1. 1
Ira Shatzmiller
May 2015
A Comparison of cost-of-service and performance-based regulation: reliability and quality of service
Introduction
Observersof the electricityindustryhave summarized the conundrumaroundthe price
regulationof electricity:“Price andqualitygohandinhand. It makeslittle sense tobuyacheapproduct
withoutknowledge of itsquality. The same appliesforelectricity –cheapelectricitydoesnotreally
meananythingif there are constantinterruptionsinsupply. Butpayinghuge sumsof moneyforno
interruptionsatall doesnotmake sense either. The question,therefore,is:whatisthe optimal quality
level andatwhat price shouldthisbe offeredtoconsumers?”i
Overthe past twentyyears,incentive-orperformance-basedregulation(“PBR”) hasbeen
advancedas a solutiontothisproblem. Proponentsof PBRclaimthat,unlike traditionalcost-of-service
regulation(“COSR”),PBRincentsthe suppliertofindcostefficiencies,whileloweringpricesforthe
consumer. While some have arguedthatPBRhas the powerto more accuratelymimica competitive
market, othershave arguedthat PBRresultsinunacceptable levelsof degradationinreliabilityand
customerservice.
Thispaperwill address these argumentsandconclude whetherPBRis,infact, a superior
solutionto COSRin termsof locatingthe optimal qualitylevelandprice forconsumers.
Criticismof COSR
Today,COSR remainsthe commonregulatorymethodforinvestor-ownedutilities inNorth
America. A regulatory commission approves“justandreasonable”ratessothat the regulatedentity
recoversits“prudentlyincurred” costsin providingelectricity,which includesareturnoncapitalii
. The
base rate revenue requirementisestablishedthrougharate case,where estimatesare made of the
prudentcostof capital,laborand otherinputs. Upondeterminationof the revenuerequirement, itis
allocatedforrecoverybasedon customernumbers,deliveryvolumes,andotherbillingdeterminants.iii
Criticismof COSRisvaried. Amongthe more procedural arguments,itisallegedthatallowed
costs can be difficulttodetermine if the regulatedcompanysellssome productsinunregulatedmarkets,

2. 2
sometime resultingincostsforthe unregulatedservices needingtobe assignedtothe regulated
servicesiv
. Bythe same token,complicationsmayarise whencommoncostsare incurredjointlyby both
the regulatedandunregulatedsegmentsof the firm.v
It isalso claimedthatinthe currenteconomicallyvolatileperiod,there istoomuchof a lag
betweenwhenthe regulatedcompanyactuallypurchasesthe inputsandthe revenue requirement
hearing.vi
The requirementunderCOSRthatcosts be “prudentlyincurred”isalsosubjecttocriticism,as
there isno shortage of evidence of prudence risk, exemplifiedinthe 1980s and early1990s where costs
for buildingexpensive nucleargenerationwere disallowedvii
. Disputesoverthe prudence of certain
costs continue today,asexemplifiedbythe Courtof Appeal decision PowerWorker’sUnion (Canadian
Union of Public Employees,Local1000) v. Ontario (Energy Board)viii
,wherebythe OntarioEnergy Board
(the “OEB” or “Board”) reducedby$145 Millionthe revenuerequirementsubmittedbyOntarioPower
Generation (“OPG”) tocoveritsnuclearcompensationcosts for2011 and 2012. The dispute,which
centresonwhetherthe laborcosts submittedbyOPGwere prudentlyincurredornot,iscurrently
before the Supreme Courtof Canada.
The underlyingproblemof determiningwhethercostswere prudentlyincurredornotstems
fromwhat economistshave termed“informationalasymmetry”betweenthe regulatorandthe
regulated, whichhasbeen atopicof theoretical researchsince the 1980six
, includingbyrecentthe
recentNobel Prize laureateJeanTirolex
.Ascertainingthe regulatedfirm’s“real”costsisextremelytime-
consumingandcostly,because correctingof the informational asymmetrybetweencompanymanagers
and regulatorsrequiressubstantialdataexchange,processing,andanalysis.xi
Assummarizedbyone
observer,if regulatorsknew the efficientwaytoproduce andmarketutilityservices,theycouldsimply
mandate the provisionof the optimal servicesandsetpricestorecoverthe minimumcostof providing
them. In fact, giventhe uncertaintiesof future marketconditionsandchangingregulatory
requirements, eventhose runningthe company cannotentirelydeterminewhatthe mostcost-efficient
practiceswouldbe.The challenge ismuchgreaterforregulators whogenerallywill nothave practical
experience with runningautility.
These problemsmaybe furtheramplifiedinthe presence of “regulatorycapture”,namelyif the
regulatedfirm(orotherinterestgroup) isable toinfluence the regulatorintodeciding onissuesin
accordance withitsowninterests.xii

3. 3
The most consistentcriticismof COSR,however, relatestothe premise thatunderCOSR, a
regulatedfirmhasnoincentive tocutcosts or otherwise operateefficiently. Asa practical matter,as
longas itscosts meetthe prudence threshold,the regulatedfirmwill be reimbursedforthesecostsand
alsoreceive areasonable rate of return. Furthermore,itisclaimedthatCOSRcreatesa biasin the
choice of inputs,particularlyif the rate-of-returnishigherthanthe firm’scostof capital, a phenomenon
knownas the Johnson-Avercheffectxiii
. Asithasbeendescribed:“Overcapitalizing isassociatedwithan
oversupplyof qualitysince qualityistypicallyacapital-usingattribute (Spence,1975). It can therefore
be expectedthatbothprice andqualitylevelswillbe toohigh. Empirical studiesshow thatunderrate-
of-returnregulation,existingreliabilitylevelsinthe electricitysectorare generallyhigherthanfroma
social pointof view. This“gold-plating”effectsuggeststhatconsumersmaybe payingtoohigha price
for toohigha level of quality.”xiv
In lightof the foregoing,agrowingsentimentamongelectricityindustryobserversisthat energy
supply issimply toocostlytoregulate well usingCOSR,andfailstoachieve the maximumpossible
benefittosocietyxv
.
The alternative totraditional rate-making,PBR.
PBR isan alternative totraditional COSRof energyutilities,andisnow the standardform of
regulationof investor-ownedfirmsoutside of NorthAmerica. PBRisalsoextensivelyusedinother
regulatedindustries,mostnotablyintelecommunications.xvi
Several differenttoolsmake upwhat are understoodtobe PBR mechanisms,butwhich all have
as a common denominatorthe decouplingof the price of electricityfromitsproductioncostsxvii
.
The basic approachestoPBR include rate caps,revenue caps,and benchmarking;important
categoriesPBRtoolsinclude benefitsharingandplanterminationprovisions.
The mechanismsfordeterminingallowedrate growthvary,butall have the attribute of being
external. The simplestapproachistoholdratesconstant forthe plan duration,whichissometimes
calleda rate freeze ormoratorium. A simple variantof the rate freeze isasetof pre-scheduledrate
adjustments,whichmaybe increasesordecreases.xviii

4. 4
The most commonformof PBR inthe worldtoday isan indexedrate capestablishedinadvance
of itsoperation,oftenrepresentedby the mathematical formulaΔPCI= P – X +/- Z. The growthof the
price cap index (PCI) dependsonthe difference betweenaninflationfactor(P) andan “X” factor (X),
plusor minusa “Z” factor (Z). The inflationfactor(P) isthe growthrate inan inflationmeasure thatis
external tothe utility,asitsvalue doesnotdependonthe company’sactions. The “X”factor isgenerally
alsoexternal andissometimescalledthe “productivityfactor”,asrate proceedingsinNorthAmerica
usuallyinvolve thisvalue. The Zfactor adjuststhe allowedchange inratesforreasonsotherthan
inflation andproductivitytrends,andis generallydesignedtorecoverthe impactthatchangesin
governmentpolicyhave onthe company’sunitcost.xix
Advocatesof PBRclaimthat using such mechanismscanreduce the frequencyandscope of
regulatoryintervention. Theyalsoclaimthatas PBRmechanismsrelyheavilyon externaldata,the
informational asymmetry problembetweenregulatorandregulatedisalleviated. Furthermore,utilities
can be assuredthatsuperiorperformance will notentail immediatemodificationstoregulatorypolicy,
inturn deprivingtheirshareholdersof the benefitsof suchperformance.xx
However,advocatesof PBRclaimthat the greatestbenefitof PBRthat itsadvocatespointtois
the motivationtobe cost efficient:bydecouplingprice fromincurredcost,incentivesforcostsavings
and ultimatelylowerconsumerpricesare strengthenedxxi
.
Criticismof PBRConcerningReliability andService Quality
AlthoughPBRiscomingto be the norm, manyhave expressedconcernwithitseffectsonnon-
price dimensionsof performance,whatisgenerallyreferredtoas“qualityof service”,for obvious
reasons. A simple price caporother incentiveplanrewardsthe firmforlowering itscost, butabsent
mandatoryqualitystandards, costreductionsare sometimes achievedbyshortchangingquality,an
incentive notfound underCOSR.xxii
A 2010 studyby AnnaTer-MartirosyanandJohnKwokaxxiii
(the “Study”) isone of the few
empirical investigationsof this concern,andusesa sample of U.S.electricitydistributors studied over
the periodbetween1993-1999, several of whichwere subjecttoPBR at the time. The Studyrecognizes
that while there are numerouspossible dimensionsof qualityof serviceinelectricity,outage-related
indicesrelatingtoaverage duration(SAIDI) andaverage frequency(SAIFI) are the onlywidelyaccepted

5. 5
and measuredcriteria. SAIDI,the “SystemAverage InterruptionDurationIndex”,isdefinedastotal
minutesof service interruptionsinayeardividedbythe numberof customersserved. SAIFI,the
“SystemAverage InterruptionFrequencyIndex”,measureshow oftenanaverage customer’sservice is
interruptedinagiven year. It iscomputedbydividingthe total numberof customersinterruptedbythe
average numberof customersserved.xxiv
The Studyacknowledgesthat differences inthe way
interruptionsare definedandmeasuredwasacomplicatingfactor.
The Study came to some surprisingconclusions. The empirical measurementstaken onthe
sample revealedthatthe meanSAIFI forutilitieswithout PBRwas1.28, while forthose with PBRSAIFI
averaged1.08, a higherSAIFI numberindicatingahigherfrequency. Amongthe latter,there wasa
substantial difference betweenthose withandwithoutqualitystandards –specifically,0.96for utilities
withqualitystandardsversus1.42 forthose without. Similarlywithrespectto SAIDI,durationaveraged
122 forutilitieswithoutincentive regulationand117 forthose withit. But among utilitieswith PBR,
qualitystandardswere associatedwithremarkablylarge differencesinduration,namely,199 forutilities
withoutsuchstandardsversus90 forthose withstandardsxxv
.
The Study concludedthatthere did notappearto be any positive relationshipbetween PBRand
SAIFI,basedthe followingexplanation:the singlemostcommoncause of outagesis equipmentfailure,
somethingonlypartially withinthe control of autility. Asa result,the associationbetween PBRand
SAIFI maybe difficulttodiscernempirically. Incontrast,once such failure hasoccurredandbeen
detected,the durationof the resultingoutage isafunctionof repaircrew readiness,equipment
availability,etc., whichare mattersmore withinthe control of the firm. That impliesthatSAIDI,more
than SAIFI,wouldbe affectedby PBR,inthe absence of qualitystandards.xxvi
The Studytherefore
suggeststhatPBR resultsindegradationof one aspectof service quality –durationof outages – unlessit
ispairedwithexplicitqualityprovisionsxxvii
. The Study doesstate thatwhile itsresultsindicatethatPBR
has a significantimpactonSAIDI, itqualifiesitsresultson the possibleendogeneityof PBRand a more
complicated,two-stepchainof causation,whichisthe utility’sdecision toreduce theirquality-related
expendituresinordertoincrease profitsunderincentiveregulation,followedbythe effectof this
reductioninexpendituresonqualityitselfxxviii
.
Criticismof PBRConcerning ReliabilityandService Quality: Ontario
Turningto Ontario,observersFrancis CroninandStephenMotlukbelievethatreliabilityhas
beensignificantlyloweredsincethe implementation of PBRinOntario in2000, throughthe OEB’s 2000

6. 6
Rate Handbookxxix
. Theycite Ter-Martirosyan andKwoka’sStudyinconcluding thatincorporatingstrict
reliabilitystandardswithfinancialpenaltiesintoPBR canoffsetthe tendencyof PBRplans without
standardsand penaltiestoimprudentlycutcritical OM&A activities.xxx
Croninand Motlukfurthercite the Study’sfinding thatoverhalf of the utilitiessubjecttoPBRin
the sample,inbothNorthAmericaandEurope, had such penalties. InNorthAmerica, followingaseries
of significantoutagesoftencausedbyimprudentreductionsinOM&A expenses,some regulators
imposedinspections,maintenance,andsometimesinvestment onthe utility, goingasfar as to specify
the nature,timingand,insome cases,the capital investment andstaffingthe utilitywouldneedto
expendtomeetthe regulations.xxxi
The authors painta stark comparisonwiththe OEB’sresponse to whattheyclaimis the
purporteddegradationinreliabilityandservice qualityinOntario. They argue thatpriorto the
restructuringof the electricitythroughthe introductionof the Ontario Electricity Competition Actof
1998, Ontarioelectricity distributorswere acknowledgedtobe technicallyefficientandprovidinghighly
reliable power. Atthe time of the restructuring,the OEB’simplementationtaskforce predictedthat
Ontarioutilitieswould reacttothese increasedincentives, andthatrobuststandardswouldbe
necessarytoensure the continuedsupplyof reliable power. The OEBoptedto require those local
distributioncompanies(“LDCs”) withhistoricaldatatocontinue supplyingpowerwithinthe levelsof
reliabilityobservedoverthe precedingthree years,followingwhichthe OEBwouldreviewthe standards
by 2003 and setfinancial penaltiesfornon-compliance.xxxii
The taskforce indicatedthatthose LDCs
withoutreliabilitydatashouldbegintocollectit,andthatbenchmarksbe set forthisgroup usingpeer-
groupaveragesxxxiii
.
For a varietyof reasons,the taskforce recommendedthatonly minimumcustomer-service
standardsbe appliedtothe LDCs duringthe firstgeneration of PBR. The levelsof the minimum
standardswere determined throughasurveyof the LDCs.
The OEB wasexpectedtotake action quickly,possibleevenearlyinthe first generation,butno
laterthan the beginningof the secondgenerationfollowingthe initial three-yearPBRterm, toset
reliability-performance targetsbasedon areasonedrationale. The OEBitself stateditsintenttomove
expeditiously:“Uponreviewof the firstyear’sresults,the OEBwill determinewhetherthere issufficient
data to setthresholdstodetermineservice degradationforyears2 and3.”xxxiv

7. 7
In 2003, the OEB issuedaStaff DiscussionPaperexaminingthe reliabilityperformanceof LDCs
relative tovariousproposedbenchmarkssuchassectoraverage or peergroupaverage performance
overthe preceding three years. Itfoundthatanywhere from25 – 50% of Ontariodistributorsfailed
these benchmarks. Furthermore,LDCsthatfailedtypicallyhada reliabilityperformance thatwas50 –
100% worse thanthe selectedaverage. Andyet,the authorsmaintain thatthese findingsfailedtoelicit
any concernfromthe OEB,nor didthe OEB offeranyexplanationforthe huge discrepancy,nordidthe
Staff DiscussionPaperactuallyshedanylightonwhetherLDCswere incompliance withthe reliability
guidelinesestablishedbythe OEBin2000.
In January2008, the OEB releaseditsdiscussionpaperonreliability,itsonlypublicly-released
analysisof LDC performance since the 1999 taskforce report. The paperemploysonlydatafrom2004-
2006 to examine LDCperformance,nopre-PBRdataandno data forthe firstthree yearsof the PBR are
examined. Assuch, the authorsclaim it isimpossibletosaywhat the performance of the electricity
distributorsinOntario hasbeen relativetothe minimumstandardsestablishedin2000, as thisquestion
isnot addressed inanypublicOEBanalysis. Theyfindpuzzlingthatthe OEBreportsthat it will notuse
thisdata for itsreliability-trendanalysis,claimingthatthisdata“may nothave beenreported
consistentlyorcalculatedproperly”. Thisverydatawascollectedbythose same utilitiesforatleast
fifteenyears,reportedtothe ImplementationTaskForce in1999 and to the OEB initsrequiredfilings
since 2000. If the OEB iswillingtoemploythe 2002 and 2003 reliabilitydatainitscostbenchmarking
that determine eachLDCs’future annual revenue,shouldn’tthisdatabe sufficientfortrendanalysisas
well?xxxv
As of 2009, the OEB still hadn’tconductedapublicreview of LDCreliabilityperformance from
2000 – 2003, nor had it conducteda review of anypost-PBRimplementation performancesoverthe
2000 – 2007 period todetermine whetherLDC’swere compliantwiththe standardsimposedin2000xxxvi
.
Croninand Motlukargue that inchoosingto rejectuse of itsown data priorto 2004, the OEB
not onlymissesasignificantdegradationin2004-2006 comparedwith2000-2003, it missesanearlier
degradedcomparedwiththe pre-PBR1993-1997 period. Onlyby examiningthe performance relativeto
the pre-PBRperiodcould the OEBdetermine compliance,andthe OEBseesnodegradationinlarge part
because ithas chosentoeliminate the periodsof higherreliabilityperformance initscomparison. The
OEB didn’treportwhattestshad beenperformedtodetermine thatthe datareportedinthe earlier
yearshadn’tbeenreportedconsistentlyorcalculatedproperly. It’sunclearwhatmethodologywasused
to remove statisticsthatappearedtobe unreliable. The earlierdatacame fromthe same populationas

8. 8
the laterdata and therefore canbe jointlyusedtoassessthe 2000-2007 trend,as well asto assess
performance relative tothe pre-PBRperiodusedin2000 to set standards. xxxvii
CroninandMotluk
underline thatthe OEBhad ample time toimplementqualitystandardsoranincentive/penaltyregime.
As of 2009, the OEB was inits tenth yearof collectingreliabilitydata fromindividualLDCs,more than
sufficienttime togainexperience. IndicatorssuchasSAIDIand SAIFIare standardsthat are usedfor
monitoringandregulatingservice qualityaroundthe world,andthese indicatorshave beenusedby
Ontariodistributors’associationforatleastfifteenyears.
Croninand Motluk don’tofferanyexplanationsforwhattheydepictas inactivityorobfuscation
on the part of the OEB, leavingthe reader’simaginationtofill the void. However,theydolinkthe
purported inactivity toaviolationof the Bonbrightprinciple of “justandreasonable rates”,arguingthat
service qualityandreliabilitystandards should be explicitlyformulatedaspartof the sale of accessby
distributorstocustomers.”xxxviii
They alsoquote the Council of EuropeanEnergyRegulators(CEER),whichstatesthe following in
its3rd
BenchmarkingReportonthe Qualityof ElectricitySupply(2005):“Price-capregulationwithoutany
qualitystandardsorincentive/penaltyregimesforqualitymayprovideunintendedandmisleading
incentivestoreduce qualitylevels.(...)The increasedattentiontoqualityincentiveregulationisrooted
not onlyinthe riskof deterioratingqualityderivingfromthe pressure toreduce costsunderprice-cap,
but alsothe increasingdemandforhigherqualityservicesonthe partof consumers....agrowing
numberof Europeanregulatorshave adoptedsome formof qualityincentiveregulationoverthe last
fewyears.xxxix
”
4th
GenerationPBRinOntario
As of the 4th
generationof PBRinOntario,there still remaintobe anyfinancial penaltiesor
incentivesinplace forservice quality. Inthe OEB’s“Reportof the Board – RenewedRegulatory
FrameworkforElectricityDistributors:A Performance-BasedApproach”of October18, 2012, the Board
has establishedan“ElectricityDistributorScorecard”whichestablishesperformance outcomesthatit
expectsdistributorstoachieve infourdistinctareasxl
:
• CustomerFocus:servicesare providedinamannerthat respondstoidentifiedcustomerpreferences;

9. 9
• Operational Effectiveness:continuousimprovementinproductivityandcostperformance isachieved;
and utilitiesdeliveronsystemreliabilityandqualityobjectives;
• PublicPolicyResponsiveness:utilitiesdeliveronobligationsmandated bygovernment(e.g.in
legislationandinregulatoryrequirementsimposedfurthertoMinisterial directivestothe Board);and
• Financial Performance:financial viabilityismaintained;andsavingsfromoperational effectivenessare
sustainable.
Distributorswill be requiredtoreporttheirprogressagainstthe scorecardonan annual basis,andthe
OEB has indicatedthatit will engage stakeholdersinfurtherconsultationonthe standardsand
measurestobe includedinthe distributorscorecard.”xli
However,itdoesnotappearthat further
consultationwillresultinpenalties,asthe OEB has statedthat “The standardsand measuresmustbe
suitable foruse bythe Board inmonitoringandassessingdistributorperformance againstexpected
performance outcomes,inmonitoringandassessingdistributorprogresstowardsthe goalsand
objectivesinthe distributor’snetworkinvestmentplan,incomparingdistributorperformance acrossthe
sectorand identifyingtrends,andinsupportingrate-setting.”1
The OEBalsoforeseesthatthe
“expandeduse of benchmarkingwillbe necessarytosupportthe Board’srenewedregulatory
frameworkpolicies.”xlii
The Board will maintainitsexistingregulatorymechanisms,subjecttocertainrefinements.
Specifically,the X-factorwill be refinedandthe “publicationof distributorresults”mechanismsreferred
to above (amongpossible others) will be integratedintothe scorecard.xliii
How couldan effective PBRplanassure reliabilityandservice quality?
If the OEB were evertoapply penaltiesfordegradedreliabilityorservice standards,whatwould
it looklike? Severaljurisdictionsofferdifferentmodels.
OFGEM
1 RRFE, p. 58.

10. 10
In a 2006 article entitled “Incentive RegulationinTheory andPractice:ElectricityDistribution
and TransmissionNetworks”,xliv
Paul Joskow providesadetailedaccountof the mechanismsthat
OFGEM (the Office of Gasand ElectricityMarkets,the U.K.regulator),hasputin place tomaintainor
enhance service quality:
(a) two distributionserviceinterruptionincentivemechanismstargetedatthe numberof outagesand
the numberof minutesperoutage;
(b) storminterruptionpaymentobligationstargetedatdistributioncompanyresponse timestooutages
causedby severe weatherevents;
(c) qualityof telephoneresponsesduringbothordinaryweatherconditionsandstormconditions;
(d) a discretionaryawardbasedonsurveysof customersatisfaction.
Joskowreportsthatoverall,4%of total revenue onthe downsidecanbe lostand an unlimited
percentage of total revenue onthe upside are subjecttothese incentives. Joskow providesadetailed
analysisof howOFGEMusesstatistical andengineeringbenchmarkingstudiesandforecastsof planned
maintenance outages todeveloptargetsforthe numberof customeroutagesandthe average number
of minutesperoutage foreachdistributioncompany:“The individualdistributioncompaniesare
disaggregatedintodifferenttypes(e.g.voltages)of distributioncircuitsandperformance benchmarks
and targetsare developedforeachbasedoncomparative historical experience andengineeringnorms.
Aggregate performance targetsforeachdistributioncompanyare thendefinedbyre-aggregatingthe
targetsfor eachtype of circuit(OFGEM(2004c) appendix toJune 2004 proposals) tomatch up circuits
that make up eachelectricdistributioncompany. Bothplanned(maintenance) andunplannedoutages
are takenintoaccount to developthe outage targets. The targetsincorporate performance
improvementsovertime andreflect,inpart,customersurveysof the value of improvedservice quality.
There isa fairlywide range inthe targetsamongthe 14 distributioncompaniesinthe UK,reflecting
differencesinthe configurationsof the networks. OFGEMalsohas addedcost allowancesintothe price
control (…) to reflectestimatesof the costsof improvingservice qualityinthese dimensions.”xlv
He goeson tosay:
“Once performance targetsare set,a financial penalty/rewardstructure needstobe appliedtoitto
transformthe physical targetsintofinancial penaltiesandrewards. The natural approachwouldbe to
applyestimatesof the value of outagesandoutage minutestocustomers(OFGEMsurveysindicated

11. 11
customersvaluedreducingthe numberof minutesperoutage more thanthe numberof outages) to
define pricesforoutagesandoutage duration.”
Joskowexpressesdisapprovalthat OFGEMdidnot take this customersurvey approachinthe
mostrecentdistributioncompanyprice review,optinginsteadtodevelop pricesforoutagesandoutage
durationbytakingthe target revenue atriskand dividingitbya performance bandaroundthe target
(25% and 30% respectively). He indicates thatthisapproachseemsratherarbitraryand yieldsafairly
wide variationinthe effectiveprice peroutage andthe price perminute of outage across distribution
companies.xlvi
Joskowalsoprovidesanaccountof OFGEM’s stormrestorationcompensationincentive
mechanism. Underthismechanism,the distributioncompaniesare givenincentivestorestore service
withinaspecifiedtimeperiodandif theydonottheymustpay compensationtocustomersasdefinedin
the incentive mechanism. The mechanismincludesadjustmentsforexceptional events. Undernormal
weatherconditionscustomers are eligible tobe paid£50 poundsforan interruptionthatlastsmore
than 24 hours(£100 fornon-domestic)anda further£25 for eachsubsequent12-hourperiod. Again,
Joskowexpressesconcernthatitisnot clearwhere the valuesforthese paymentsoriginate from. If a
customerconsumes20kWh perday (600kWh per month) the impliedvalue of lostloadis£2.5 per lost
kWh or roughly$5000/Mwh of lostenergy. xlvii
Finally,Joskow providesanaccountof the compensationarrangementsare appliedwhenthere
are severe weatherconditions,where boththe triggersandthe compensationchange.xlviii
The trigger
periodsforcompensationare definedbelowandthe amountof compensationstartsat£25 whenthe
triggerishit witha cap of £200 percustomer.
Category of severe weather Definition Trigger periodfor compensation
Category1 (mediumevents) Lightningevents(≥8timesdaily
meansfaultsat highervoltage
and lessthan35% of exposed
customersaffected)
24 hours
Non-lightningevents(≥8and≤
13 timesdaily meanfaultsat
highervoltage andlessthan35%
of exposedcustomersaffected).
24 hours

12. 12
Category2 (large events) Non-lightningevents(≥13times
dailymeanfaultsathigher
voltage andlessthan35% of
exposedcustomersaffected)
48 hours
Category3 (verylarge events) Anysevere weatherevents
where ≥35% of exposed
customersare affected.
48 hours x (Numberof
customersaffected/35% of
exposedcustomers)²
Finally,there are penaltiesandrewardsforthe qualityof telephone service, basedonthe results
of customersurveys.xlix
Massachusetts,Michigan,NewYorkState
Relatingtoqualityservice standardsinaNorthAmericancontext, Ter-Martirosyan andKwoka
provide twoof whattheybelieve tobe the more thorough-goingandinterestingplans introduced,in
MassachusettsandMichigan. In2001, MassachusettsdevelopedaService Qualitymetricbasedoneight
factors – frequencyanddurationof outages,five aspectsof customerservice,andone measure of
workplace safety. Joskow specifiesthat the benchmarksare developedbasedonhistorical experience
and penaltiesandrewardsare triggeredwhenactual performance fallsoutside of one standard
deviationof historicalperformance. Thiseffectivelyleadstoa “dead-band”aroundhistorical
performance. There are alsocaps andflooron the incentive arrangement.l
Eachfactorwas assigneda
weightandcombinedintoacomposite indexthatpermittedanelectricorgas utilitytoearnor lose up
to 2% of itsrevenuesfromdistributionandtransmissionservices(MassachusettsDTE2001).
Mass. DTE’s SQ Plansli
Performance Measure Weight Penalty or Offset
Operations Frequency of outages 22.5% $3.0M
Duration of outages 22.5% $3.0M
Customer Service On cycle meter reads 10% $1.3M
Timely call answering
(w/in 20 seconds)
10% $1.7M
Service appointments 10% $1.7M

13. 13
met
Complaints to
regulators
5% $0.7M
Billing Adjustments 5% $0.7M
Safety Lost Work Time
Accidents
10% $1.3M
Risk/Reward Potential 100% $13.4M*
*Basedon 2% of T&D revenues(usingMass Electric as anexample)
Alsoin2001, Michiganestablished10specificstandardsof quality,againinvolvingbothoutages
and customerservice (one additionalstandardwassubsequentlyadded). Utilitieswere requiredto
reporttheirperformance oneach,andshortfallsfromestablishedstandardscouldresultinpenalties
and ultimatelycreditstocustomers lii
.
In “Reformingthe EnergyVision”,the NYS Departmentof PublicServiceStaff Reportand
Proposal, itisstatedthat “Generally,mostNew Yorkelectricutilitiesare subjecttoseveral performance
metricswithnegative-onlyrevenueadjustmentsforfailingtomeetcertaincriteria. These metricsare
relatedtooutage duration,numberof outages,customerservice,safety,andvariousmetricstargeted
to particularneedsidentifiedforindividualutilities. Earningsexposure forelectriccompanyoperations,
by rate plan,range fromtotal negative incentivesof 263 basispointsto total positive incentivesof 45
basispointsincludingpositive incentivesforenergyefficiency.” liii
Conclusion
In lightof the foregoing,myconclusionsare two-fold. On one level,itwouldappearthatwhile
Ontariohas implementedPBRinthe electricitysector,itlags behind inmeasuringreliabilityin a
disciplinedmannerandapplyingincentives/penaltiestoensure service qualitytoratepayers. If the
leadingstudyonthe questionistobe accepted,PBR withoutmandatoryservice qualitystandards does
entail adegradation inSAIDI,whichthe OEBshouldtake measurestocorrect.
On a more philosophical level, the comparisonbetweenCOSRandPBRwithwhichthispaper
beganmay require asoberreassessment. AccordingtoJoskow,the theoretical frameworkunderpinning
PBR forlegal monopoliesingeneral hasdevelopedconsiderablyoverthe lastfifteenyearsandis

14. 14
reasonablymature. However,the practical applicationof these conceptstoelectrical distributionhas
laggedbehindthe theoryforthe several reasons. While PBRhas beenpromotedasa straightforward
and superioralternative toCOSR,itwouldmore accuratelybe termedacomplementtoCOSR. It
requiresaprecise accountingsystemforcapital andoperatingcosts,costreportingprotocols,data
collectionandreportingrequirementforthe non-costcategoriesof performance. liv
Evensimple cap
mechanismsrequirerate casesor price reviews. Ultimately,the informationburdenof implementing
PBR isnot unlike thatforCOSR,and a determinationof whetherswitchingsystemsisworththe effort
ultimatelydependsonwhetherthe performance improvementsjustifythe additionaleffort. lv
Other observerspointto otherproblemswithPBR, resultinginseveral jurisdictionsabandoning
theirPBR plan because of unforeseen exogenous eventsthatcouldnotbe administeredwithinthe
confinesof the plan,adverse publicreactiontoutilityearningsinexcessof those commonlyauthorized
underCOSR,and questionsaboutthe legalityof the plansunderstate statutes.lvi
There isalsoa
fundamental complaintleveledagainstPBRinthat itrewardsutilitiesforthingstheyshouldbe doing at
any event.lvii
Regardless,asPBRplanshave evolvedaroundthe world,the focushasshiftedfromreducing
operatingcoststo investmentandvariousdimensionsof service quality. Joskow feelsthese
mechanismsshouldbe more fullyintegrated,asqualityof service schemesappeartohave beensimply
“boltedon”to cost reductionschemeswithoutanyincorporationof consumervaluationsof quality,or
an explorationof differentqualityindifferentdimensions. If PBRisto provide a satisfactoryanswerto
the questionthispaperbeganwith–how to arrive at the correct level of qualityforprice inelectricity–
more empirical research onPBRneedstobe done.

15. 15
References
Ajodhia,V.,andRudi Hakvoort,“EconomicRegulationof qualityinelectricitydistributionnetworks”,
Utilities Policy,13, 211-226.
Berg,Thomas F.,“The Incentive RegulationBandwagon: PickingupSpeed”,PublicUtilities Fortnightly,
May 1, 1992, p.16.
Cronin,FrancisJ.and StephenMotluk,“Ontario’sFailedExperiment(Part1)”, PublicUtilities Fortnightly,
July2009, p. 39.
Cronin,FrancisJ.and StephenMotluk,“Ontario’sFailedExperiment(Part2)”, PublicUtilities Fortnightly,
August2009, p.52.
Joskow,Paul (2005), “Incentive RegulationinTheoryandPractice:ElectricityDistributionand
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Kaufman,Lawrence,“Incentive RegulationforNorthAmericanElectricUtilities”, Energy Law and Policy
(Toronto:Carswell,2011) at p. 275.
Lowry,Mark NewtonandLawrence Kaufman,“Performance-BasedRegulationof Utilities”, Energy Law
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NYS Departmentof PublicService StaffReportandProposal,Case 14-M-0101, “Reformingthe Energy
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OntarioEnergyBoard, “Reportof the Board – RenewedRegulatoryFrameworkforElectricity
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electricitydistribution”, Journalof Regulatory Economics(2010) 38:258-273.
Sappington,DavidE.M.and Weisman,DennisL.“DesigningSuperiorIncentive Regulation”, Fortnightly,
February15, 1994.

16. 16
i Virendra Ajodhia and Rudi Hakvoort, “Economic regulation of quality in electricity distribution networks”, Utilities
Policy 13 (2005) 211-221 at p. 211.
ii Mark Newton Lowry and Lawrence Kaufman, “Performance-Based Regulation of Utilities”, Energy Law Journal,
2002,23, 2, p. 399.
iii Supra note ii atp. 402.
iv Ibid.
v Ibid.
vi Ibid.
vii Supra note ii atp. 406.
viii 2013 ONCA 359.
ix Paul Joskow, “Incentive Regulation in Theory and Practice:Electricity Distribution and Transmission Networks”,
MIT, January 21,2006 at p. 3; http://economics.mit.edu/files/1181.
x “The Prizein Economic Sciences 2014”, The Royal Swedish Academy of Sciences,Background, “Market Power and
Regulation” http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2014/popular-
economicsciences2014.pdf
xi Supra note ii atp. 403.
xii Supra note ix at p. 3.
xiii Supra note i at p. 212.
xiv Ibid.
xv Supra note ii atp. 406.
xvi Supra note ii atp. 399.
xvii Supra note ii atp. 404.
xviii Supra note ii atp. 408.
xix Lawrence Kaufman, “Incentive Regulation for North American Electric Utilities”, Energy Law and Policy at p. 280.
xx Supra note iii atp. 405.
xxi Anna Ter-Martirosyan and John Kwoka, “Incentive regulation,servicequality,and standards in U.S.electricity
distribution”,J. Regul. Econ (2010) 38:258-273 at p. 259.
xxii Ibid.
xxiii Ibid.
xxivSupra note xxi at p. 262.
xxv Supra note xxi at p. 263.
xxvi Supra note xxi at p. 268.
xxvii Ibid.
xxviii Ibid.
xxix Francis J.Cronin and Stephen Motluk, “Ontario’s Failed Experiment (Part1)”, Public Utilities Fortnightly, July
2009 at p. 39.
xxx Supra note xxix at p. 40.
xxxi Ibid.
xxxii Ibid.
xxxiii Francis J.Cronin and Stephen Motluk, “Ontario’s Failed Experiment (Part2), Public Utilities Fortnightly, August
2009 at p. 51
xxxiv Ibid.
xxxv Supra note xxxiii atp.55.
xxxvi Supra note xxix at p. 41.
xxxvii Supra note xxxiii atp.54.
xxxviii Supra note xxxiii atp.51.
xxxix Supra note xxxiii atp.53.
xl Ontario Energy Board, Report of the Board, Renewed Regulatory Framework for Electricity Distributors: A
Performance-Based Approach, October 18, 2012,p. 57.
xli Supra note xl at p. 58.
xlii Supra note xl at p. 59.

17. 17
xliii Supra note xl at p. 61.
xliv Supra note ix at p. 31.
xlv Ibid.
xlvi Ibid.
xlvii Ibid.
xlviii Supra note ix at p. 31.
xlix Ibid.
l Ibid
li Supra note ix at p. 36
lii Supra note xxi at p. 262.
liii NYS Department of Public ServiceStaff Report and Proposal,Case14-M-0101,“Reforming the Energy Vision”,
April 24,2014.
liv Supra note ix at p. 51.
lv Supra note ix at p. 52.
lvi David E.M. Sappington and Dennis L. Weisman, “DesigningSuperior Incentive Regulation”, Public Utilities
Fortnightly, February 15, 1994,p. 12.
lvii Thomas F. Berg, “The Incentive Regulation Bandwagon: Pickingup Speed”, Public Utilities Fortnightly, May 1,
1992,p. 129.