States Test an Unusual Idea: Tying Electric Utilities’ Profit to Performance
When a tropical storm bore down on parts of the East Coast in the late summer of 2020, it spurred tornadoes and flooding and caused 8,800 trees to crash onto power lines. At one point, three-quarters of a million Connecticut residents were without electricity.
It took Connecticut lawmakers just a few months to pass a bill designed to make sure it didn’t happen again. To keep utilities accountable, the 2020 “Take Back the Grid” Act ties their profits to goals set by the state, not by shareholders. Recently state regulators detailed what this profound shift could look like, issuing the goals and principles for a framework that will guide their decision-making.
Given that climate change is generating ever more frequent and intense storms, Connecticut’s Public Utilities Regulatory Authority will require that the companies it oversees focus on goals that include reliability in the delivery of electricity and reductions in greenhouse gas emissions. Regulators are also requiring that utilities charge “reasonable, equitable and affordable rates.”
Over the next year, the state will work on the specifics. In theory, utilities will earn financial rewards or face penalties based on how they meet the new metrics. This evolving framework makes Connecticut just one of two states, along with Hawaii, that have embarked on such an extensive regulatory overhaul to connect utility performance with how those companies make money from customers.
Utility regulation is a wonky, often opaque process, but the decisions involved are central to people’s lives—determining, for example, how much they pay for electricity, where that electricity comes from, and how reliable it is during a huge storm or on a blistering hot day. By changing the basis for those decisions, states could upend a business model that electric utilities have relied upon for decades.
Proponents hope the shifts in policy will not only result in better electric service for customers but also push utilities along the path toward renewable electricity in line with state climate goals. “The traditional utility business model runs counter to a lot of the necessary investments we need to reduce greenhouse gas emissions,” said Cara Goldenberg, a manager in the electricity practice at the Rocky Mountain Institute, a nonprofit advocate of the transition to clean energy.
In the United States, big utilities have long acted as monopolies and operated under a “cost of service” model, earning approved returns on investments in infrastructure like power plants and power lines. The importance of their product— electricity—has fostered an unusual regulatory balance: State officials want companies to earn enough money to stay in business, but regulate just how much they can charge customers.
Now that climate change has started to reshape the electric system, spurring millions of rooftop solar projects and massive wind and solar farms in states like California and Wyoming, some argue that this dynamic needs to change. Historically, incentives encouraging new infrastructure have allowed utilities to prioritize construction in service of shareholders rather than customers, said Howard Crystal, legal director of the energy justice program at the Center for Biological Diversity.
“A basic problem of our energy system is that we have given enormous power to for-profit companies to generate and supply our energy needs within a system in which they are incentivized to build things,” he said. “By changing the incentive model for the utilities, we can both achieve climate goals but also achieve more savings for the consumer.”
One way to alter those incentives is the framework Connecticut is experimenting with, known as “performance-based regulation,” or PBR. Rather than earning revenue by building new stuff, utilities will see their compensation tied to meeting standards set by the state, although Connecticut will still allow utilities to earn some money from infrastructure investments.
The umbrella term PBR encompasses a range of different policies that states have used to govern utilities for decades. California helped pioneer some of those methods in the U.S. in the 1980s, like separating utility profit from sales of electricity while allowing utilities to keep drawing the revenue they need to provide service. That policy has allowed states to pursue policies that encourage energy efficiency while limiting how often utilities can request to raise rates. Generally, however, California and other states that have applied performance-based standards have taken a narrow approach.
By contrast, Connecticut’s plan and one created earlier by Hawaii are viewed as transformational. Connecticut’s decision will reset “the entire framework for how we regulate utilities,” said Marissa Paslick Gillett, chair of Connecticut’s utilities regulatory authority. She predicts that the state will begin putting the policy into effect in 2024.
Gillett describes PBR as a spectrum, with Connecticut and Hawaii on one end and states like Illinois and Colorado, which have taken smaller steps, on different points of that range. All told, 17 states have considered or incorporated at least some performance-focused mechanisms into utility regulation, according to the Rocky Mountain Institute. The shift is a significant one for what Gillett calls one of the most “risk-averse industries.”
Utilities have long been tasked with providing reliable and affordable electric service, but the specifics of that mandate are changing as extreme weather challenges existing grids and as consumer-owned technologies like rooftop solar arrays connect to the infrastructure.
United Illuminating, one of Connecticut’s large utilities, says it supports the state’s effort. The company “looks forward to aligning its operations, investments, customer service engagement and system planning within this new, constructive regulatory framework,” Sarah Wall, a spokesperson, said in an email.
Mitch Gross, a spokesperson for the multistate energy provider Eversource, said the company supported related policies in Massachusetts. But he added that its “investor community” was concerned that the Connecticut decision was “imbalanced, harming the interests of customers given the need for sustained, long-term investment in utility infrastructure.’’
Residents of Connecticut and Hawaii pay high electricity rates; Hawaii’s, which averaged 30.31 cents per kilowatt-hour in 2021, is the highest in the nation, according to the U.S. Energy Information Administration. In Connecticut, where the average that year was 18.32 cents per kilowatt-hour, frustration had been brewing about rates even before Tropical Storm Isaias knocked out power to roughly a quarter of the state in 2020. By contrast, electricity rates averaged 11.10 cents per kilowatt-hour nationally in 2021.
But promising a reduction in rates can be challenging, not least because Connecticut needs to invest in more infrastructure to meet state climate goals like reaching zero-carbon electricity by 2040. Gillett said the state was focusing for now on value, making sure that people are getting what they pay for in terms of reliability.
While leaders in Hawaii and Connecticut highlight their states’ climate and clean energy objectives, the PBR concept does not mandate such a focus. But several states are pursuing the idea: Emissions reductions and affordability sit atop the list of the most commonly cited goals of implementing PBR, according to an analysis from the Rocky Mountain Institute.
Rather than hoping that utilities will devise operational plans that align with state policy goals, performance-based regulation requires it. “Putting a thumb on the scale and giving them a bonus, or punishing them for falling short, quickly changes their motivation to maximize those outcomes,” said Mike O’Boyle, senior director of the electricity team at Energy Innovation, an energy and climate think tank.
Hawaiian regulators want to build resilience on their island grids, in part by deploying and hooking up many home solar and storage projects. When PBR policies went into effect in Hawaii in 2021, the state created incentives for utilities to speedily connect those projects to the grid. In 2021, it took Hawaiian operators 115 days to link a new rooftop solar project to the grid. This year, that process takes 85 days.
Some early adopters of PBR metrics, like California, have stopped short of completely reworking their regulatory frameworks around standards of utility performance. Yet numerous states have recently begun investigating such models. Washington is in the first stage of a five-phase plan to consider performance-based criteria for its utilities, and North Carolina and Nevada have enacted laws encouraging exploration of the idea.
As more states add renewable energy to their grids, the numbers could climb.
“More and more states are coming to terms with the fact that the traditional way we’ve regulated utilities was set up for a very different system,” reliant on centralized fossil fuel plants, said Goldenberg of the Rocky Mountain Institute. “The same questions are facing many other states: How are we going to achieve these goals while keeping rates affordable for customers?”