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Sun, Nov

Utility Regulatory Incentives Must Change in Order to Capture DER Benefits

Analysis
Typography

Despite this potential value from embracing a distribution-centric grid, utilities face institutional barriers to realizing these benefits. Reducing the size of a utility’s ratebase – its wires-related investments – cuts directly into shareholder profits. Expecting utilities to proactively integrate DERs into grid planning, when doing so has the potential to adversely impact shareholder earnings, is a structurally flawed approach. It will be impossible to completely capture the potential benefits of DERs until the grid planner’s financial conflict with the deployment of DERs is neutralized.

Incentive Barriers 

Realigning the incentives of the grid planner to solely focus on delivering a safe, reliable and affordable grid, regardless of the ownership and service models that materialize in the market, is a necessary first step to realize the potential of DERs. There are two fundamental paths forward to address this conflict of interest.

The first path towards realizing this objective would be to separate the role of distribution planning, sourcing, and operations from the role of distribution asset owner, similar to the evolution of Independent System Operators (ISOs) and Regional Transmission Operators (RTO) at the bulk system level. FERC’s decree to create independent operators in Order 2000 was driven by the observation that the lack of independent operation of the bulk power system enabled transmission owners to continue discriminatory operation of their systems to favor their own affiliates and further their own interests.

However, while an independent distribution system operator (IDSO) is an appealing governance model, some state regulators may choose a second path for addressing the utility conflict of incentives: maintaining the utilities’ traditional role in planning and operating the distribution grid, while neutralizing the misalignment by changing utility incentives. Given the near-term focus in many states on retaining the utility’s current role in grid planning and operation, this paper chooses to focus on this path and proposes a model that ensures the utility incentive against non-utility owned assets is neutralized. 

Proposed Solution 

In order to ensure least cost/best fit distribution investments in states without an IDSO, this paper proposes the creation of a new utility incentive model, Infrastructure-as-a-Service, which would neutralize the utility incentive to deploy utility-owned infrastructure in lieu of more cost-effective third-party options. This model would enable utility shareholders to derive income from third-party grid services, mitigating the financial impact that may bias utility decision-making. Such a model would help ensure that utilities take full advantage of DER readily being adopted by customers. 

Infrastructure-as-a-Service 

Infrastructure-as-a-Service is a regulatory mechanism that would modify the incentives faced by utilities when sourcing solutions to meet grid needs. This new mechanism would allow utilities to earn income, or a rate of return, from the successful provision of grid services from non-utility owned DERs. Infrastructure-as-a-Service facilitates the least cost/best fit development of distribution grids by creating competitive pathways for DERs to defer or replace conventional grid investments, while maintaining equal or superior levels of safety, reliability, resiliency, power quality, and customer satisfaction. As the figure below shows, the three primary steps of a utility distribution planning process (forecast, identify needs and evaluate solutions) remain identical to the current process, followed by the infrastructure-as-a-Service mechanism’s enhancements to sourcing in steps four (select and deploy) and five (operate and collect). 

Under the proposed approach, after evaluating all feasible technical solutions for a particular grid need, including alternative grid solutions derived from DER portfolios, Infrastructure-as-a-Service would empower distribution planners to select and deploy third-party assets that address the specified need if more cost-effective for ratepayers than conventional solutions. Importantly, Infrastructure-as-a-Service would create an opportunity for utilities to operate and collect streams of service income, or a rate of return, based on the successful deployment of competitively sourced third-party solutions. This service income provides fair compensation for effective administration of third-party contracts that enable alternative resources to deliver grid services, and helps mitigate the structural bias towards utility-owned infrastructure that currently exists under distribution “cost plus” regulation. Note that other mechanisms attempting to achieve a similar utility indifference to DER solutions have been proposed, such as the modified clawback mechanism being discussed in New York. While the clawback mechanism offers the potential to reduce the financial disincentive that utilities face in utilizing DERs, the potential utility upside may be small as compared to the lost opportunity and insufficient to neutralize the utility disincentive. This downside to the clawback mechanism may be overcome via the infrastructure-as-a-service mechanism.

Distribution Loading Order 

Neutralizing the utility disincentive to utilizing DERs is critical but not sufficient to drive transformation in distribution planning. New incentives may be ignored in practice without corresponding changes to long-established and familiar utility processes that have sourced only self-supplied solutions to date. The adoption of a Distribution Loading Order would borrow an existing concept from bulk system procurement policy in California, which prioritizes procurement of preferred resources, including energy efficiency, demand response, and renewable energy, ahead of fossil fuel-based sources. In the distribution context, a Distribution Loading Order prioritizes the utilization of flexible DER portfolios over traditional utility infrastructure, when such portfolios are cost-effective and able to meet grid needs. The table below depicts the types of resources that would be prioritized over traditional investments in such a policy.

In concert with a mechanism like Infrastructure-as-a-Service, a Distribution Loading Order provides the procedural framework for evaluating distribution solutions in order to ensure grid planning is consistent with longer term policy objectives that support environmental, reliability, and customer choice goals. Importantly, a Distribution Loading Order would ensure that DER solutions are properly incorporated into grid planning. However, utilities would always maintain the authority to select and deploy a suitable portfolio of solutions, including conventional solutions when more appropriate, to ensure reliability. For these conventional investments, utilities would continue to earn an authorized rate of return. 

Benefits of Infrastructure as a Service 

Creating a pathway for DERs to offer grid services in lieu of utility infrastructure investment would be beneficial for utility ratepayers for a variety of reasons. 

1. Saves ratepayers money: Allowing full and fair consideration of DER solutions equips grid planners with a broader suite of tools to meet grid needs, resulting in higher infrastructure utilization and lower customer electricity bills. 

2. Promotes competition: Expanding the set of suppliers that are eligible to offer distribution solutions unleashes the power of markets to benefit ratepayers. Well-designed competitive markets can deliver superior solutions that are more affordable than those resulting from a self-supply “cost plus” planning model. 

3. Increased flexibility and sources the best solution: Sourcing mechanisms that can deliver resources with new desirable characteristics (e.g. granular sizing, fast lead-times, flexible operational traits) into the distribution planners’ toolbox creates no-regrets flexibility. And by rendering a utility neutral to the choice of ownership structure, the planner can focus on the singular objective of delivering the least-cost, best-fit solution. 

4. Encourages innovation: Providing clear market opportunities for third-party solutions promotes product and service innovation, putting the collective innovation capabilities of all market participants and customers to work.

5. Engages customers: Utilizing DERs to provide grid services increases the capability and willingness of individual customers to actively manage their energy profiles. Ultimately, a neutral decision model like Infrastructure-as-a- Service will help foster the transition from passive ratepayers to proactive customers. 

The CPUC recently enhanced the 2016 scope for its Distribution Resource Plan proceeding to formally consider the utility role, business models, and financial interest with respect to DER deployment. Infrastructure-as-a-service is one mechanism to consider that would reduce the conflict of interest towards third-party services inherent in the utility incentive model today. Alternative efforts, such as creating greater functional independence between ownership and operations, as in an IDSO model, should also be explored. Irrespective of the mechanism, an effort to neutralize the utility decision model is needed to ensure that DERs are fully utilized and valued for grid services.

Source: SolarCity Grid Engineering