New Electric Utility Business Model a Bold Effort in NY
The US electric grid has not been updated since World War II, when telephones, dishwashers, and air conditioning were the cutting-edge technology innovations of the century. Today, this same grid is struggling to cope with the technological advances of the last decade, a reality that hit home for New Yorkers in the wake of Superstorm Sandy when millions of people lost power for days and even weeks.
But New York is taking steps to change this, first by initiating a proceeding in April to overhaul the state’s utility business model, and now by opening the proceeding to comments.
New York played a leading role in establishing today’s utility business model. Thomas Edison developed the first power plant on Pearl Street in Manhattan in 1882, serving 85 lighting customers.
The business model of Edison and his protege, Samuel Insull, was simple – keep adding more customers and keep building larger power plants. This was a win-win model for Edison’s customers and for his utility companies. Customers won because the ever-larger power plants were more efficient, meaning Edison could sell electricity at a lower cost per unit every time he built a new plant.
As the price per kilowatt of electricity kept declining, customers used more electricity. To encourage growth in this new electricity infrastructure, New York, like all of the other states, protected the utilities’ investment by granting them an exclusive right to serve customers. In exchange for being permitted to operate as a monopoly, New York set the price the utility could charge for electricity. The prices were structured to reward the utility for successfully building a bigger and more robust system.
Needless to say, Edison’s business model proved wildly successful.
We now have access to electricity 24/7, at the flip of a switch. The US electric power industry fuels the world’s largest economy. We rely on our heating and air conditioning, appliances, televisions, computers, phones – all powered by electricity – to provide our daily needs. The electrification of America was the greatest engineering feat of the 20th century, surpassing even the invention of the Internet and sending a man to the moon.
Out with the old, in with the new
This model has worked well for the past 130 years because it used the right incentives for what society needed. But today this business model is out of sync with what we need now.
Customer expectations have evolved beyond the relatively basic requirements of Edison’s time; they need and expect power quality and reliability to support the digital economy. We now know that when customers are armed with the knowledge that the cost to produce electricity varies by time of day and year, they are willing to change well-worn patterns to bring down their electricity bill. For example, price-conscious customers might run their dishwashers at night instead of during the day, yielding not just lower prices for themselves but the entire system at large.
Indeed, many customers want to take advantage of new technologies and falling prices to enjoy on-site electricity options, like rooftop solar panels and electric vehicles. More efficient industries, buildings, homes, and appliances now allow customers to accomplish much more with far less energy. Advances in telecommunications and information systems create new opportunities for energy services we could not have imagined just a few years ago.
It’s not just customer choice and technology, however, placing pressure on Edison’s outdated utility business model. It has also become increasingly evident that our reliance on fossil fuels burned in large centralized power plants has created an environmental burden for our children. We need a system that is less polluting. Climate change has increased the likelihood of extreme weather events, which could render large central plants useless in meeting our energy needs. Upgrading to a smarter grid will allow us to fully integrate distributed generation, like rooftop solar and combined heat and power, that can operate independent of the central grid.
To meet the needs of today and tomorrow’s world, we must ask ourselves if the services are best delivered as they have been for the last 130 years. We must look to new opportunities that reward utilities for successfully furnishing a sustainable platform for our energy needs, not just for providing more power plants and equipment. The utilities will be our portal to energy services, but they do not necessarily have to be the provider of them.
To accomplish this, the New York Public Services Commission, in consultation with stakeholders, must identify the outcomes they want utilities to achieve – and tie the utilities’ revenues to their performance in meeting these outcomes. New York has a good start with performance-based rate-making. It is time to build on that foundation to reward results, not utility spending.
This will be no easy task. The electric power industry has grown into a $300 billion/year industry using the old model. Over the last 130 years, regulators, utilities, investors, and customers have become entrenched in our ways. Any transition will require a shift in deeply-rooted practices and sufficient time to fully develop. Changing to a performance-based model will require detailed analysis to establish optimum outcomes and performance metrics.
The outcomes will still address traditional objectives of resource adequacy and reliability of service, while taking into account new elements such as clean energy, customer engagement, system efficiency, and openness to innovation. This will require fundamental changes in the reward system that go far beyond decoupling. New reward systems are needed to align the incentives for traditional utility companies, the clean tech industry, and customers. As always, regulators must be vigilant in monitoring the utilities’ performance, but it will mean developing new skills. Rather than judging prudency in retrospect, the Commission will be challenged to be more of a partner in envisioning the possibilities of the future utility.
Some strategies by which the Commission can achieve this objective in part include:
- transitioning from traditional rate of return regulation to performance based regulation;
- fully valuing all costs and benefits associated with distributed energy resources;
- removing barriers to non-utility entities participating in energy service markets; and
- requiring the utility to optimize the load it serves.
New York gave birth to the electric power industry 130 years ago, making it the perfect place to reinvent the utility business model for the 21st century. New York boldly proposes to take on this challenge.
John Finnigan is a senior regulatory attorney with the EDF.
This article was republished with permission from the EDF.
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