How the US Can Address Utility Decarbonization Foot-Dragging

When it comes to climate change, many big US power utilities seem to be looking the other way. For good reason too. Renewables threaten the traditional way they do business — based on a model that ties transmission and distribution to centralized power plants. This system rewards big spending irrespective of its relevance to climate goals and erects barriers to distributing much-needed renewable energy resources. No utility dependent on such a system is about to voluntarily sell off its generating assets, leaving it with only transmission and distribution services. But state lawmakers and regulators could — by changing the traditional formula for rate-setting that rewards huge capital costs at the expense of cheaper localized alternatives.

In addition to revenues from electricity sales, traditional vertically integrated electricity companies earn money by building new generating stations, transmission lines and substations. Every dollar spent on such projects, subject to necessary and often easy-to-obtain approvals, gives them the right to obtain a “fair” return on investment from ratepayers. This made sense a century ago, when utilities were building the nation’s first power plants and stringing up power lines across the country.

Today these utilities face a newer challenge — bringing carbon emissions to zero. This means shutting down fossil fuel burning plants and replacing them with renewables and demand-side management programs. (Reactor life extensions are another possibility, although far less certain given aging management problems and costly upgrades.) The utilities' record so far is unimpressive. To be sure, renewables and demand-side energy management programs have made progress but fossil fuels still produce the lion's share of the nation's electricity — 60% in 2021 — with renewables accounting for only 20% and nuclear, which is declining due to aging reactors, most of the rest at 19%, according to the Energy Information Administration. It’s generally agreed that the current system won't allow those numbers to change quickly enough to meet President Joe Biden’s goal of creating a carbon-free power sector by 2035 and net-zero emissions for the entire economy by no later than 2050.

Cost-of-Service Regulation

One reason is cost-of-service regulation under which state regulators approve rate hike requests based on utility capital expenditures with a built-in return on investment (ROI) — roughly 10% for new generation and a few points more for new transmission. With interest rates rising, utilities are asking for more, often to ensure favorable prices for their stocks and bonds. This antiquated system feeds on projections of growth in electricity consumption (when in theory we should be aiming to reduce it) and does little to encourage the integration of lower-cost, locally distributed energy resources — for example rooftop solar, microgrids, demand response — into power grids. Quite the opposite, in fact, because when regulators routinely approve ROIs for capexes, there’s less impetus to economize. Newer, more efficient and cheaper technologies get pushed to the sidelines.

Cost-of-service regulation — underpinned by a state-approved “construction work in progress” law (allowing ratepayers to be charged for financing costs during and after construction), and compliant state regulators — is why Southern Co. embarked on its disastrous nuclear newbuild project in Georgia. Total cost is now reckoned at $35.7 billion, making it one of the most expensive power plants ever built. Since 2011, Georgia ratepayers have shelled out on average some $1,000 each in additional charges for construction financing of the long-delayed two-reactor newbuild while receiving zero power from the plant. When the first reactor comes on line, ratepayers will encounter a new set of charges reflecting actual construction costs as well as usage rates. Start-up is slated for sometime this spring but has been delayed twice this year and conceivably could be again.

Similar dynamics also led to another Southern Co. fiasco — the multibillion-dollar Kemper carbon sequestration plant in Mississippi, on which the plug was pulled in 2017 after the system proved unreliable and costs had ballooned from $3 billion to $7.5 billion. The plant, intended to gasify lignite coal and store its captured carbon emissions, today stands as a stunning failure to realizing long-touted promises of carbon capture. Complicit in both these disasters is the US Department of Energy, which financially supported both projects and promoted them as new ways in which the nation might fight climate change.

There’s little question that the most egregious examples of cost-of-service regulation are in the US south, where state regulators rubber-stamp rate-hike requests from vertically integrated utilities that continue to operate as monopolies on generation, transmission and regulation. In much of the rest of the country, organized wholesale markets set up competitive pricing systems according to rules established in the late ‘90s by the Federal Energy Regulatory Commission (FERC). FERC’s overhaul allowed access to transmission lines by new entrants, including independent power producers, with the aim of providing more efficient, lower-cost power to consumers. Some states went even further, requiring utilities to sell off their power-generating facilities, leaving only the delivery system (poles and wires) as a continuing monopoly. And many states began looking at ways to reward utilities for introducing demand-side management programs.

Even so, these changes did not do away with the cost-of-service approach to setting rates; nor in most states did they break up vertically integrated utilities, thus preserving the old model: transmission and distribution tied to centralized power plants. The result: distributed energy resources are not getting the rapid buy-in they should from big players still dominating the playing field and profiting from big spending irrespective of its relevance to climate change goals.

New Approaches Needed
 
When customers with rooftop solar panels feed their excess power to the grid, they change our way of looking at supply. At the same time, demand response programs (using sensors, analytics, smart controls) alter how customers use electricity and change the calculations on demand. Utilities are no longer the only providers of electricity. And that should change everything.

According to a January 2023 report by the National Association of Regulatory Utility Commissions (Naruc), the "traditional cost-of-service (COS) structure results in a 'throughput incentive': a reduction in volumetric retail sales by the utility negatively impacts profits. This paradigm can motivate a utility to overinvest in capital resources to maximize opportunity for additional profits. Accordingly, the COS structure can conflict with policy goals to advance EE [energy efficiency] and DF [demand flexibility]."

Most utilities — and states (which control ratemaking in the absence of any national system) — have been slow to heed the warning. But there has been new thinking about the way rates should be set. Instead of rewarding utilities for volume sales and capital spending, 18 states and the District of Columbia are in the process of initiating, a “performance-based ratemaking” (PBR) framework for utility compensation in which rates are designed to incentivize utilities to move to lower-cost renewables that also reduce emissions.

One further state — Hawaii — stands out as the only one to discontinue cost-of-service regulation "and fully leverage a PBR approach," according to the Naruc report. Adopting this approach took years of effort but resulted in a series of metrics allowing the state to benefit from an abundance of rooftop solar that is replacing costly oil-fired generation.

New York state has developed a new compensation structure that it says will more accurately and efficiently value newly installed distributed energy resources. If, say, a utility considers spending $2 billion to replace a substation but instead finds “non-wire” alternative resources to deliver the same amount of electricity, it would be rewarded with a higher ROI for some portion of its capex, to be determined by the regulator.

Skeptics say these steps won’t be enough. They want no less than a revolution in the way utilities operate, beginning with a selloff of generating assets. Left with only transmission and distribution services, the thinking goes, utilities will no longer feel a need to protect centralized generation by erecting barriers to distributed resources.

That would make a big difference. And climate change won’t wait.

Stephanie Cooke is the former editor of Nuclear Intelligence Weekly and author of In Mortal Hands: A Cautionary History of the Nuclear Age. The views expressed in this article are those of the author.