Performance-based ratemaking ("PBR") is an approach to ratemaking designed to improve utility performance and streamline regulation. There are four well-established approaches.  Targeted performance incentive mechanisms (“PIMs”) are designed to strengthen performance incentives in targeted areas using metrics and targets.  Another kind of targeted incentive directly encourages preferred practices by such means as cost trackers and management fees.  Revenue decoupling relaxes the link between utility revenue and system use, thereby encouraging utility conservation and peak load management initiatives.  Multiyear rate plans typically involve a rate case moratorium and attrition relief mechanisms that provide automatic rate relief for changing business conditions between rate cases.  These plans often include the other three kinds of PBR mechanisms.  Cost containment is encouraged and ratemaking can be streamlined.

The PBR services of PEG encompass expert witness testimony, plan design, and research on related empirical issues.  We maintain a large international library of PBR decisions.

We have developed an incentive power model to quantify the impact of alternative regulatory systems on utility cost performance.  This model can be used to study the benefits of PBR.

Revenue decoupling is an approach to Altreg that has been used for more than three decades by North American utilities. In a revenue decoupling mechanism, rates are reset periodically to ensure that a company's revenue matches its revenue requirement. This makes utility finances less sensitive to the slowdown in use per customer that can accompany aggressive demand side management ("DSM") programs and growing distributed generation and storage ("DGS") on the customer side of the meter. Utilities are therefore more likely to embrace DSM and customer DGS. A well designed decoupling mechanism can help utilities avoid frequent rate cases that might otherwise be triggered by slow volume growth. The need for decoupling is especially acute when volume growth is slow but utilities are compelled to use historical test years in rate cases.

Revenue decoupling has been a major focus of our recent work. We have filed relevant testimony in proceedings leading to the approval of numerous decoupling mechanisms. A special strength is the design of broad-based revenue adjustment mechanisms ("RAM") that escalates the revenue requirement in the absence of a rate case. Five approaches to RAM design have been established.

• Under a revenue per customer (RPC) freeze, revenue per customer is fixed for the term of the plan. The revenue requirement then grows automatically with the number of customers served. The formula may apply to the total revenue per customer or individual rate classes. This is the single most popular approach to decoupling today. RPC freezes don't compensate utilities for input price inflation. As a consequence, many utilities operating under RPC freezes have been compelled to file frequent rate cases. The other four approaches to RAM design do not have this failing.
• Under revenue per customer indexing, the allowed revenue per customer is subject to automatic escalation for price inflation. Most RPC indexes approved to date have relied on the theoretical result that the growth in cost per customer is the difference between input price and productivity growth. These indexes have inflation -X formulas, where X reflects a productivity target and also corrects for any inaccuracy of the chosen inflation index as a measure of energy utility input price inflation. This approach has a solid scientific foundation and is apt to generate considerably more attrition relief than a revenue per customer freeze. Utilities who have operated under this kind of RAM include ATCO Gas, Enbridge Gas Distribution, and Southern California Gas.
• Under the "inflation-only" approach to RAM design, the revenue requirement is adjusted only for growth in a familiar macroeconomic inflation measure such as the Gross Domestic Product Price Index. This is tantamount to a revenue per customer index in which X is set equal to customer growth. This approach has been approved for use in decoupling plans for Southern California Gas and the gas and electric services of Pacific G&E and San Diego G&E.
• Under the "all-forecast" approach, revenue requirement escalation depends on a multi-year forecast of the growth in total cost. This is tantamount to a rate case with multiple forward test years. The revenue requirement in the "out" years is usually scheduled to rise in a "stair-step" pattern. This approach to RAM design has been used extensively in California and is now being used in New York state. It has the disadvantage of being non-responsive to unforeseen hyperinflation.
• Under the "hybrid" approach to RAM design, O&M expenses are typically escalated using an index, whereas capital cost escalation is based on a multi-year forecast. This general approach has been used chiefly by California utilities. 

MRPs are the most common approach to PBR around the world. An MRP features a moratorium on rate cases that typically lasts three to four years. An attrition relief mechanism ("ARM") adjusts rates or allowed revenue automatically to reflect inflation and other changes in business conditions. Some costs may be addressed separately using cost trackers. Most MRPs also include PIMs to balance incentives for cost containment with incentives to pursue other goals (e.g., reliability or energy conservation) that matter to customers and policymakers.

Some MRPs feature earnings sharing mechanisms that share surplus and/or deficit earnings between the utility and customers when the rate of return on equity deviates from its target. Plans may also feature an efficiency carryover mechanism that incentivizes long term performance gains and discourages the opportunistic timing of expenses by permitting the utility to keep a share of cost savings (or absorb a share of high costs) if rates are trued up to cost at the end of the plan.

Several approaches to the design of ARMs are well established.

•An index-based ARM is developed using industry price and productivity research and can be calibrated to produce superior returns for superior productivity growth. This approach was developed in the United States but is more popular today in Canada and some countries overseas (e.g., New Zealand).

•A stairstep ARM increases revenue by a certain percentage each year, with the percentages set in advance. Allowed revenue then has a stairstep trajectory. This is currently the most popular approach to ARM design in the United States.

•Two hybrid approaches to ARM design have been widely used. In North America, revenue for O&M expenses is indexed, while that for capital cost has a stairstep trajectory. This approach to ARM design was developed in California. In Britain, a multiyear cost forecast is approved and a revenue cap index  is chosen that yields equivalent net present value. 

MRPs have been especially popular in North America historically where utilities need marketing flexibility since infrequent rate cases lessen concerns about cost allocations and cross-subsidies. Such plans have helped railroads, oil pipelines, and telecommunications utilities provide complex arrays of services to markets with diverse competitive pressures from common sets of assets. MRPs are also favored for energy distributors in most populous provinces of Canada and are increasingly popular for gas and electric utilities in the United States.

Recent developments have increased the potential usefulness of MRPs in the US.

•Slower volume growth due to conservation, slow economic growth, and increased distributed generation has reduced the "gravy" many utilities relied on in the past to help finance cost growth.

•Natural gas-fired and wind-powered technologies have replaced solid-fuel technologies as the low cost choice for incremental generating capacity.

•Vertically integrated electric utilities need fewer plant additions, and those that they do need are smaller than in the past.

•Some utilities are engaged in accelerated modernization of distribution systems that involve elevated levels of capital expenditures for several years.

•Diffusion of "smart grid" technologies creates opportunities for new products and services.

•Some customers will pay a premium for better quality service.

Under cost of service regulation, utilities will respond to these conditions by filing rate cases more frequently and requesting additional marketing flexibility. Frequent rate cases raise regulatory cost and weaken utility cost containment incentives. The recurrent issues of cost allocation and cross-subsidies will incline regulators to discourage desired marketing flexibility. In a prior period of frequent rate cases, in the 1970s and 80s, the productivity growth of US energy utilities slowed markedly.

Overseas, the privatization of many utilities in the last 20 years has forced governments to choose a regulatory system. The majority have chosen MRPs over cost of service regulation. Regulators in Britain, Australia, Germany, the Netherlands, Norway, and New Zealand are recognized MRP leaders.

The British approach to PBR is one of the best known. The latest version of this approach is called "RIIO" (Revenue = Incentives + Innovation +Outputs). The heart of the RIIO system is an MRP.  The typical plan term is 8 years. Since the ARM is based on multiyear cost forecasts, the regulator must carefully review utility business plans. Statistical benchmarking and independent engineering studies loom large in cost appraisals. 30 months is typically required to process a RIIO application. There are PIMs for a wide range of outputs. Special cost trackers encourage innovative projects.

RIIO has recently been touted as a promising approach to regulating US electric utilities in an era of smart grid innovations and increased distributed generation. However, many components of RIIO (e.g., MRPs and APMs) are already widely used in America and Americans have developed their own approaches to addressing certain regulatory challenges. For example, integrated resource planning has been used for years in some states, and planning in some states can be extended (as in California) to incorporate DG and smart grid innovations. There is a long tradition of "pilot" projects to encourage innovation. Alternative approaches to ARM design are more familiar and can involve lower implementation costs.

A PIM is designed to strengthen utility performance incentives in a targeted area. Basic components of a PIM include a performance metric or indicator (called an "output" in Britain), a performance appraisal that compares the utility's value for the indicator to a benchmark value, and a mechanism for adjusting utility rates to reflect the performance appraisal. Here are some common performance areas targeted by PIMs:

•Reliability (e.g.,SAIDI, SAIFI)

•Other customer service dimensions (e.g.,telephone response time)

•Demand-side management (e.g.,estimated net benefits)

•Cost (e.g.,cost/dkth of gas procured).

PIM Design and Support

PEG personnel have testified in support of PIM proposals for reliability and other dimensions of service quality for clients that include Hawaiian Electric, Kentucky Utilities, Louisville Gas & Electric, Oklahoma Gas & Electric, San Diego Gas & Electric, and Western Resources.  Our experience also includes development of reliability benchmarks for the Ontario Energy Board and a consortium of Massachusetts power distributors.  In addition, we have conducted several surveys of PIMs and metrics which are discussed further below. 

PEG personnel have been North America’s leading PBR consultants for thirty years.  We are best known for our work to popularize the multiyear rate plan approach to PBR.  We pioneered the use of input price and productivity research in the design of the attrition relief mechanisms that are a key component of these plans.  Our MRP services encompass plan design and statistical research on industry input price and productivity trends.

We have been involved in some of the most important cases advancing MRPs in North America.  Here are some of our notable MRP accomplishments:

•In the 1990s we provided research and testimony that helped Central Maine Power become the first US electric utility outside California to operate under an MRP with a price cap index. We provided research and testimony that helped Boston Gas become the first US gas distributor to operate under an MRP with a price cap index.

•We have helped numerous other utilities become the first in their respective jurisdictions to obtain MRPs.

•Multiyear rate plans are now one of the most popular approaches to Altreg in the United States.

•We have played a major role in the spread of MRPs to all four populous provinces of Canada. For example, after initially working for some of Ontario’s largest energy utilities, we have for many years advised the Ontario Energy Board on MRPs, helping it become a world PBR leader.  Most Ontario power distributors operate under “incentive ratemaking” plans that are part of the Renewed Regulatory Framework that we helped the Board to design.  PEG also has played and continues to play a leading role in PBR proceedings in Alberta, British Columbia, and Quebec.

Recent Projects

The ongoing vitality of our US PBR practice is indicated by the following projects we have undertaken in recent years.

•  We co-authored influential white papers on PBR for Lawrence Berkeley National Laboratory.  The first considered the state of the art in PBR in the context of growth in distributed energy resources.  The second paper addressed multiyear rate plans and included research on the O&M, capital, and multifactor productivity trends of US power distributors.

•  We represented the Hawaiian Electric companies in a recent and closely-watched PBR proceeding.

•  Our recent research and testimony for Duke Energy and Puget Sound Energy recently helped those companies secure approval of MRPs in North Carolina and Washington State, respectively.  In 2024, we have filed new evidence for Puget Sound Energy that helps it base its multiyear rate plan proposals on a solid foundation of input price research.

•We speak frequently on PBR at conferences and webinars.  Berkeley Lab has funded our presentations and seminars on PBR to numerous organizations that include NARUC, NASUCA, and the National Conference of State Legislatures.  We helped the NCSL write a white paper on PBR in 2022.

The performance incentives generated by alternative regulatory systems is a critical issue in MRP plan design and advocacy. In research for several clients, PEG has developed a sophisticated model to quantify the impacts on cost performance of alternative concrete regulatory systems. For each system considered, the model generates results for:

•Strength of incentives

•Earnings

•Customer benefits

Using a sophisticated optimizing algorithm, we have modeled how rational companies respond to several key features of regulatory systems. These include:

•Plan term (e.g., 2 -10 years)

•Rate rebasing provisions (e.g., full rate case, efficiency carryover mechanisms)

•Earnings sharing mechanisms 

Our results show that if an MRP is not designed appropriately, some initiatives will not be pursued, and utilities and their customers will both lose. Results can also help managers plan for MRP success. For example, some of the biggest benefits of an MRP may not be realized unless there is timely implementation. Our Incentive Power model can help clients appraise established regulatory options, identify promising new options, and present supportive evidence.

An important part of PEG’s Altreg practice is surveying and analyzing Altreg precedents.  Any assessment of PBR and other Altreg options must take account of developments in North America, elsewhere in the world, and academia. We periodically summarize our Altreg research and analysis in polished white papers and surveys. 

For example, we have prepared four white papers surveying multiyear rate plan and other Altreg trends and precedents for the Edison Electric Institute (“EEI”), in addition to several other reports on Altreg topics for EEI since the early 1990s.  A report on our most recent survey was released in February 2024. 

Other white papers and surveys we have prepared include the following. 

•Several surveys of trends in PBR for Duke Energy and Sempra Energy

•A comprehensive survey of service quality and other PIMs for Detroit Edison  

•A comprehensive survey of service quality benchmark mechanisms and regulatory approaches for the Ontario Energy Board.  This paper was cited by the DC Commission in Order No. 16427.

•A survey of customer-specific reliability benchmark mechanisms for the Ontario Energy Board.   

•A survey of metrics required to be reported as part of AMI installation approval orders for Commonwealth Edison 

•A comprehensive survey and analysis of incentive regulation approaches throughout the world on behalf of the Bundesnetzagentur, Germany’s energy network regulator

•A survey and analysis of the practice of PBR in the US and the UK on behalf of the power distribution companies in the state of Victoria, Australia

•A concept paper on PBR mechanisms, and related cost and measurement issues for the Ontario Energy Board which was published at the outset of the Board’s pathbreaking “Renewed Regulatory Framework for Electricity” initiative

•A survey on the ‘state of the art’ in incentive regulation theory and design for the Electric Power Research Institute.