Approaches to Utility Remuneration and Incentives Prepared for: - PowerPoint PPT Presentation

www.londoneconomics.com ■ London Economics International LLC Approaches to Utility Remuneration and Incentives Prepared for: The Ontario Energy Board www.londoneconomics.com September 17-18, 2019

Introduction www.londoneconomics.com ■ 2 To provide context for potential approaches to utility remuneration in Ontario, LEI will review experiences in other jurisdictions Exploration of changes to utility remuneration is driven by the desire to encourage continuous improvement and greater economic efficiency while creating a foundation for innovation which benefits customers Prior to considering changes to utility remuneration, it is important to understand what we are changing from As such, we will begin with an overview of Ontario’s current remuneration policies and rate-setting options We will then look to other jurisdictions (the United Kingdom, New York, and California) to gain insight into various examples and lessons learned with regards to utility remuneration Overall, these case studies offer relevant takeaways on the challenges encountered, and the nature of solutions developed in their respective contexts

Agenda www.londoneconomics.com ■ 3 Agenda 1 Introduction 2 Case Study 1: The United Kingdom 3 Case Study 2: New York 4 Case Study 3: California 5 What concepts could be explored in Ontario?

Introduction ► Defining aspects of Ontario’s market www.londoneconomics.com ■ 4 Ontario has one of the more sophisticated regulatory frameworks in the world, which can be characterized by numerous defining features ONTARIO’S DEFINING ASPECTS Relatively large number of Significant distributors provincial and municipal No supply ownership function for distributors Approximately 20 years of regulatory experience in the power sector Deployment of performance-based regulation (“PBR”) Hybrid of planned and market approach to generation Use of Global development and Adjustment to dispatch fund capacity and policy objectives

Introduction ► Ontario’s current remuneration policies www.londoneconomics.com ■ 5 Ontario’s current regulatory framework has evolved from COS, to IRM focused on productivity, to a broader scorecard-based incentive structure The current regime: ► Progression of remuneration models allows utilities to choose from a menu of incentive ▪ options uses a scorecard to monitor outcomes Future ▪ regimes ▪ deploys benchmarking to drive efficiencies Performance Under the Renewed Regulatory Framework ► Scorecard (“RRF”), distributors have 3 options for setting Each model builds upon and rates: Price Cap IR, Custom IR, or an Annual IR incorporates elements of the Price Cap previous one Index I - X RRF calls for distributors to focus on customer ▪ preferences and demonstrate that investment plans Ontario today support cost-effective planning and operation COS Electricity distributor scorecard metrics Operational Public policy Financial Customer focus effectiveness responsiveness performance Financial Safety, Conservation ratios for Service system and demand liquidity, quality, reliability, management, leverage, customer asset connection and satisfaction management, of renewable profitability cost control generation Source: OEB. 2017 Sector-Wide Consolidated Scorecards of Electricity Distributors. October 2018.

Introduction ► Ontario’s rate -setting options www.londoneconomics.com ■ 6 Ontario distributors have three rate-setting options, choosing the method that best meets their requirements and circumstances Key elements of the three rate-setting options Setting of Rates Price Cap IR Custom IR Annual IR Index “Going - in” Rates Determined in a single forward test-year COS Determined in a multiyear No COS review, existing rates review application review adjusted by the Annual Adjustment Mechanism Form Price Cap Index Custom Index Price Cap Index Coverage Comprehensive (i.e. Capital and OM&A) Inflation Composite Index Distributor-specific rate trend for Composite Index Adjustment Mechanism the plan term to be determined by Annual the Board, based on: (1) the Productivity Peer Group X-factors comprised of industry Based on Price Cap IR-X-factors distributor’s forecast (revenue and TFP growth potential and a stretch factor costs, inflation, productivity); (2) the inflation and productivity analyses; and (3) benchmarking to assess the reasonableness of the distributor’s Role of Benchmarking To assess reasonableness of distributor cost N/A forecasts forecasts and to assign stretch factors Sharing of Benefits Productivity factor Stretch factor Case-by-case Highest Price Cap IR stretch factor Term 5 years (rebasing plus 4 years) Minimum term of 5 years No fixed term Same as in the 3 rd generation incentive regulation Z factors Performance Reporting A regulatory review may be initiated if a distributor’s annual reports show performance outside of the +/ - 300 basis point & Monitoring earnings dead band or if performance erodes to unacceptable levels Appropriate for Distributors that anticipate some Distributors with significantly large Distributors with relatively steady incremental investment needs will arise multi-year or highly variable state investment needs during the plan term investment commitments with relatively certain timing and level of associated expenditures Source: OEB. Renewed Regulatory Framework for Electricity Distributors: A Performance Based Approach. October 2012. p.13.

Introduction ► Key issues for utility remuneration www.londoneconomics.com ■ 7 The underlying key issues prompting consideration of change in utility remuneration are wide ranging Rapid pace of evolution Aligning capex and opex 01 incentives Motivation for evaluating changes to utility remuneration is driven by Alignment requires a margin that declining technology costs and encourages utilities to treat capex potential for increased customer and opex interchangeably, and 02 choice leads to ownership and capital neutral decisions Providing greater Managing uncertainty 03 customer choice and allocating risk Will require consideration of what Requires advanced scenario sorts of choices are valuable to planning tools and due diligence consumers, how much it costs to on the part of utilities 04 make that choice available, and how choice can be allowed without creating intraclass subsidies Funding public policy 05 mandates Reassessing the The prospect of grid defection regulatory compact limits policymakers’ ability to use Involves refining the the distribution bill to accomplish understanding of the obligation a range of social objectives 06 to serve and what constitutes just and reasonable rates

Introduction ► Review of approaches from other jurisdictions www.londoneconomics.com ■ 8 The jurisdictional case studies selected for review provide initiatives and lessons for Ontario Jurisdictions reviewed include the UK, New York, and California ► These jurisdictions share a common history with Ontario of unbundling from vertically ▪ integrated utilities to disaggregated generation, transmission and distribution (except for California, which is partially unbundled) Akin to Ontario’s IESO, many of these jurisdictions have an independent system ▪ operator which administers a wholesale energy market All jurisdictions have moved away from traditional COS regulation ▪ Rationale for selecting case study jurisdictions Rationale Approach Innovative features RIIO (Revenue = Incentives + Innovation PBR • Financial incentives tied to distributor + Outputs) performance-based underpinned performance outcomes regulatory model underpinned by a by a focus on • Sharing of totex savings between UK focus on total expenditure totex customers and the utility Ongoing REV and VDER initiatives tackle • Utility demonstration projects under the evolving role of the distribution Hybrid of PBR REV to explore new products and utility and the monetization of DERs for and DSPP services NY utilities and third parties Lessons from regulator-led DER Action • Ownership-neutral DER incentive pilot Three-year rate Plan as well as an incentive pilot mechanism plans (COS mechanism to encourage utility • DER wholesale market participation hybrid) CA investment in DERs initiative under development Acronyms: Reforming the Energy Vision (“REV”) ; Value of Distributed Energy Resources (“VDER”) ; Distributed System Platform Provider (“DSPP”)

Introduction ► Comparison of selected jurisdictions www.londoneconomics.com ■ 9 Of the jurisdictions selected, Ontario is most comparable to New York in terms of installed capacity and annual load Installed capacity Population Number of distributors Distributors have supply/procurement functions Total energy supplied Peak demand Load growth Sources: OEB; IESO; Digest of UK Energy Statistics; Ofgem; New York State Comptroller; NYISO; California Energy Commission; Energy Information Association; United States Census Bureau; US Bureau of Economic Analysis.

Agenda www.londoneconomics.com ■ 10 Agenda 1 Introduction 2 Case Study 1: The United Kingdom 3 Case Study 2: New York 4 Case Study 3: California 5 What concepts could be explored in Ontario?