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Using Energy Efficiency To Redesign The Utility Incentive Structure

Published September 11, 2017

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By design, utilities are regulated entities with a business model that incentivizes the building of assets like power plants, substations, transmission towers, etc. All the money utilities spend to ensure safe, reliable and affordable electricity is rewarded with a return on investment for the utility and its shareholders.

This business model is usually referred to as Cost of Service Regulation (COSR). According to the National Association of Regulatory Utility Commissions (NARUC), under COSR, the regulator determines the Revenue Requirement—i.e., the “cost of service”—that reflects the total amount that must be collected in rates for the utility to recover its costs and earn a reasonable return. This model has been in place for over 100 years, and its structure has conditioned utilities to look to infrastructure as the way to grow.

But with the advent of energy efficiency (EE) and distributed energy resources (DERs), this model of asset deployment and expected returns is changing. Regulators still expect utilities to provide safe, reliable and affordable power but they’re also asking utilities to help customers use less without due consideration for how it impacts their bottom lines. Many states provide utilities incentives to increase energy efficiency. Some are even providing incentives for a more complete shift in their business model. These states also serve as a kind of roadmap for other utilities to follow.

Energy Efficiency As The Way Forward

Energy efficiency programs have been around for a long time, and continue to play a big part in the transition that the industry is seeing. In Creating Customer and Investor Value through Energy Efficiency, Doug Lewin (VP of Regulatory Affairs and Market Development) and Peter Kind (Executive Director at Energy Infrastructure Advocates) suggest that incentivizing utilities to make this shift, through the enhancement of existing regulatory models, can better align the interests of customers and utilities. While shifting customer preferences and new technologies are rapidly changing the industry, regulatory innovation must keep pace. 

The need for regulatory incentives is driven by the fact that energy efficiency, implemented by the utility for its customers, makes the utility more of a service provider than it has ever been. Policymakers in Illinois, Michigan, Utah and Maryland have adopted models that help utilities earn more by helping their customers use less. And they work: the American Council for an Energy-Efficient Economy (ACEEE) found that the Maryland’s EmPOWER program was cost effective and returned two dollars of benefit for every one dollar the utility spent. In Michigan, the energy efficiency program signed into law in 2008 and increased in 2016 has saved customers $150 million annually while utilities have earned incentives $10 –$20 million per year.

As business model changes become increasingly important for utilities, there is a need to transition without dramatically disrupting the safe, reliable and affordable energy they provide for their customers. New regulatory models enable that transition and reduce the risks faced by utilities and customers. Regulations are now changing to speed the transition from one in which growth was predicated on building infrastructure and selling a commodity, to one where growth depends on building better experiences for customers and selling services. Utilities need and want to be customer-centric but they can only do so if regulations are customer-centric, too.

Read more in Creating Customer and Investor Value through Energy Efficiency.

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