Wind power plants behind mountains at sunset of the north shore of Ohau, Hawaii
Five Lessons from Hawaii’s Groundbreaking PBR Framework
On December 23, 2020, the Hawaii Public Utilities Commission (PUC) issued a landmark decision to adopt a comprehensive performance-based regulatory framework for the islands’ investor-owned utilities. The newly adopted framework delivers a portfolio of thoughtful and innovative regulations that will align utility business incentives with clean energy and customer service goals and has set a new standard for regulatory reform elsewhere in the United States.
Hawaii’s decision is the culmination of a two-and-a-half-year process, during which a diverse set of stakeholders learned from each other, collaborated, and iterated on different performance-based regulation (PBR) proposals. The result is a suite of regulatory mechanisms designed to incent superior utility performance in novel domains, such as clean energy expansion and distributed energy resource interconnection and utilization.
The bold new framework could not come at a more important time. After four years of stalled progress and backsliding in federal climate policy, a major course correction is underway. The Biden Administration has already rejoined the Paris Agreement, and has set its sights on decarbonizing the economy by significantly expanding energy infrastructure investment. To fully leverage this window of opportunity, states will need to pursue regulatory reforms to ensure that utilities help drive rapid, cost-effective, and equitable decarbonization in the power sector.
Hawaii’s experience is ripe with ideas for how PBR can support climate and clean energy policy goals, while still keeping rates manageable for families and businesses. Details of the mechanisms adopted are well described elsewhere, including by the Hawaii PUC, Hawaii stakeholders, and in industry news. Here, based on RMI’s role as Commission advisor and facilitator of the proceeding’s stakeholder process, we offer five important takeaways that can improve other states’ efforts navigating new utility business models.
Lesson 1: Electricity Decarbonization Can Coexist with Affordability
To support a clean yet reliable, flexible, and safe power system, utilities need to invest in new resources and technologies. PBR mechanisms, such as multi-year rate plans or other regulatory tools like cost trackers, can provide utilities with longer-term revenue certainty and more immediate cost recovery to support these more nontraditional investments.
However, these mechanisms also introduce a risk of increasing energy bills without sufficient attention to how utilities are actually spending ratepayer money. For example, a growing number of utilities use cost trackers to quickly recover revenue for investments that qualify as “grid modernization,” which can have a wide and ill-defined scope. Without sufficient scrutiny to how different regulatory mechanisms work together and their long-term impact on customer rates, utility spending can balloon without producing equivalent benefits.
To protect customers from unnecessary rate hikes, regulators need to balance new sources of revenue with mechanisms that encourage utility cost reductions elsewhere. Under Hawaii’s PBR framework, the utility has the opportunity to increase earnings through efficiently managing costs and by meeting performance targets that advance the state’s clean energy goals, leverage grid investments, and deliver benefits to Hawaii’s most vulnerable communities. However, overall customer rates are still set to decrease compared to business as usual through use of an approved Customer Dividend. The Commission also adopted incentives to support cost-effective procurement of renewable energy and non-wires solutions, which can lower rates further.
Hawaii’s comprehensive PBR approach demonstrates how thoughtful consideration of the full regulatory structure can ensure utilities have the resources to support decarbonization without an over-reliance on customers to foot the bill. Said differently, Hawaii was able to balance the push and pull across regulations to create a win-win-win for customers, the utility, and the climate as opposed to focusing on isolated changes to single mechanisms.
Lesson 2: Audits Can Unearth Significant Utility Cost Saving Opportunities
One way to identify potential utility cost savings is through a management audit. Since utilities are not subject to the same cost pressures as firms in competitive markets, they do not need to constantly seek structural and operational improvements to improve their bottom line. This lack of competition, in addition to a business model that inherently incents spending, often results in utility over-investment. To remedy this dilemma, regulators have used management audits to provide greater visibility into utility procedures and identify opportunities for cost efficiencies.
In Hawaii, a Commission-ordered management audit revealed more than $25 million of potential annual capital and O&M cost reductions. The findings from the audit directly informed how rates were set under the new PBR framework. As other states consider updates to the utility business model, management audits offer a complementary tactic that can provide insight into savings opportunities.
Lesson 3: Benchmarking May Be Less Useful When Peers Face the Perverse Incentives that PBR Seeks to Fix
In an attempt to reflect the difference between economy-wide and industry-specific cost trends, some regulators use peer benchmarking as the basis for utility productivity assumptions used in PBR design. These studies examine the change in costs for a group of utilities that share similar characteristics over a period of time.
While the economic rationale for this exercise may be logical, there are important limitations to consider when using this approach. The results of these analyses are significantly impacted by which utilities are assessed, what time periods are used, and which costs or revenue streams are evaluated. Additionally, these analyses must generally be based on utilities that are still operating under traditional cost-of-service regulation without strong incentives to be more efficient—exactly what PBR seeks to address.
In Hawaii’s PBR decision, the Commission outlined these issues, while also noting Hawaii’s unique operating and regulatory environment, and ultimately declined to adopt the results of two productivity benchmarking analyses proposed by stakeholders. Instead, the Commission approved a mechanism that ties annual revenue growth to inflation, offset by the previously mentioned Customer Dividend to incent productivity gains and return cost efficiencies to customers. Given that many limitations of these analyses are not exclusive to Hawaii, other states or utilities looking to move away from a cost-based revenue model should explore alternative approaches to determine what a reasonable level of productivity is under a comprehensive PBR framework.
Lesson 4: Implementing Novel Performance Incentives Requires Experimentation
Hawaii’s new portfolio of performance incentives focus on faster renewable and distributed energy adoption, the use of DERs for diverse grid functions, opportunities to lower utility bills for low-income customers, and customer benefits from grid modernization investments. Hawaii’s experience, along with efforts in other states like New York and Rhode Island, show that designing these incentives is not easy. Existing data to create baselines for performance may be minimal, potential costs and benefits may not be clear, and utilities’ response to new incentives may be unpredictable.
These challenges should not discourage consideration of new performance incentive mechanisms (PIMs) when there is a clear need to use financial rewards or penalties to influence utility decision making. Regulators, utilities, and other stakeholders should balance the challenges and uncertainty of implementing these more emergent PIMs with the risk of delaying implementation. Although it may be necessary to first collect data for a period of time to inform the design of more novel PIMs, PBR processes should support alternative data sharing opportunities to streamline PIM development where they are urgently needed. Integrating flexibility in PIM design and ensuring sufficient review of outcomes also can allow PIMs to evolve with experience.
Lesson 5: PBR Efforts Need Inclusive and Collaborative Stakeholder Processes
Changing a utility’s business model has an impact not only on utility shareholders but also has the potential to significantly affect a wide range of stakeholders, including utility employees, customers, clean energy companies, low-income communities, and local governments. Given this reach, PBR development should emphasize inclusivity, foundation setting, and collaboration.
Hawaii’s PBR process allowed parties to the proceeding to work together to find common ground, offered the opportunity for iterative solution development, and afforded the Commission the flexibility to integrate a number of party ideas into the adopted framework (including, for example, the first-of-its-kind “RPS-A” PIM for accelerated clean energy adoption). The Commission also provided a clear vision at the outset of the proceeding and continued to provide guidance throughout the process to ensure stakeholder proposals didn’t stray off course.
As federal leadership on climate ramps up, utilities will be relied upon to drive decarbonization. Fixing their business model so earnings opportunities are tied to meeting the diverse needs of a clean energy future will be fundamental to their success. Hawaii is taking bold steps to change the status quo. Other states can build on the lessons learned by Hawaii to accelerate the transition to a clean, affordable, and equitable energy system on the tight timeline demanded by the climate crisis.