Piecing It Together
The complex nature of utility regulation leaves state legislators in a unique position. On the one hand, state legislation is often a necessary step in enabling state regulators and utilities to implement—or even consider—some of these alternative regulatory approaches. At least 17 states and Washington, D.C., have enacted legislation to enable performance-based regulatory approaches. In many cases, that legislation simply expands the list of ingredients that state regulators can use in a recipe.
On the other hand, the manner in which legislation is implemented will ultimately be the product of complex ratemaking proceedings between state PUCs and utilities. Legislatures may expand the list of potential ingredients—may even require certain ingredients be used—but the cake is truly designed and baked elsewhere.
This dynamic requires legislation that is prescriptive enough to ensure certain outcomes are achieved, while leaving enough flexibility for regulators and utilities to solve for challenges. It’s up to legislatures to provide clear guidance and a vision for what type of cake they want. It’s the job of state regulators to use their expertise and the available ingredients to design a cake that delivers on the legislature’s vision.
This section will review state examples to explore key factors and considerations in developing PBR legislation that aims to strike this balance. While New York’s Reforming the Energy Vision (REV) initiative is a leading national example in PBR implementation, it was not driven by legislation and therefore will not be included as part of the following discussion.
Establishing a Foundation
Reforming a regulatory framework that’s been in use for nearly a century is no small matter. The COS regulatory construct developed progressively over decades, with policymakers and utilities continually improving upon the framework when and where necessary. Therefore, policymakers, utilities and stakeholders will need to carefully consider what regulatory framework is going to replace COS regulation before fully transitioning away from that tried and true methodology.
In service to this concept, a number of states that have pursued PBR started off by exploring alternative regulatory approaches through robust studies and stakeholder processes. In some cases, legislatures directed state PUCs to issue reports to relevant legislative committees with findings on how PBR could be applied in their states—often with case studies exploring how PBR has played out in other states. In other cases, the state PUC or another state agency has issued findings independent of the legislature’s directive, thereby sparking discourse among relevant policymakers and stakeholders.
In 2019, the Colorado legislature enacted SB 236, directing the state PUC to investigate whether PBR, with an emphasis on performance metrics and financial incentives, would be “net beneficial” to the state and align utility operations and investments with five policy goals: safety, reliability, cost-efficiency, emissions reductions and DERs growth. The following year, the state PUC issued a report to the legislature, outlining its findings and recommendations. The commission recommended starting by incorporating PIMs into existing proceedings aimed at emissions reductions through clean energy and transportation electrification planning. However, the law did not authorize the PUC to move forward with any of its recommendations without legislative approval.
In Connecticut, Hawaii and Washington, legislatures took a more affirmative stance—essentially stating their preference to pursue PBR and directing their state PUCs to figure out the best path to get there. Connecticut HB 7006 (enacted, 2020) required the state PUC to initiate proceedings to investigate, develop and adopt a framework for implementing PBR for each electric utility in the state, thereby requiring the commission to make findings on the record of certain regulatory policies. In enabling the PUC to open a proceeding, lawmakers also gave the commission authority to move forward with PBR on its own initiative; in some other states, PUCs can only respond to what a utility brings before them.
Similarly, Washington SB 5295 (enacted, 2021) required the state PUC to open a proceeding to develop a policy statement addressing alternatives to COS regulation, including several PBR approaches. The legislature required the PUC to engage in a broad stakeholder process in the proceeding to ensure robust engagement.
Hawaii became the first state in the nation to require a PBR framework for its regulated utilities that directly ties utility revenue to the utility’s performance in certain areas when it enacted SB 2939, the Hawaii Ratepayer Protection Act, in 2018. The legislation required the state PUC to engage in a robust stakeholder process to establish the PBR framework. However, the legislature also noted that its decision to move forward with PBR was initiated by a white paper developed by the state PUC four years earlier, which explored ways to better align the utility business model with customer interests and policy priorities.
Similarly, a group of stakeholders in North Carolina initiated public discourse around PBR through a yearlong process that resulted in a 2020 report, which outlined a variety of recommendations for the state’s policymakers. The stakeholder initiative, called the North Carolina Energy Regulatory Process (NERP), included a diverse group of around 40 organizations—including state officials, utilities, environmental groups, consumer advocates and more—worked to address how the state and industry would achieve the state’s goal of reducing greenhouse gas emissions from the power sector by 70% by 2030. One of the areas of focus centered around PBR, with NERP including regulatory guidance for the state PUC and draft legislation for lawmakers to consider. In 2021, the legislature adopted some of NERP’s recommendations when it enacted HB 951, which authorized PBR in the state.
State legislation plays an important role in defining the goals and expected outcomes from transitioning to PBR, as well. By clearly defining the expected benefits to the state and to customers, and by emphasizing the areas that lawmakers want to enhance utility performance, the legislature provides the state PUC and utility companies with guidance on how to craft the new regulatory framework.
Nearly all state legislation related to PBR outlines priority objectives or areas of focus. Some priorities are nearly universal: improved system reliability, addressing the affordability and volatility of electric rates, improving customer satisfaction, and maintaining customer and worker safety are all commonly referenced in state legislation. In recent years, several states have included additional priorities, such as reducing emissions, supporting the expansion of DERs, enhancing system resilience, enabling access to utility and customer data, and addressing issues related to energy equity.
In 2009, the Massachusetts legislature authorized the state PUC to develop rules and regulations to establish and require PBR for the state’s electric distribution, electric transmission and natural gas utilities. At the time, the PUC was required to prioritize service quality standards for the following: customer satisfaction, service outages, distribution facility upgrades, repairs and maintenance, billing service and public safety. However, the PUC wasn’t limited to those priorities. A decade after the enabling legislation, the PUC authorized a new PBR plan for National Grid, an investor-owned distribution utility, with priorities that include reducing emissions, improving resilience and accelerating investment in clean energy technologies, such as electric vehicle infrastructure and energy storage demonstrations.
In addition to affordability, rate stability and reliability, Washington’s legislation required the state PUC to consider lowest reasonable cost planning, clean energy and renewable procurement and integration, emissions reductions, demand-side management, fair compensation for utility employees, and reducing energy burdens on low-income residential customers. The Illinois legislature included many similar objectives, but also included workforce diversification and energy and environmental justice issues.
Meanwhile, the Hawaii legislature took it a step further by providing a lengthy justification for why it felt a transition away from COS regulation would be beneficial to residents, with a particular emphasis on cost containment and reducing capital expenditures.
“The existing regulatory compact rewards utilities for increasing capital expenditures by basing allowed revenues on the value of the rate base, irrespective of utility performance,” the legislation states. “The legislature is concerned that the existing regulatory compact misaligns the interests of customers and utilities because it may result in a bias toward expending utility capital on utility-owned projects that may displace more efficient or cost-effective options, such as distributed energy resources owned by customers or projects implemented by independent third parties.”
The legislature required the state PUC to consider the following: economic incentives and cost-recovery mechanisms, volatility and affordability of electric rates and bills, electric service reliability, customer engagement and satisfaction, availability of options to manage electricity costs, access to utility system data on aggregate energy use for third parties and individual use for customers, rapid integration and interconnection of renewables, and timely execution and interconnection of competitive third-party procurements.
Providing Regulatory Flexibility
Regulatory flexibility is a key consideration in legislation that aims to implement PBR. Even as legislatures defined their state’s objectives in pursuing PBR, they did not restrict regulators from considering additional objectives and goals. They established a baseline but provided no ceiling, allowing regulators to consider ways to target emerging issues and priorities. In some cases, overly prescriptive legislation can limit the state PUC’s ability to consider options outside of what has been included in the law—whether by requiring a PBR approach that isn’t right for the state or by restricting regulators from considering additional approaches that may be beneficial.
A number of states have successfully enacted legislation directing PUCs to pursue PBR without being overly prescriptive. Connecticut, Hawaii, Illinois, Massachusetts and Washington provided regulators with significant discretion and authority when it came to PBR implementation.
Connecticut required the state PUC to establish standards and metrics for measuring utility performance across various objectives, but allowed the PUC to identify the manner in which those standards and metrics would be applied to a new regulatory framework. Similarly, the legislature did not specify the mechanisms that needed to be used in a new framework; rather they simply directed the PUC to identify mechanisms that would align utility performance with desired outcomes. The PUC was required to consider the effectiveness of utility revenue decoupling mechanisms and PIMs with rewards or penalties tied to performance, but the legislation did not require that either of these mechanisms be included in the final framework.
Massachusetts was even less prescriptive; the legislation requires the state PUC to implement PBR for the state’s utilities and its only specific requirement is that utilities must report annually on how their performance in certain areas compares to relevant state and national standards. However, the PBR plan for National Grid that was approved in 2019 includes a five-year MYRP, tracking of performance metrics and an earnings-sharing mechanism.
In Hawaii, the legislature similarly left the details up to the state PUC. The legislation leaned into the idea of PIMs, requiring the PUC to establish performance incentives and penalty mechanisms that directly tie utility revenue to the utility’s achievements on those metrics and breaks the direct link between allowed revenues and investment levels. In response, the PUC engaged in more than two years of stakeholder work which resulted in a five-year MYRP that sets tight limits on annual rate increases and largely divorces utility revenue from capital investments, in addition to including an earnings sharing mechanism. At the same time, the MYRP includes a suite of PIMs, marketing flexibility to support new projects and services, and added financial incentives for the utility to exceed the state’s renewable requirements.
In addition to developing framework details, legislation may restrict the PUC’s authority to require utilities to submit PBR plans or may prevent the PUC from modifying a utility’s proposed PBR plan after submission. In many cases, states have provided PUCs with the necessary authority to open PBR proceedings and, when presented with a utility’s PBR proposal, to approve, deny or modify that proposal. In other cases, states have left it largely to the utility’s discretion.
For example, in North Carolina, the PUC is only able to react to a utility’s petition to pursue PBR. There is no requirement that utilities file performance-based ratemaking proposals. If a utility does file a PBR proposal, the PUC is not authorized to modify those plans—only to approve or deny them. By contrast, Washington now requires utilities to submit MYRP proposals in every general rate case filing, and the PUC is authorized to approve, reject or modify those proposals as it sees appropriate. This component may be critical to safeguarding consumer interests and ensuring that proposals live up to the goals established by the legislature.
In some cases, the legislature may feel that implementation has fallen short of expectations. This was the case in Illinois, which was an early adopter of legislation to enable PBR. However, the legislature felt this legislation had failed to achieve its goals. In 2021, the Illinois legislature enacted the Climate and Equitable Jobs Act—an enormous energy package that tackled everything from clean energy to workforce transition and energy justice. While regulatory reforms received less media attention, the changes enacted by the legislation are likely to prove substantial.
“Though Illinois has taken some measures to move utilities to performance-based ratemaking through the establishment of performance incentives and a performance-based formula rate … these measures have not been sufficiently transformative in urgently moving electric utilities toward the State’s ambitious energy policy goals,” states the legislation.
The new law requires the state PUC to establish a PBR framework designed to achieve certain objectives. It also requires electric utilities that serve over 500,000 customers to file MYRPs that tie rewards and penalties to the utility’s achievement of performance metrics related to reliability and resilience, peak load reductions from demand response, expanding supplier diversity, affordability, interconnection speed and customer performance.
In particular, the legislation aimed to eliminate the use of formula rates, which the legislature determined had “resulted in excess utility spending and guaranteed profits without meaningful improvements in customer experience, rate affordability or equity.” The legislation directs utilities that are currently operating under formula rates to file MYRPs and grants the PUC authority to approve or modify those plans.