California To Decide Fate of Independent Energy Providers

The California Public Utilities Commission will vote December 15 on a proposal encouraging utilities to embrace distributed energy resources. Changes in consumer preferences, technological progress, and legislative and regulatory shifts have created an environment for the expansion of distributed energy resource deployment. This means utilities are facing a new market landscape in which distributed energy resources may play an increasing role. One example is the state of California.

Distributed energy resources (DERs) are power generation and storage assets that provide an alternative to the traditional electric power system. DERs are usually closely located to the consumers, and typically supply surplus power to the electric grid. According to the California Public Utility Commission, DERs include distribution-connected generation resources, energy storage, electric vehicles, and demand response technologies.

Customers have become increasingly interested in managing electricity use to limit utility bills and increase grid reliability when a storm or other event occurs. Costs are also decreasing for battery storage, control devices and software that allow customers to manage energy usage. One benefit of DERs is decreased costs for energy and infrastructure. Because DERs often produce electricity locally, they reduce the need for costly generation and transmission infrastructure. Energy losses that occur as electricity is transmitted hundreds of miles from a power plant to customers can be largely avoided.

California utilities currently lack a financial incentive to invest in DERs. The New York Public Service Commission has identified several shortcomings of the traditional ratemaking model. For one, cost-of-service ratemaking hinders innovative improvements to meet consumer needs at a lower cost. Secondly, the cost-of-service framework motivates utilities to make investments in areas they can control, causing them to shy away from third-party resources that could offer economic reliability and savings to customers.

Today, utilities can earn a financial return on capital spent on investments in traditional infrastructure such as power lines, replacing poles, wires, transformers and substation upgrades. However, when utilities pursue DERs over traditional grid investments, they decrease the demand for customers to buy electricity from utilities.

Because DERs could conflict with utilities’ financial goals, California Public Utilities Commissioner Mike Florio introduced a draft proposal in April 2016 to create a model aiming to financially incentivize utilities to adopt DERs. This is the first time a California regulator has introduced a detailed proposal with an alternative economic structure to resolve the conflict of aiming to bring more DERs online while ensuring they do not harm the utilities’ financial profits.

The CPUC has attempted to motivate utilities to adopt DERs in the past. Since 2001, the CPUC has developed policies to engage and promote procurement of DERs. Unfortunately, they have resulted in very few cases that displaced traditional upgrades. The CPUC’s 2014 distribution resources plan in particular failed to account for the fact that utilities earn no financial benefit by procuring them. Commissioner Florio’s draft proposal aims to offer utilities a better rate of return for DER projects that replace more costly capital upgrades.

Several organizations commented on the draft proposal. Vote Solar and the Environmental Defense Fund stated that the incentives pilot is not likely sufficient for utilities to overcome various barriers to increase DER adoption, noting utilities’ excessive sensitivity to risk. The California Solar Energy Industries Association has noted that the pilot program consists of many regulatory steps that would require major amounts of staff resources. Instead, the association recommends reducing the regulatory steps and to increase participation from third parties in evaluating and proposing DER alternatives to create a system that fosters competition and empowers consumers.

After hosting public workshops to discuss the proposed pilot, the CPUC filed an amended proposal in September 2016. Florio came to the conclusion that offering an incentive for utilities to adopt DERs could not hurt in stimulating greater opportunities, and could be used to provide bonuses and other monetary incentives to employees in distribution planning and related areas.

Florio’s amended proposal suggested a more familiar method to determine incentives, the Efficiency Savings and Performance Incentive (ESPI) mechanism. ESPI was adopted in September 2013 and allows utilities to earn incentive awards by meeting or exceeding goals in performance categories including energy efficiency resource savings, forecasted performance, advocacy of codes and standards, and non-resource programs that support energy efficiency through activities such as marketing, training and education. Offering incentives with a broad range of policy goals likely will provide more successful results and diversify risks. The exact percentage of the financial incentive and how it would be applied is still being debated.

Commissioner Florio made it very clear that ratepayers should not pay more in order to offer shareholder incentives for utility deployment of DERs. In Florio’s view, this is possible as long as the amount paid to the DER provider plus the cost of the utility incentive equals less than the cost of a traditional capital investment. Florio will establish limitations for the deployment of DERs to locations where the benefits exceed the cost so that utilities do not lose money and so ratepayers’ costs do not increase.

For customers in California to better control energy use and increase grid reliability, it is a good idea for utilities to be financially incentivized to adopt DERs. It is just as important, however, that the incentive does not harm utilities’ business model by causing them to lose money and that customers’ costs do not increase as a result. Commissioner Mike Florio’s pilot proposal is a first step to better understand how financial incentives will affect utilities’ deployment of DERs. Over time, this model could be analyzed, refined and utilized in other states seeking to increase DER deployment.