - bringing performance management concepts to bear on this challenge.

Modern performance management practices can and should be applied to public and private utilities alike, especially given the quickly evolving market forces facing the electricity sector today. We point out a handful of examples of publicly owned utilities that have taken steps to improve performance, focusing on some of the larger municipal utilities and public utility districts, though many of these lessons could apply to other models of public power. This article focuses on high-level performance management, but other changes, such as rate design, may also be important levers for improving public power performance. 

Three Steps For Public Utility Performance Management 

Three basic steps can improve performance in public power utilities. All publicly owned utilities could benefit from the first step, but all three steps will certainly not be necessary in every case.

Modern performance-management practices can – and should – be applied to public and private utilities alike. –Sonia Aggarwal

1. Take "no regrets" actions. Principles include:

  • Convene diverse perspectives from customers and other local interests to define top-line goals for the electricity system. Develop a list of performance metrics that reflect those goals.
  • Require utility management to regularly report performance against those metrics publicly. Simply beginning to measure performance can reveal substantial opportunities for savings.
  • Encourage utilities to integrate performance goals and metrics into integrated resource plans, and continuously update those plans to reflect changing market conditions and public priorities.

2. Explore evolutions in governance. Principles include:

  • Clarify the board's purpose in setting performance targets for the utility. Clearly draw the line between board decisions and utility management decisions.
  • Establish a schedule for periodic board review of utility performance metrics.
  • Define standards and actions required for board excellence, focusing on outcomes that indicate effective governance. Incorporate periodic self-evaluation into routine activities of governing boards and utility executives.

3. If performance lags, consider more drastic measures. Options include:

  • Consider decoupling public utility revenue from volumetric sales as a way to reduce financial uncertainty and drive energy efficiency.
  • Consider linking a share of employee compensation to utility performance.
  • Consider spinning off utility functions that continually underperform into separate, non-profit entities.

The following examples demonstrate performance improvement that real utilities experienced from taking each of these steps.

Examples Of Performance Management In Publicly Owned Utilities

Despite uncontested benefits for customers, energy efficiency can be difficult to get right and lead to revenue shortfalls. –Michael O’Boyle

Step One: Take 'No Regrets' Actions

Introducing performance-management for publicly owned utilities can start with very low-cost, "no regrets" steps. Publicly owned utilities should collect diverse perspectives, work with customers and others to define outcomes, and develop repeatable metrics to track performance. Beginning to regularly measure performance can drive improvements.1 No doubt this takes some upfront work, but experience has shown programs that clearly define and regularly measure performance lead to more efficient operations and help utilities and their boards adapt to changing technologies, market forces, and customer preferences.

Toronto Hydro - engage local interests, define goals, begin measurement

Toronto Hydro is a municipal utility, owned by the city of Toronto, serving more than 700,000 customers with a peak load of 4,273 MW in 2014. This large muni has made continuous improvement a central part of its model, and has taken the "no regrets" steps to drive performance.

The first step Toronto Hydro took to improve performance was to engage folks representing a diverse set of local interests to define top-line goals for utility management. Toronto Hydro surveyed the City of Toronto, customers, contractors, suppliers, industry associations, public interest organizations, government, academia, and employees. Toronto Hydro then compared how these local interests prioritized various performance characteristics with how utility management prioritized them. The result helped local interests and utility management get on the same page about their goals and priorities for the utility system.

Since Toronto Hydro's initial analysis, the Ontario Energy Board has required Toronto Hydro and other utilities to compile performance "scorecards" that track metrics for utility performance in four categories: customer focus, operational effectiveness, public policy responsiveness, and financial performance.2 The scorecard then indicates whether target performance levels have been achieved and whether the utility is improving. For example, the scorecard for 2013 shows that Toronto's service quality and customer satisfaction have improved every year since 2009. 

These performance measurements have resulted in better transparency and better understanding of local interests' priorities, focusing utility management on continuous improvement in the categories its customers care most about. For example, Toronto Hydro decided to start econometric benchmarking to enhance affordability. The benchmarking efforts will also help assess which features of Toronto Hydro's business have the greatest impact on cost and reliability performance, with the intent to improve future planning. 

So far, it is not clear whether performance will continue to improve in the long run because the utility has reported most of these metrics for only a couple of years. But it is clear that these measures have improved local input and transparency, and have refocused utility management on performance. 

Principles

  • Convene diverse perspectives to define top-line goals for the electricity sector
  • Develop metrics for those performance areas that can be impartially measured
  • Require utility management to regularly report performance against those metrics to increase transparency and assess need for further action

Austin Energy - build performance metrics into integrated resource plans

Austin Energy is the nation's eighth largest public utility and a department of the City of Austin providing electricity to more than 448,000 customers and a population of almost one million in the City of Austin and several neighboring cities.

In addition to using basic performance metrics, Austin Energy engages in long-term integrated resource planning (IRP) to optimize the system around its goals for reliability, affordability, and environmental performance. Through its "Resource, Generation, and Climate Protection Plan," Austin Energy considers multiple scenarios to meet greenhouse gas reduction targets and measures costs against its goal to keep annual rate increases below two percent. As a result, the utility has the tools necessary to meet the City Council's environmental performance goals while balancing affordability goals for electricity service. 

In 2014, the Austin City Council adopted a 50 percent renewable energy goal for 2020, a 65 percent renewable energy goal for 2025, and several capacity targets for solar, wind, and storage, forcing Austin Energy to update its ten-year plan. The city council also stated that the utility should comply only if it could keep annual rate increases below two percent. 

Austin Energy's first analysis found that the new goals would raise rates by an average of six percent annually, three times the affordability target set by the council. In response, Austin Energy presented several less ambitious scenarios that would save customers money, but still reach up to 55 percent renewables by 2025. The city council adopted one of those scenarios, which included several innovative mechanisms to support demand response and energy efficiency. This transparent IRP process identified a solid compromise with the city council, consumer groups, and environmental advocates, improving environmental performance and affordability at once.

Principles

  • Integrate performance goals into integrated resource plans
  • Continuously update integrated resource plans to reflect changing market conditions and public priorities

Step Two: Explore Evolutions in Governance

SMUD - focus board attention on performance, and clearly delineate decision-making responsibilities

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The Sacramento Municipal Utility District (SMUD) serves 1.46 million customers in a 900-square-mile territory that includes Sacramento and surrounding areas. SMUD is governed by a seven-member Board of Directors selected by the voters to serve staggered four-year terms. The SMUD Board of Directors determines policy and appoints the general manager, who is responsible for day-to-day operations.

In 2002, SMUD's board had become disconnected from utility executives' decision-making process. To remedy this disconnect and improve governance, the board and executive team recognized that the board needed to redefine its role and clarify its strategic direction while giving the utility executives sufficient leeway to accomplish the city's goals.

To ensure board activities supported utility performance, the SMUD board implemented twelve "Governance Process Policies" that required the board to set and measure utility performance.3 The new policies also explicitly directed the board to focus on "SMUD's intended impacts outside the organization, not on the administrative or programmatic means of achieving those effects." In essence, this clarified that the board should focus on defining high-level outcomes for the utility, and utility executives should be free to decide how to accomplish those high-level objectives. 

This more clearly drew the line between board decisions and utility management decisions. Utility management now reports on performance in its annual report, and the board has an annual opportunity to revise high-level utility goals in response to its customer-owners' priorities, thereby strengthening the link between public policy, customer preferences, and utility priorities. Biannual self-evaluations by the board and utility management team indicate that effectiveness of the board increased dramatically from 2002-2012.4

Principles

  • Clarify the board's purpose in setting performance targets for the utility. Clearly draw the line between board decisions and utility management decisions
  • Establish a schedule for periodic board review of utility performance metrics
  • Incorporate periodic self-evaluation into routine activities of governing boards and utility executives

Optional Step Three: Consider More Drastic Measures

The examples in this section are intended to illustrate options available to focus greater attention on performance in particular areas.

Southern California - revenue decoupling can improve financial performance and efficiency

Despite uncontested benefits for customers, energy efficiency can be difficult to get right. In publicly owned utilities and IOUs alike, energy efficiency can lead to revenue shortfalls. For publicly owned utilities, missed revenue targets can impair credit ratings if uncorrected. As a result, some publicly owned utilities are challenged to balance financial stability with energy efficiency programs.

"Decoupling" a public utility's revenue from its sales volume can remove the disincentive for energy efficiency by aligning financial performance with efficiency. Decoupling adds the amount by which revenue fell short in a previous year to the next year's revenue target, so the utility collects its full projected revenue target. This guarantees that the utility will recover all of its projected revenue no matter how much energy efficiency erodes sales volume, mitigating the risk of revenue shortfall.

Two munis in Southern California - Los Angeles Department of Water and Power (LADWP) and Glendale Water and Power (GWP) - have applied decoupling to improve finances and maintain support for energy efficiency programs. LADWP is a large muni that serves 1.4 million customers, and GWP is a smaller muni serving 30,000 customers. LADWP's decoupling mechanism takes the difference between its projected revenue and actual revenue in the previous year, and includes it in customer bills as a part of a "variable cost adjustment" component of rates. GWP includes a "revenue decoupling charge" separate from other charges twice each year that is calculated the same way. 

Decoupling has been noted positively by the utilities' bond rating institutions. A 2013 Fitch bond rating noted that the revenue stability provided by decoupling positively impacted LADWP's rating. Because of these positive results, LADWP's board has proposed to permanently adopt decoupling. In both LADWP and GWP, decoupling has helped to increase revenue certainty, freeing up resources for other activities, improving financial stability, and supporting energy efficiency performance.

VEIC - spinning off part of the business into separate non-profit entities can improve performance on important goals

Vermont Efficiency Investment Corporation (VEIC) is a non-profit energy efficiency administrator contracted by Vermont's energy efficiency utility, Efficiency Vermont, to serve both publicly owned utilities and IOUs in achieving Vermont's efficiency goals. 

The success of VEIC sheds light on two additional options for publicly owned utilities and their governing boards looking to take more drastic actions to drive performance. First, VEIC uses a performance-based employee compensation structure. And second, VEIC represents one model for how a narrowly focused, non-profit, third-party administrator can deliver remarkable performance on delivering new electricity services for publicly-owned utilities. 

Since 2000, VEIC has saved customers 13.7 million megawatt-hours, meeting 13.3 percent of Vermont's overall energy demand with efficiency. In 2014, every dollar VEIC invested in efficiency resulted in returns of $2.60. According to the American Council for an Energy Efficient Economy, Vermont ranks third best of all 50 states in overall energy efficiency performance. These high returns at a modest cost are due in part to sophisticated customer outreach, identification of the best opportunities for saving, and performance-based compensation that incents innovative approaches to achieve VEIC's goals.

VEIC's performance goals are set by the Vermont Public Service Board (VPSB) and tied to compensation. Up to three percent of the utility's revenue is ultimately at risk. There is a performance assessment every three years, and a consultation between VEIC, the VPSB, and other interested parties in the region to set quantitative performance indicators. 

VPSB measures nine main metrics that are tied directly to overall utility compensation, which the non-profit entity passes through directly to its employees. There are also an additional 12 minimum performance requirements, which have associated financial penalties on the utility as a whole. 

This approach has resulted in continuous improvement of energy efficiency in Vermont. VEIC gives a few reasons why a non-profit entity, similar in many ways to a public utility, will improve performance if some revenue is tied to performance. According to VEIC, tying revenue to performance helps:

  • increase cash reserves, improving the credit rating and keeping costs of debt low;
  • mitigate risks during economic downturn; and
  • maintain a culture of continuous improvement and competition.

Because VEIC passes through some of the performance incentive to its employees, VEIC has high employee retention rates, a culture of high performance, and has been listed several times as one of the "best places to work" by Vermont Business Magazine. In an era of an aging workforce, VEIC maintains that these attractive compensation structures and a positive corporate culture help to retain employees and attract talent, reinforcing high performance. For publicly owned utilities looking to create a culture of continuous improvement and bolster financial performance, VEIC's compensation structure may be an interesting option to consider.

For publicly owned utilities that hope to explore new organizational models that take advantage of emerging market trends and evolving customer demand, VEIC illustrates an interesting option, particularly because many of the utilities served by VEIC are munis and co-ops. Utility governing boards could turn to non-profit third-parties to handle one or more utility functions if performance is lagging. The VEIC model of a non-profit third party can still fit with the public power mandate to put customers first, respond to local concerns, and maintain ownership in the public sphere.

Options:

  • Consider decoupling public utility revenue from volumetric sales as a way to reduce financial uncertainty and drive energy efficiency
  • Consider linking a share of employee compensation to utility performance, fostering a culture of continuous improvement, improving accountability, and aligning utility operations with customer value
  • If a new business model or performance goal is outside the expertise of utility management, consider spinning off certain utility functions into separate, non-profit entities

Conclusion

These examples make it clear that the first step for performance management in any public utility, or any utility for that matter, is to engage a diverse set of local interests to get a clear picture of the outcomes they want from the electricity system, and how they rank those priorities. To set clear performance goals, utility boards must have clear direction from their constituents.

Next, consistently setting, measuring, and updating quantitative performance metrics should be a central feature of any public utility management program. For small utilities this can be a relatively large challenge, but even the simplest goals are useful places to start orienting utility operation around increasing customer value. The exercise of measuring and tracking performance can illuminate low-hanging fruit to improve performance and facilitate technology integration.5

Including quantitative metrics in integrated resource planning is another useful tool to determine how best to meet performance goals that may seem to pull operations in opposite directions. For example, Austin Energy was able to save money and meet some of the country's most ambitious decarbonization goals, using a collaborative and transparent IRP process. 

Governance reforms can also help. Clearly defining the board's role as outcome-focused rather than operations-focused can help provide clearer direction to utility management, and improve overall performance. Focusing board attention on examining and updating performance metrics ensures that the board helps support continuous improvement. 

Finally, if utility governing boards are interested in keeping utility management focused on its core strengths, they can consider revenue decoupling or performance-based compensation for employees. Another useful, but more drastic, option to consider is using a third-party administrator to improve performance in a particular area. 

The customer-owners and municipal boards of publicly owned utilities are in a unique position to define what constitutes excellent performance. What do customer-owners and the officials who represent them value most? And how do those values align with what the utility is delivering? 

The art of utility governance comes in weighing the relative importance of values that may pull utilities in divergent directions and translating important priorities into clear direction for utility management.

Endnotes:

1. See PacifiCorp case study in Aggarwal and Burgess, New Regulatory Models, Western Interstate Energy Board, 2014, at 21. After developing a quantitative target for cutting costs of overhead fault repairs in the distribution system, PacifiCorp was able to slash costs by almost half in just 13 months.

2. See Appendix I for additional detail. Scorecard - Toronto Hydro Electric System Limited, Sept. 24, 2014.

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3. See, e.g., SMUD Board Policy GP-1, "Purpose of the Board," Adopted December 19, 2002. The first three enumerated purposes of the SMUD board focus on performance: "The purpose of the Board of Directors is to: Identify and define the purpose, values and vision of SMUD, along with the quantitative and qualitative results that SMUD is to achieve, and communicate them in the form of policy; Identify and define those results or conditions of SMUD that are acceptable and not acceptable to the Board and communicate them in the form of policy; Monitor the organization's performance against the results that the Board has established for the SMUD." (emphasis added).

4. Eric Douglas, Improving Public Utility Governance: A Case Study: The Sacramento Municipal Utility District, Leading Resources, Inc., 2015, at 35-37. The categories examined included the strategic vision, analysis and judgment of the board, productiveness of communication, decisiveness, governance, roles and responsibilities, effectiveness of meetings, and building and maintaining relationships between the board and executives. Each saw marked improvement in the 10 years since the 2002 implementation of governance policies.

5. Melissa Whited, Tim Woolf, and Alice Napoleon, Utility Performance Incentive Mechanisms, Synapse, March 2015.


Lead image © Can Stock Photo Inc. / Violka08