More Regulators Rely on Risk-Based Decision-Making

The dangers of the U.S.’s failing infrastructure have united both major political parties in calling for substantial capital investments to shore up safety and reliability. In California, the tragic explosion of the gas pipeline in San Bruno and the massive methane leak from the gas storage wells at Aliso Canyon have highlighted the potential for catastrophic consequences associated with future infrastructure failures.

But the sticker shock associated with infrastructure replacements and upgrades is a very real concern that cannot be overlooked. Regulators and the general public are also loath to reward public utilities—which they believe have become complacent with regard to safety—by hugely increasing the infrastructure investment opportunities through which these utilities profit under the typical cost-of-service model. Regulators and the public worry that utilities may exploit these very real dangers of failing infrastructure to push through massive infrastructure spending sprees well beyond what is needed. These concerns have led to the increased use of risk-based decision-making, which is an evidence-based methodology for utilities and regulators to justify and evaluate reasonable infrastructure spending.

Risk-based decision-making is not new—at its core, all utilities use some form of risk-based decision-making in determining where and how much to spend on infrastructure. However, regulators’ increased use of risk-based decision-making allows them to better understand how the utilities assess safety risks and then manage, mitigate, and minimize those risks. Faced with such additional scrutiny, the hope is that utilities will better promote a safety culture and provide more transparency with regard to their infrastructure spending.

California’s Approach

Not surprisingly, given California’s recent high-profile infrastructure failures, the California Public Utilities Commission (CPUC) has taken a number of steps to promote risk-based decision-making with the utilities it regulates. In 2013, the CPUC ordered the four large California energy utilities—San Diego Gas & Electric, Southern California Gas Co., Southern California Edison, and Pacific Gas and Electric—to file applications describing the respective models each would propose to use to prioritize and mitigate risks.

Since that time, the CPUC has been evaluating these models in a consolidated rulemaking. Its goal is to establish a specific risk assessment approach that would be used by all utilities in a new precursor filing to their general rate-case applications. Called the Risk Assessment Mitigation Phase (RAMP), the utility would describe how it plans to assess, mitigate, and minimize its risks. Only after the utility has justified its risk management in the RAMP will it then be allowed to proceed with its general rate case application for the specific cost recovery of the capital expenditures it proposes.

On August 18, the CPUC issued a lengthy decision adopting what is known as a “multi-attribute” approach to risk-based decision-making and directing utilities towards a more uniform risk management framework. The “multi-attribute” approach, and the software to implement it, was developed over a 10-year period from 1998 to 2008 with the support of the Electric Power Research Institute (EPRI).

The EPRI Model

The EPRI model relies on technical and complicated procedures to evaluate, model, and mitigate risk and to attempt to correlate expenditure levels on safety to the expected level of risk reduction. Approximately 20 utilities currently use it for risk assessment. The model accounts for the physical condition of utility assets and the probabilities of failure, and then calculates a “risk score” proportional to the probability of failure and the ensuing consequences. In theory, the EPRI model’s calculation of risk reduction better enables the utility to prioritize spending based on its cost effectiveness in reducing risks.

Proponents of the EPRI model contend it best ensures that public and employee safety is a priority; promotes cost-effective and optimized risk management; is transparent, easy-to-use, and understandable; and allows for common application and uniformity by all utilities. Before authorizing full implementation of the EPRI model, the CPUC has required utilities to provide showings of “pilots” demonstrating the use of probabilistic models with attributes similar to the EPRI model, and it intends to “test drive” the EPRI model against the utility models. The California utilities were scheduled to unveil their pilots on October 1, after this column went to production.

The Future of Risk-Based Decision-Making Across the Country

In light of California’s increased focus on risk-based decision-making and the use of the EPRI model by utilities across the country, other utility regulators will likely give the approach a closer look. There are several potential benefits. Requiring utilities to determine their capital infrastructure proposals through an auditable risk-based decision-making process could provide regulators with the comfort they need to know that utility rate increases are being put to appropriate use. Utilities should enjoy healthier profits over the short and long term from major capital infrastructure projects that they are more easily able to justify with clearer evidence. And the public will benefit from the increased safety and reliability associated with these major capital investments without paying for more than they need. ■

Vidhya Prabhakaran (vidhyaprabhakaran@dwt.com) is a partner in Davis Wright Tremaine LLP’s energy practice in the firm’s San Francisco office.

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