The document discusses challenges facing electric utilities in balancing financial metrics with stakeholder objectives like conservation and renewable integration. Innovation is critical but limited by regulatory disincentives as efficiency benefits customers rather than utilities. New performance models like RIIO in the UK and the Iowa model provide incentives for outputs. Technologies like batteries and smart grids have reduced peak demand but require significant investment. Distributed generation also threatens the traditional utility model by enabling customer independence and reducing load growth. New policies are needed to absorb higher costs and share risks between utilities and customers.

1. Utils
Aligning Interests in the Electric Forum
Electricity Markets
Professor – Jonathan McClelland
New York University
By Steven L. Avary
5/1/2014

2. 1 | P a g e
Electric utilities are squeezed. Not only are there pressures to satisfy financial metrics
and returns on capital, concerns about load growth and aging infrastructure, they have
to balance it with stakeholder objectives of energy conservation, cybersecurity concerns,
resiliency and reliability, and renewable integration.
Innovation is critical to align these issues; however, investments in innovative projects
have been limited historically due to disincentives, which is a consequence of the trade-
off between the traditional regulatory model and utilities operating as natural
monopolies. Innovations for energy efficiency or environmental degradation mitigation
do not contribute to the supply-side from which utilities derive their rates and
regulatory assets. Rather, benefits inure to its customers or society-at-large from a
reduction in negative externalities. 1
These efficiencies shrink load growth and energy
sales. Ceteris paribus, reduced sales translate into diminished earnings, cash flow and
internal funding for further innovative projects; thus, utilities face a conundrum. As
such, the efficacy and sustainability of the traditional model, based on cost of service
inputs, is in doubt.
Performance based output models have promise, with the potential for wider scale
adoption. Models include the “Revenue using Incentives to deliver Innovation and
Outputs” or (RIIO) developed in the U.K., the Iowa model, and the “Grand Bargain”. 2
RIIO is broad-scaled and includes a revenue cap with a focus on societal preferences.
RIIO’s metrics emphasize customer satisfaction, reliability and availability, safe
network services, connection terms, environmental impact, social obligations, and price.
A series of negotiations by various parties in allocating shared earnings is the
touchstone for the Iowa model, which also provides for an “escape clause”, and has
experienced 17 years of relatively flat electricity prices. 3
The Grand Bargain is a hybrid
of the RIIO and Iowa models.
Financial concerns include throughput and program cost recovery. 4
To counter the
throughput incentive problem, rate adjustment mechanisms independent of electricity
sales are proffered, including Decoupling and Lost Revenue Adjustment Mechanism
1
Lehr, Ronald, “New Utility Business Models: Utility and Regulatory Models for the Modern Era”,
America’s Power Plan, 2013, p. 28 (http://americaspowerplan.com/site/wp-content/uploads/2013/10/APP-
UTILITIES.pdf)
2 Ibid, pp. 2-3
3 Ibid, p. 29
4 York, Dan and Martin Kushler, “The Old Model Isn’t Working: Creating the Energy Utility for the 21st
Century”, ACEEE White Paper, September 2011, p. 5 (http://aceee.org/files/pdf/white-
paper/The_Old_Model_Isnt_Working.pdf)

3. 2 | P a g e
(LRAM). Decoupling allows recovery of fixed and variable costs through symmetrical
rate design, which may lead to higher or lower rates; whereas, LRAM derives its rate
after evaluation of sales lost from energy efficiency and multiplies it with a per unit
energy fixed-cost figure. LRAM’s rate changes are asymmetrical. Rates increase, but
only from approved efficiency program costs. Cost recovery includes whether to
expense or capitalize. 5 Expensing provides the benefit of time value of money;
however, the tendency is to capitalize because efficiency costs are considered a
“regulatory asset”.
Technology advances have lessened the burden on the system through devices like
personal micro turbines, battery storage, and smart grid instruments. These
innovations have provided greater customer independence, ability to disconnect from
the grid altogether, or to contribute to electricity generation with the use of turbines and
batteries that allow a customer to remit electricity via net metering, offsetting consumer
demand, and netted out on their bill. Peak demand at some utilities has reduced 30%+
at facilities that incorporated time differentiated pricing and advanced meters.
Expectations are with widespread adoption, they may reduce peak demand by 20%+. 6
Study findings on four utilities funded by the DoE utilizing certain technologies
contributed to resiliency improvements. Customer outages dropped 11% to 49%, and a
56% decline in average outage duration. Required grid changes to buffer against cyber
threats are mandated through Presidential Executive Order, with a framework
established in The North American Electric Reliability Council Critical Infrastructure
Protection Standards. 7
Options in smart grid instruments provide benefits through
such alternatives as pricing based on time of day differentials. A national deployment
of smart grid technology is estimated to provide net economic benefits of $1.3 - $2.0
trillion over a 20-year period, according to The Electric Power Research Institute;
however, in order to do so, $17 - $24 billion of investments per year are needed, with a
cost-benefit payoff of 2.8x to 6x. 8
Solar technology value improved with dramatic changes in the cost curve as
photovoltaic panel prices decreased to $0.86/watt in 2012 from $3.80 in 2008. 9
5 Ibid, p. 4
6 Malkin, David and Paul A. Centolella, “Results-Based Regulation: A Modern Approach to Modernize
the Grid”, GE Digital Energy, p.6
7 Ibid, p. 10
8 Ibid, p. 5
9 Kind, Peter, “Disruptive Challenges: Financial Implications and Strategic Responses to a Changing
Retail Electric Business”, Edison Electric Institute, January 2013, p. 4
(http://www.eei.org/issuesandpolicy/finance/Documents/disruptivechallenges.pdf)

4. 3 | P a g e
Additional scale is expected to bring the all-in costs below $5/watt. For revenues, solar
rates have firmed to $0.15/kWh, expanding the market to $170 billion (30% of total
utilities). Additional stimulus is via tax incentives, such as subsidies, five-year MACRS
depreciation and an ITC of 30%. Other technologies, such as fuel cells, geothermal, and
wind, enjoy various tax incentive support, as well as promotion through renewable
portfolio standards. Consequently, the traditional model’s monopsonistic position is
under greater pressure from distributed generation alternatives, with their enhanced
reliability and more diverse portfolio of fuel sources.
With anticipated decline in load growth related to distributed energy resources (DER),
non-DER customers are expected to see rate increases of 20%+. Coupled with demand
side management, the traditional model is expected to continue to lose market share,
which would require higher capital costs and higher customer rates. Assuming greater
demand price elasticity with inclusion of DER, the higher rates could lead to demand
destruction and a further downward spiral.10
Various policies are needed to absorb the
higher costs, including for stranded costs, which will have to be shared between the
utility and customers. To tackle concerns of load growth, while addressing social equity
concerns with aforementioned investments, it is proposed that these risks can be
alleviated by aligning utilities and customers by establishing a mechanism for shared
earnings. 11
The key for utilities future is flexibility, optionality from both the supply- and demand-
side, to better align and deliver on customer preferences, which may be reflected in
customers’ bills, where customers absorb some of the costs to fulfill these demands. For
such a system to work there has to be shared costs, earnings and responsibilities from
customers and utilities. 12
10 Ibid, p. 5
11 Malkin, op. cit., p. 16
12 Lehr, op. cit., p. 5