Earlier in this series of commentaries I posed a series of questions about US energy policies implemented at the state and federal levels. My colleague Ken Costello, a former senior economist at the National Regulatory Research Institute, followed up with his own list of provocative questions. For this issue I chose to provide my answer to one of the questions and asked Ken to comment too.

“Does grid modernization advance the “public interest” or is its main intent to enrich utilities (by expanding their rate base) and advance the agenda of special interests (like clean energy vendors, environmentalists and other advocates)?’

 

Branko Terzic:

Firstly, let’s discuss what “grid modernization” (GM) would require in terms of capital investment by an electric utility.

The “grid” refers here to the transmission and distribution networks owned by regulated electric utilities.  These facilities to be owned by the monopoly utility are assumed to provide monopoly services which require regulation as to investment, depreciation rates and operation and maintenance (O&M) expenses.

There may be instances where certain “grid” supporting facilities could be owned and operated by competitive enterprises but that would put the investment outside of typical PSC regulatory authority. One example of outside regulation investment might be distributed storage batteries. Another example is that transmission extensions to new generating facilities may be owned by the generator owner rather than the transmission network.  Who makes such investments is a regulatory or legislative decision.

For utilities to make major investment in GM improvement regulators have used formal or informal “certificates of public convenience and necessity” (CPCN) filings and proceedings. The requirements in such cases are for the utility to 1) demonstrate that the new assets are needed, 2) that alternatives have been explored and rejected as inferior, and 3) that the cost is “reasonable”. The regulator will review the facts presented and usually after public hearings for major projects a decision will be made as to whether approval is in the “public interest” and will be granted or not.

Th GM investment, like all utility investments, is made before the assets go into service so the transmission and distribution assets are paid for, up front, by the utility and booked as Construction Work in Progress (CWIP). When the construction is completed, and the assets go into service, they go on the balance sheet as Plant in Service.  The assets are paid for by debt and equity capital.  The electric utility customers pay for the service delivered by the assets over the asset service life through depreciation expense and a return on rate base which is mostly undepreciated “Plant in Service_

Electric utility “grid modernization” investments can be made for the following purposes:

1. To replace overhead with underground facilities to meet public safety requirements
2. To add new transmission lines to connect to new generation sites.
3. To add capacity to existing transmission lines by replacing conductors.
4. To replace existing transmission substations with higher capacity equipment
5. To replace existing distribution facilities (conductors, substations and transformers) with new facilities able to deliver higher capacity to customers to meet new load caused by electrification of transportation or replacement of natural gas for cooking and space heating
6. To add facilities required to meet environmental standards.

To answer the question the issue of “public interest” also needs clarification. Most state public utility commission enabling statues call for the regulators to meet the goals of “adequate, reliable, safe service at reasonable prices”

Former Federal Power Commission Chairman Joseph C. Swidler writing in his memoirs “Power and the Public Interest” (University of Tennessee 2022) observed:

“A commission, though is not a court. A regulatory agency is a guardian of the public interest, and not merely to adjudicate disputes….a regulatory agency is provided with its own expert and investigative resources to insure that it reaches a correct conclusion, consistent with the facts and the law, governed by the standard of public interest.”

In my opinion “grid modernization” would advance the public interest if done for any of the six reasons for new investment listed above.

Ken Costello comments:

Most industry observers support “grid modernization” (GM) at both the transmission and distribution level. Pressure for GM comes from different quarters: electric utilities, clean air and climate advocates, GM technology vendors, consultants, labor unions, and state and federal politicians and bureaucrats. Wall Street also favors GM.

My focus here is on distribution. I am more of a skeptic, pointing out below some of the difficulties that regulators face in evaluating GM plans by utilities. Regulators must do a deep analysis to determine whether a GM plan is net beneficial to utility customers and society as a whole. After all, we are talking about large sums of money that require, for the sake of the paying utility customers, looking at whether the benefits are comparable.

Some 60 percent of the U.S. electricity distribution system, which is the part of the grid that covers “the last mile” of delivering power to homes and businesses, is older than its 50-year life expectancy. Its design happened at a time when power plants in central locations exclusively controlled a one-way flow of electricity to customers. That is not the world we live in now; a modern system would accommodate greater consumer control and two-way flows of power, facilitating decentralized generation.

Many experts assert that making the transition to a clean energy future will demand new technologies, such as those rooted in GM. New technologies like GM have enormous potential for improving the performance of distribution utilities. They can enhance the quality of utility services, achieve clean energy goals at less cost, lower the cost of existing services, and advance other regulatory objectives effectively and economically. New technologies are also vital for advancing long-term policy objectives, like safety, reliability, resilience, lower cost energy, and improved energy efficiency.

Therefore, it seems obvious that GM is the wave of the future and regulators, without much inquiry, should approve GM plans that ostensibly are in the public interest? But wait a minute, although Branko identified six conditions, any one of which could make GM in the public interest, regulators should look deeply to determine whether a particular GM plan would. That is, even if a GM plan satisfies any one of those six conditions, the regulator may still rightly reject it.

In several states, GM legislative statutes or regulatory rules authorize the public utility regulator to approve GM plans. In evaluating a plan, regulators need to consider the reasonableness of the plan and whether a plan would advance certain objectives, like a reduction in greenhouse gases, facilitation of grid access for renewable and other forms of clean energy, and improved reliability and resilience. Many consider GM to harmonize with the state energy policy, as well as with trends and expected future developments in the electric power industry.

Having said this, regulators face a formidable challenge in ensuring that utility investments in GM are cost-beneficial or in the public interest. Legislative statutes or regulatory rules, while encouraging grid modernization, generally fall short of requiring regulators to approve GM. Regulators will have to judge whether a GM plan is cost-beneficial and achieve the objectives of the GM statute. This is a difficult task.

Regulators have often rejected portions or all of GM proposals by utilities for different reasons. A prominent one is the benefits to utility customers falling short of the costs for GM investments, or poor explanation by utilities on the benefits to customers. Many rejections of GM plans across the country stem from insufficient documentation of utility-customer benefits, as compared with cost implications. We have also seen as a common problem GM investment undergoing cost overruns (sometimes severe).

Regulators must address myriad hard questions:

(1) How should they interpret those benefits that are difficult to quantify and highly uncertain in their decision;

(2) What is the best method of cost recovery that balances utility and customer interests (riders and surcharges versus base rate treatment);

(3) What is the optimal timing of investments - can GM be accelerated too quickly given the high uncertainty over benefits and costs;

(4) How can regulators suppress the utility's inherent incentive to overinvest (e.g., gold plating) given that a utility’s rate base would increase, resulting in higher earnings;

(5) How do the benefits depend upon utility actions in deployment - should utilities be held accountable for achieving the calculated benefits in their GM plans; and

(6) Are other actions available for achieving the same benefits from GM that might be less costly?

GM has become a hot topic for regulators and will continue to do so in the coming years. My advice to regulators: Be vigilant by judiciously reviewing utilities' plans to improve the chances that a decision is in the “public interest”.

This means that regulators should not outright reject a plan just because it would increase electricity rates or be prejudiced against a plan in spite of the evidence; or accept a plan just because it will support clean energy and the governor's/legislative energy agenda, while ignoring the effect on utility customers. There is a danger that either of these scenarios can happen and probably already has in some states. Regulators should not lose sight of the fact that utility customers end up paying for the cost of GM investments in rates.

In the end, GM plans that fail a cost-benefit test would be detrimental to the state. States should reject GM investments of hundreds of millions, or billions, of dollars with negative social returns to the state and its citizens. The burden falls on regulators to make sure that this does not happen.