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OVERVIEW OF PERFORMANCE-BASED REGULATIONBEFORE THE NEVADA PUBLIC UTILITIES COMMISSION
Mike O’BoyleDirector of Electricity Policy
September 26, 2019
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1.WHY
2.HOW
3.EXAMPLES
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THE POWER SECTOR HAS EVOLVEDOld Goals: § Meet growing demand
§ Build new infrastructure
§ Build to deliver universal service
§ Affordability, Reliability, Safety
Old Options:§ Centralized power plants
§ Transmission lines
§ Distribution system
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THE POWER SECTOR HAS EVOLVEDOld Goals: § Meet growing demand
§ Build new infrastructure
§ Build to deliver universal service
§ Affordability, Reliability, Safety
Old Options:§ Centralized power plants
§ Transmission lines
§ Distribution system
New Goals: § Build à Maintain
§ Reliability à Resilience
§ Clean power
§ Customer satisfaction & choice
§ Affordability, Safety
New Options:§ All the old stuff, plus:
§ Innovative distributed energy resources (EE, DR, PV, EVs, etc.)
§ Advanced IT & rate designs
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THIS CREATES TWO NEW ISSUES
1. Increasing options for power system optimization leads to greater information asymmetry between utility and regulator
2. New goals for the power system mean regulators must reexamine existing incentives to build more capital and maintain existing investments
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REGULATION CAN EVOLVE TOO
Old Methods: • Line-by-line investment review
• Capital investment and sales growth drive shareholder value
• Infrequent rate cases
• Operational expenses largely a pass-through not subject to review
New Methods: • Focus on outcomes to help sort
through complexity
• Create incentives to optimize the system including customer-side resources, third-party providers
• Multi-year rate plans with capital efficiency incentives
• Meet customer demands for clean energy, lower bills, enhanced reliability & resilience
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From: “Did we pay the right amount for
what we got?”
To: “Are we paying (the right amount) for what we want?”
Utility and Regulatory Models for the Modern Era
by Ron Lehr
Changes the central question…
PERFORMANCE-BASED REGULATION
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1.WHY
2.HOW
3.EXAMPLES
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COST OF SERVICE REGULATION, SIMPLIFIED
Revenue = [O + T + D] +(Capital Costs – D) *
ROR…As utility investment increases
Revenue and value increases…
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Revenue = [pass-throughs] + (Capital Expenditures) * ROR
ELEMENTS OF COST OF SERVICE EQUATIONGreatest opportunity for affecting overall shareholder value creation
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HERE COMES SOME FINANCE….
Alfred Kahn
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THE SHAREHOLDER VALUE ENGINE (1)
Neither the absolute level of a company’s revenue, nor its rate of return, directly drive shareholder value.
It’s all about the difference between the ROR and the underlying cost of capital.
This difference creates the value opportunity that drives stock price.
𝑆𝑡𝑜𝑐𝑘 𝑃𝑟𝑖𝑐𝑒 = 𝐵𝑉 +𝑟 − 𝑘 𝐵𝑉𝑘 − 𝑔
This is the residual income model, a form of the standard discounted cash-flow model. From Stephen Penman, Accounting for Value, Columbia Business School Press (2010).
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The provision of incentives and the wherewithal for dynamic improvement in efficiency and innovations in service may require allowing returns to exceed [the cost of equity]…The rate of return must fulfill an institutional function: it somehow must provide the incentives to private management that competition and profit-maximization are supposed to provide in the nonregulated private economy.”
THE SHAREHOLDER VALUE ENGINE (2)
𝑆𝑡𝑜𝑐𝑘 𝑃𝑟𝑖𝑐𝑒 = 𝐵𝑉 +𝑟 − 𝑘 𝐵𝑉𝑘 − 𝑔
Alfred Kahn, 1970
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SHAREHOLDER VALUE SHOULD BE TIED TO PERFORMANCE
Merely permitting all regulated companies as a matter of course to earn rates of return in excess of the cost of capital does not supply the answer;
There has to be some means of seeing to it that those supernormal returns are earned,
Some means, for example, of identifying the companies that have been unusually enterprising or efficient and offering higher profits to them while denying them to others.
Alfred Kahn, again!
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Revenue = [Pass-throughs] + (Capital Costs) * ROR
INCENTIVE-BASED REGULATION, VERSION 1
± Performance
…As utility investment increasesperformance improves
Closer to the cost of capital
Revenue increases…
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Revenue = [Revenue Cap] + K ±Performance
INCENTIVE-BASED REGULATION, VERSION 2
…As utility investment increasesperformance improves
Revenue increases…
But there are risks . . . More counterfactuals means more forecast error
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MOVING FROM COST OF SERVICE TO PERFORMANCE-BASED REGULATION
Opex(including
depreciation & taxes) Totex
ROR
ROR
Rev
enue
Incentives available for value-creating
activities*
ILLUSTRATIVE
Traditional Model(r>k); value derived from all investment activities
Performance Value Modelvalue derived from both
investments and performance
*Overall costs may actually decrease; but potential returns to shareholders should grow commensurate with the additional risk shifted to utilities
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1.WHY
2.HOW
3.EXAMPLES
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EXAMPLES OF COMMON PBR MECHANISMS ALREADY COMMONLY IN USE
Performance Area Performance Incentive
Affordable • Multi-year rate plans• Revenue decoupling
Clean • RPS alternative compliance payments• Efficiency performance incentives
Reliable • Reliability standards and penalties
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KEY AREAS OF PERFORMANCE & WHERE PERFORMANCE-BASED REGULATION FITS
Performance Area Performance Incentive
Affordable • Multi-year rate plans / Decoupling• Revenue caps or revenue per customer• Shared savings mechanisms• Participation in time-of-use rates• Load factor improvements
Clean • RPS, and efficiency incentives• Customer access to clean energy• CO2 per kWh or customer
Reliable • Reliability standards and penalties• Resilience – reliability for critical
infrastructure or rapid system recovery
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THANK YOU
@USPOWERPLAN@ENERGYINNOVLLC
WWW.AMERICASPOWERPLAN.COMWWW.ENERGYINNOVATION.ORG
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September 26, 2019
Nevada PUC Workshop, Carson City NV
PIM Compensation Options
Carl Linvill, PhD, PrincipalThe Regulatory Assistance Project (RAP)®
+1 802 498 [email protected]
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Regulatory Assistance Project (RAP)® 23
No Deadband, Symmetric Compensation
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Regulatory Assistance Project (RAP)® 24
Symmetric Deadband & Compensation
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Regulatory Assistance Project (RAP)® 25
One-sided Penalty
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Regulatory Assistance Project (RAP)® 26
Asymmetric Compensation
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Regulatory Assistance Project (RAP)® 27
One-sided Reward
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Regulatory Assistance Project (RAP)® 28
Hit the Target, Get the Toy
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Regulatory Assistance Project (RAP)®
Favorite Examples
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About RAPThe Regulatory Assistance Project (RAP)® is an independent, non-partisan, non-governmental organization dedicated to accelerating the transition to a clean, reliable, and efficient energy future.
Learn more about our work at raponline.org