Connecticut PBR Push Raises Investor Capital Concerns for Eversource

Connecticut regulators and stakeholders are constructing a new utility regulatory framework aimed at achieving state policy goals and enhancing electricity affordability, but utilities caution that the approach may be misguided.

The Connecticut Public Utilities Regulatory Authority (PURA) released its phase one final decision on performance-based regulation (PBR) on April 26, 2023, under Docket 21-05-15. Drawing on the landmark Hawaii 2021 PBR framework, the decision adopts goals, foundational considerations, and priority outcomes for a controversial regulatory "paradigm shift" to a new utility business model.

The decision states that Connecticut's "legacy business model" and traditional regulation are "fundamentally at odds" with today's technologies, policies, and accelerating adoption of distributed energy resources. While utilities and regulators agree on this premise, they diverge on the resolution.

"There is potential for PBR to work out well," said Douglas Horton, vice president of distribution rates and regulatory requirements at Eversource Energy, Connecticut's dominant investor-owned utility. However, "the current regulatory environment seems overly punitive." He cautioned that "lowering the utility return on equity and replacing it with performance incentives" could have "drastic ramifications."

PURA Chair Marissa Gillett responded: "Utilities should welcome PBR because it gives them tools to earn from better performance. It specifically tells utilities what is expected of them and how to demonstrate that performance, which is a level of certainty they have never had," adding that it offers "more helpful guidance toward earnings than how to achieve cost recovery in a rate case."

Other states, such as Illinois and New York, have adopted limited and targeted performance-based measures that better align utility and customer interests, but Connecticut is expanding on Hawaii's work with even more comprehensive regulatory reform, analysts agree. Many stakeholders support PURA's customer-focused plan, but the state's investor-owned utilities (IOUs) argue that reduced revenues could impede urgently needed investment in distribution system infrastructure upgrades.

Connecticut's PBR Framework

Like Hawaii, Connecticut's phase one objective was to begin its new regulatory transformation with key goals and foundational considerations linked to priority outcomes, Chair Gillett said. The goals include better utility operations, meeting public policy goals, improved customer service, and reasonable, equitable, and affordable rates. The final decision acknowledged that these goals "may require" new utility investments that could impede affordable rates "in the short-term," but noted that "tension between regulatory goals is an inherent aspect of utility regulation."

"Connecticut's Governor and lawmakers want this regulatory reform because of frustrations with high electricity rates, but they recognize infrastructure investment is needed to reach state policy goals," Gillett said. Hawaii investors and stakeholders told introductory PURA workshops that "certainty, predictability, and clear rules" can lead to investment community commitment.

Stakeholders are now deep into the first docket of phase two (Docket 21-05-15RE01), examining how utility revenues will be earned and shared. This docket could guide "the remainder of the PBR investigation" and the state's future utility regulation, according to the phase one decision. However, it is leading to heated differences over whether adequate protections exist for utilities and customers, with no easy solutions apparent.

The overall process will have three phases, expected to be completed by the end of 2024. Discussions on performance metrics, scorecards, and performance incentive mechanisms (PIMs) are underway in the second docket of phase two (Docket 21-05-15RE02). A preliminary integrated distribution system planning (IDSP) design is being developed in a third docket (Docket 21-05-15RE03).

As interest in PBR elements, especially PIMs, accelerates nationally, regulators, utilities, and stakeholders in many states have ongoing work that has informed Connecticut, Gillett and others said.

Other PBR Efforts

At least 24 state regulatory PBR actions were noted in the North Carolina Clean Energy Technology Center's (NCCETC) October 26 Grid Modernization policy update. However, many states are taking significantly more limited approaches than Connecticut, said Autumn Proudlove, NCCETC associate director for policy and markets.

Many IOUs, including Xcel Energy Colorado, Central Maine Power, and Unitil Massachusetts, have proposed PIMs, NCCETC found. PIMs are being studied in Illinois, North Carolina, and New Hampshire. Broader PBR proceedings are ongoing in Arizona, Maryland, Michigan, Minnesota, and Iowa. In other states, utilities or regulators have considered PIMs for energy efficiency, battery storage, and resilience.

The main lesson from other states is a warning, said Shannon Laun, vice president and director of Connecticut at the Conservation Law Foundation (CLF). PBR is "unlikely to be effective without a comprehensive shift from cost-of-service ratemaking to a comprehensive performance-based framework."

Connecticut has learned additional lessons. "In the same way New York and Hawaii are still working to improve performance mechanisms, we want a PBR framework that allows making adjustments to PIMs or adding PIMs," Gillett said. "The intent is to communicate to all stakeholders that they can expect changes and how to seek them."

Illinois equity provisions showed how PIMs can drive equity performance, added Claire Coleman, consumer counsel at the Connecticut State Office of Consumer Counsel.

"Connecticut is improving Hawaii's work, with the metrics and incentives for equity Hawaii postponed," said Matthew McDonnell, partner, executive vice president, and head of consulting services at Strategen Consulting, who acted as legal consultant to the Hawaii commission and is doing the same for PURA.

"In Hawaii, skeptics said PBR was for distribution utilities, and in Connecticut they are saying Hawaii showed it is for vertically integrated utilities, but PBR can be designed to suit any market structure," McDonnell said.

Recent phase two discussions have raised a pivotal question: Should utilities have PIMs for outcomes over which they have limited control?

The Control Debate

An emerging debate over what outcomes utilities can impact may be pivotal, just as it was in Hawaii, analysts agreed.

"It is clear there are different opinions on whether utilities should have PIMs for outcomes they don't view as within their control," Chair Gillett said. "The purpose of this docket is for each stakeholder to provide persuasive evidence to the record supporting their position."

Hawaiian Electric's concerns about control "showed additional PIMs would be needed" to create revenue opportunities based on performance rather than traditional cost recovery, said Jennifer Potter, Strategen director of regulatory innovation and a former commissioner with the Hawaii Public Utilities Commission during its PBR development.

The utilities' concern with control and financial interests is understandable, acknowledged Lindsay Griffin, Vote Solar regulatory director for the Northeast, and CLF's Laun. Some utility control of outcomes is necessary with a PIM, the Connecticut Office of Consumer Counsel agreed in an August filing. But the need for 100% control narrows the potential of PIMs to drive outcomes, Coleman added.

Traditional cost-of-service ratemaking has prevented rates "too high for customers" and rates "not too low for utilities to remain financially sound," said Eversource's Horton. "PBR with those goals can align utilities' incentives with state policy and customer concerns."

However, PURA's PBR framework would be "punitive if it included penalties for things not within a utility's control and quantifiable against a measured baseline," Horton said. Eversource estimates that costs for generation, transmission service, and meeting policy goals leave only about 25% of a customer's bill in a distribution utility's control. Penalties and rewards for managing that 25% "would absolutely be acceptable, but it is not clear if that is PURA's intention."

Because of PURA's work on PBR, S&P Global Regulatory Research Associates found that Connecticut's uncertain regulatory environment for utilities has become "one of the lowest ranked in the U.S.," Horton said.

PURA's ratings "will improve significantly once PBR is in place and stakeholders realize it benefits utilities and their customers and meets Connecticut policy goals," Gillett responded. Meanwhile, "the sky is not falling, and Eversource just reported record-breaking profits."

But "it is important not to expect rates lower than they are today," Gillett continued. Significant capital expenditures will be needed to modernize Connecticut's aging infrastructure, but "PBR can keep rates lower than they otherwise would have been because the utilities will have incentives to achieve the best outcomes for customers."

Daniel Canavan, vice president of regulatory affairs for Avangrid subsidiary United Illuminating, Connecticut's smaller IOU, outlined four core principles for PBR design. "The first is that utilities must have control of outcomes for which PIMs require them to use resources, time, and energy." PIMs "should also be based on objective metrics" that have been "tracked over time," as new metrics could be distorted by "unique events." And "PURA should tread cautiously when using customer resources to achieve an outcome not shown by a cost-benefit analysis to provide more customer benefit than it costs."

Adequate data will be needed to set PIM baselines, both Coleman and Laun agreed. "Stakeholders do not want utilities to be accountable for what they cannot control, though 100% control is perhaps a bridge too far," Laun said. But the threat to utilities "is not completely clear" because "PBR will only negatively impact the utility if it fails to meet the performance standards."

Other stakeholders view utility concerns about control as doubts about eliminating the financial certainty of returns guaranteed by cost-of-service ratemaking.

The Money Debate

PURA's phase one decision called for a paradigm shift to equalize utility biases between capital expenditures that earn returns on equity (ROE) and less capital-intensive performance-focused expenditures.

"Part of regulation is to make utilities perform more like competitive businesses," said Mark LeBel, senior associate at the Regulatory Assistance Project (RAP) and lead author of a new RAP study on PBR's potential. "Higher ROEs are good policy only if the utility earns them." If utilities perform well, "they should expect to earn more than the cost of equity and reward their investors," but "if they perform poorly, they should expect only the cost of equity, or perhaps less."

Discussions about lowering the ROE and replacing it with PIMs are "unsettling," said Eversource's Horton. It is not clear that will provide utilities a market-competitive ROE that will "attract investor capital." Equalizing incentives for capital and operational expenditures "would not necessarily increase the utility's earnings," he said, as it "adds a new return component" that could work against affordability and make IOU financials less investor-friendly.

PBR could make it "difficult to attract the capital needed to upgrade Connecticut's aging infrastructure," Horton continued. If PIMs are inadequate to meet revenue requirements, failing infrastructure could cause PBR to "collapse under its own weight."

The utilities' concern about revenue requirements is legitimate, said Strategen's McDonnell. "Hawaii spent almost two years setting its revenue mechanism," and Connecticut "may spend the entire next phase of the proceeding" addressing that concern. But the goal of PBR is to protect the utility's financial integrity while accurately calibrating risk between utilities and customers. "That does not mean zero utility risk" or "insulating utilities from the responsibility to perform at a high level to earn PIMs."

PBR requires utilities to face more uncertainty about revenue requirements than traditional regulation, McDonnell acknowledged. Guardrails that ensure protection against unintended outcomes can allow them to focus on understanding risks and opportunities in performance rewards and penalties. PURA understands the importance of utilities' financial integrity, he added. "The cost-of-service revenue requirement is the starting point in building a PBR framework that allows utilities to learn to secure earnings with PIMs."

"The utilities' financial stability and integrity are important to PURA because state law obligates it to recognize how that bears on utilities' services to ratepayers," Chair Gillett said. "But I am an activist regulator because a regulator with a different regulatory philosophy is needed to meet the policy goals of the Governor and the legislature."

"PBR will provide the certainty and clarity that investors want and that utilities need to work with it," Gillett continued. "Connecticut utilities' credit and financials will remain stable or improve when PBR is fully implemented, just as they did for Hawaiian Electric."