New York State shapes the future of energy regulation with latest REV order

New York State has recently released one of the most significant developments in energy regulation in recent years, with a new order related to utility rate making and revenue models.

The New York ‘Reforming the Energy Vision’ (REV) review process has been a closely watched review process by energy commentators and market participants internationally. It seeks to align markets and the regulatory landscape with a set of overarching New York state policy objectives of giving customers new opportunities for energy savings, local power generation, and enhanced reliability to provide a safe, clean, and affordable electricity service.

The recent ‘Order adopting a ratemaking and utility revenue model policy framework’ is a critical milestone which could change the future of energy in New York. This order sets out a basis for future decisions of the regulator – the State of New York Public Service Commission – on electricity rate-making cases involving largely vertically integrated New York utilities.

It is one of the most comprehensive and integrated attempts to redesign the regulatory and revenue allowance framework in recent years. It shares some features of the well-regarded ‘RIIO’ (Revenue=Incentives+Innovation+Outputs) reform package introduced in the United Kingdom from 2013. In many ways, it goes beyond RIIO.

This article seeks to provide a summary of just two important aspects of the package, the proposal to introduce a distributed system platform model, and its recommendations on the development of new revenue approaches for existing New York utilities that align with customer value.

The proposed distributed system platform model – revenues through market services

The Commission proposes a staged, but ultimately market-driven movement to a model of regulated utilities becoming a future distributed system platform (DSP). In particular, the Order concludes that provided adequate protections are in place, existing utilities should perform the DSP function, due to operational and planning practicalities.[1]

Under this model the utilities will earn revenues by providing ‘platform service revenues’, or market based services, that increase value to customers. Examples of these are platform access fees, customer origination, and optimisation and scheduling services for distributed energy resources.[2] These ‘platform services’ are intended to facilitate market entry and unlock system value; provide incentives for innovation; reduce uneconomic grid defection; and provide a sustainable source of utility revenues going forward.

The order defines three levels of new platform services:

1. Market development functions required by the Commission to be provided by the utility;
2. Voluntary value-added services, provided through the distribution system platform function that have a ‘operational nexus’ with core utility offerings; and
3. Competitive new services that can be readily provided by third parties. Unregulated utility subsidiaries will be able to engage in competitive value added services, provided appropriate conduct standards are in place to avoid anti-competitive affiliate dealings.[3]

Role of existing utilities in new and competitive market services

The Commission’s order rejects proposals to ban existing utilities from any potentially competitive services or distributed energy resource ownership.[4] In doing so, it recognises that in some areas the activity of regulated utilities may be beneficial to both utility customers and to the operation of markets.

The Commission intends to consider cases on their merits. It will take into account whether utility services facilitate the growth and operation of markets, whether third party markets exist that adequately serve all sectors of the market, and whether utilities’ scale and scope economies may result in ‘cost effective stimulation’ of the market.

It is significant that the Commission will also consider if there is a risk of ‘market foreclosure’, i.e. where other parties are likely to be prevented from entering. It will take into account the extent to which a utility’s proposal to offer potentially competitive services also puts shareholders’ funds at risk. For example, the Commission has proposed an upfront ‘80/20’ rule, effectively proposing to preapprove new service developments that feature an 80/20 per cent risk sharing between ratepayers and shareholders. In setting out this rule, the Commission has emphasised that the development of new services by existing utilities should not be constrained by a “presumption of impermissibility”.[5]

Earnings Adjustment Mechanisms – A bridge to the energy future?

The Commission recognises, however, that the platform service revenue model is likely to emerge over time, and that existing approaches will still need to play a role.

Under the Commission’s approach, traditional incentive mechanisms are to be retained, but modified to form a ‘bridge’ to a future in which the utility will earn most if not all of its revenues from market platform services. The Commission also recommends a review of the usefulness of existing earnings incentives schemes.

The Commission has proposed – much like Ofgem in the UK – targeting a range of broader output based measures and seeking to reward outperformance. This focus on performance incentives is one of the sharpest contrasts emerging between Australia’s regulatory environment and the leading regulatory reforms being progressed in the UK and United States. Australia’s regulatory regime saw additional performance incentives introduced in 2012-13 to encourage the use of non-network solutions, increase efficiency and defer or optimise capital expenditure. It is significant that the most progressive international regulatory reforms appear to make more significant use of such performance incentives and to align them more closely with the transformation of the energy system and customer value.

Conclusion

From an Australian perspective, the New York REV program gives a compelling insight into how other regulatory jurisdictions are approaching the challenge of the ‘energy trilemma’ of energy reliability, sustainability and affordability. While there is a lot of detail still to be developed, the striking feature is the integrated vision and alignment between policy, regulatory frameworks and regulation.

While it is still a ‘work in progress’, the New York State’s new Order provides an interesting model for Australians to consider as we collectively prepare for a future of increasingly distributed energy markets.