Tag Archives: incentive based regulation

Looking beyond performance based ratemaking in New York’s Utility 2.0

Rory Christian of EDF has written about using performance-based ratemaking “+” (PBR+) in New York’s Reforming the Energy Vision proceeding. EDF, in taking an important step for an environmental advocate, recognizes the importance of providing the right economic incentives for market participants to achieve environmental goals. Prescriptive solutions too often are misguided and inflexible leading to failure and high costs.

That said, PBR+ may not be the best solution (and I don’t have the immediate answer to this question.) PBR hasn’t had a great track record in California. Diablo Canyon suffered from excessive costs that led to the push for restructuring. The competitive transition charge (CTC) opened the door for market manipulation. And the CPUC couldn’t say “no” when it awarded incentives for questionable energy efficiency gains. Other jurisdictions have had mixed results. Mechanism design is critically important to make PBR work.

Taking a step back from specific policy proposals, an important perspective to consider is that the “regulated utility” is not the same as “utility shareholders.” Shareholders are the true stakeholders in the discussion about the new utility business model. (Utility managers may hijack that role but that probably is not a sustainable position.) So we should be looking outside the box of standard regulatory tools, even PBRs, and ask “how else can utility shareholders see value from the electricity industry outside of their regulated utility affiliate?” There are potential models for alternative approaches that might ease the political and economic transition to the new energy future.

Chuck Goldman at Lawrence Berkeley National Lab made a presentation on the various business model options that are available. The Energy Services Utility (ESU) is an option that deserves greater exploration, particularly in concert with a distributed system operator (DSO). An ESU might provide a model for utility holding company shareholders to participate. But the devil could be in the details.

Nudge and counter-nudge: one combatant

The Atlantic reviewed Cass Sunstein’s latest book on using public policy to redirect individual’s choices. Some complain that the government shouldn’t be influencing daily life in this manner.  However, we already have many other private groups, most businesses, attempting to redirect daily decisions in their favor. But there at least good reasons why we might decide as a larger society to instill counter nudges that lead to overall improved economic decisions and outcomes.

The first is moral hazard where two parties have different amounts of information or levels of incentives. A classic example is a real estate agent and a home buyer. The agent is paid on the percentage of the house price and knows much more about the local market. These conspire to lead to a higher house price on average than would occur in a frictionless market.

The second is the principal-agent problem. In this case, the economic decision-maker is not the actual consumer or producer in the transaction. The health care industry is one classic case where patients defer most of their decisions to a physician, who also happens to be the benefiting service provider. Another case is the split-incentives in the rental housing market where the landlord could make energy-efficiency investments that reduce a tenant’s energy bill, but the tenant actually pays the bill. (I’ll write more on this in a future post.)

Some of this might not be needed with acted like the mathematical automaton that Milton Friedman envisioned, but we do have significant limitations on our abilities to make rational economic decisions. A decentralized price system is probably the best means of allocating use of scarce resources among us. Yet that doesn’t mean that society, through its government, shouldn’t agree to manipulate that price system to arrive at a more preferred set of individual decisions. Thus we should nudge and counter nudge as Sunstein suggests.