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Electric power is America's most capital-intensive industry, with more than $100 billion invested each year in energy infrastructure. Investment needs are likely to grow as electric utilities make power systems more reliable and resilient, deploy advanced digital technologies, and facilitate new services to meet some consumers' expectations for greater choice and control.
But do current regulatory approaches provide the appropriate incentives for grid modernization investments? This report presents three perspectives:
- Financial analyst Steve Kihm begins by explaining that any major investor-owned electric utility that wants to raise capital today can do so at a reasonable cost. The question is whether utility managers want to raise capital for grid modernization. Specifically, they look for investments that create the most value for their existing shareholders. In cases where grid modernization investments are not the best choice in terms of shareholder value, Kihm describes shareholder incentive mechanisms that regulators could consider to encourage such investments when they are in the public interest.
- From an institutional perspective, Dr. Janice Beecher finds that the traditional rate-base/rate of return regulatory model provides powerful incentives for utilities to pursue investments, cost control, efficiency and even innovation, and it is well suited to the policy objectives of grid modernization. Prudence of grid modernization investments (fair returns) depends on careful evaluation of the specific asset, and any special incentives (bonus returns) should be used only if they promote economic efficiency consistent with the core goals of economic regulation. According to Beecher, realizing the promises of grid modernization depends on effective implementation of the traditional regulatory model and ratemaking tools to serve the public interest.
- Conversely, former commissioner and clean energy consultant Ron Lehr says that rapid electric industry changes require a better alignment of utility investment incentives with changes challenging the electricity sector, emerging grid modernization options and benefits, and public policies. For example, investor-owned utilities typically have an incentive to make capital investments, but rarely to employ expense-based solutions, since utilities do not earn profits on expenses. Further, Lehr cites a variety of factors that stand in the way of creating well targeted and well aligned utility incentives, including litigated regulatory processes. These may be a poor choice for finding the right balance among competing interests, establishing rules of prospective application, justifying demonstrations of new technologies and approaches to meeting emerging consumer demands, and keeping pace with rapid change.
Year of Publication
FEUR Report No. 8 authored by: Steve Kihm (Seventhwave), Janice Beecher (Institute of Public Utilities, Michigan State University), and Ronald Lehr. Click the publication title above to see all documents related to this publication and for a link to the related webinar.
This report was funded by the U.S. Department of Energy’s Office of Electricity Delivery and Energy Reliability – Electricity Policy Technical Assistance Program and the Office of Energy Efficiency and Renewable Energy – Solar Energy Technologies Office under Task 1.4.29 – Future Electric Utility Regulation of DOE’s Grid Modernization Initiative. Lisa Schwartz, with Berkeley Lab's Electricity Markets and Policy Group, is the project manager and technical editor.