Regulating Smart Power: The Next Generation of Energy Regulation

Rapid changes under way within today’s electric utility industry are testing the skills and expertise of utility executives, energy policy-makers, and, perhaps most importantly, those in charge of managing it all—our energy regulators. With lighting speed, the "smart grid" is introducing potentially disruptive new technologies, competitors, and changes in the business relationship between utilities and customers. Meanwhile, utilities are contemplating how to quickly establish generation infrastructure capable of providing cleaner energy at competitive prices to meet a variety of policy imperatives, notably the need to reduce the impacts of climate change. These changes are likely to occur against a backdrop of higher rates and slower sales growth, creating an environment that will require utilities to view energy efficiency as a significant resource and perhaps the new basis of their business model.

As I explain in my new book, Smart Power: Climate Change, Smart Grid, and the Future of Electric Utilities, traditional energy utility regulation was built on a business model of consistently increasing energy use. Energy regulators encouraged the expansion of energy supply by allowing electric and gas utilities to earn a greater return on their investment through increased sales. This relationship, known as the "regulatory compact," is now buckling. Expansion of industry infrastructure in its current form often comes with increased environmental risks, great uncertainty, and high costs. A new regulatory compact is needed—one that focuses on providing ratepayers with the most efficient and cleanest level of energy services per dollar of customer revenue, while meeting environmental, social, and other important policy objectives and constraints.

In order to manage these shifts in mission, technology, and competitive landscape, energy regulators are going to need new resources: time, space, expert assistance, adequate budgets, and familiarity with many new and complex technical developments. In addition to the day-to-day job of regulating the industry, regulators will need these new resources to decide whether to propose, defend, enact, and implement changes in their energy regulatory statutes, regulations, and processes during this transition. Knowing how to react to the major industry shifts and maximize the benefits of each change requires a more advanced, open-ended, and future-oriented mission than the traditional regulator education and regulatory process provides.

As one example, the implementation of smart grid technologies alone will create what I like to call the "Regulatory Mountain." These technologies will enable new and more efficient ways to operate power systems but will first require new kinds of investments in transmission and distribution infrastructure. Regulators are tasked with evaluating these investments and will need to analyze their value to customers, their impact on utility rates, and how customers and generators who use the new capabilities should be charged for their use. To do so, they’ll need to become quick studies of these unfamiliar new products and service streams and understand the balance between the benefits and costs. This will not only require new expertise within regulatory commissions but also informed collaboration with other stakeholders to fully understand the mountainous complexities involved.

The regulatory challenges created by the deployment of the smart grid are only one of many interconnected issues that will tax the resources of regulators. Public policies continue to drive electric generation investment towards clean, innovative resources with little clarity at the national level. Regulators now face varying state and regional policies for carbon emissions, renewable standards, and energy efficiency—all of which may or may not be supplanted by overarching federal goals. Who should take leadership over these goals and how they would be best implemented are critical questions that will determine the future of the industry.

For example, the maximization of energy efficiency has long been a challenge to the entire industry. While utilities are often capable of crafting successful efficiency programs, energy regulators will need to establish incentives for them to do so at a large scale and overcome barriers related to information, capital availability, transaction costs, and prices signals. The goal for the next generation of regulators will be to create rate-setting formulae that motivate investment in lowest-cost energy services while meeting reliability rules, carbon limits, renewable standards, and other constraints. This will require experimentation, effective institutions for sharing information, and nothing less than cutting-edge regulatory skills.

Many commissions have already begun adjusting their approach to energy regulation, shifting from expensive, adversarial litigation methods to a more collaborative process. This approach to decision making and information sharing is ideal for examining the changes needed in the regulatory compact and must be built on a firm foundation of current regulatory practices and tools. Instead of replacing current regulator education, we should consider how to develop them further and increase the availability and use of those educational resources.

This is an era that demands new thinking and massive changes in all stages of energy production and use. As participants in the global race to reinvent energy systems that are deeply dependent on high-carbon fuels, the coming decades will require new industries, business models, and government institutions. What can we do to make sure this transition is smooth and successful? We can strengthen our national dialog on these issues by urging clear and responsive leadership from the federal government. Meanwhile, the expansion of educational resources for energy regulators is needed manage these changes on the frontlines. All of this will require experimentation with new regulatory models that meet our current and future needs—not one based on an industry of the past.

—Peter Fox-Penner, principal and chairman emeritus of The Brattle Group, specializes in economic, regulatory, and strategic issues in network industries. His recent book, Smart Power: Climate Change, the Smart Grid and the Future of Electric Utilities, examines innovative business models for the changing utility industry. Heidi Bishop is a policy and marketing coordinator with The Brattle Group.

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