Connecticut Advances Performance-Based Regulation Reform, Eversource Worries About Investor Capital Attractiveness

Connecticut regulators and stakeholders are building a new utility regulatory framework to achieve state policy goals and improve electricity affordability, but utilities believe this direction may be biased.

The Connecticut Public Utilities Regulatory Authority (PURA) issued its Phase One final decision on performance-based regulation (PBR) on April 26, 2023 (Docket 21-05-15). Drawing on Hawaii's landmark 2021 PBR framework, the decision adopts goals, foundational considerations, and priority outcomes, driving a controversial regulatory "paradigm shift" toward a new utility business model.

The decision states that Connecticut's "traditional business model" and traditional utility regulation are "fundamentally at odds" with today's technology, policies, and the accelerated adoption of distributed energy resources. State utilities and regulators fully agree on this premise, but diverge significantly on solutions.

"PBR has the potential to achieve good results," said Douglas Horton, Vice President of Distribution Rates and Regulatory Requirements at Eversource Energy, "but the current regulatory environment seems overly stringent." He warned that "lowering utility return on equity and replacing it with performance incentives" could have "serious consequences."

PURA Chair Marissa Gillett responded: "Utilities should welcome PBR because it provides a tool to earn returns through better performance. It clearly tells utilities what is expected of them and how to demonstrate performance, a certainty they have never had." She added that it offers "more helpful guidance for profitability" than how to achieve cost recovery in rate cases.

Analysts note that other states such as Illinois and New York have adopted limited and targeted performance measures to better align utility and customer interests, but Connecticut is building on Hawaii's work to pursue more comprehensive regulatory reform. Many stakeholders support PURA's customer-centric plan, but the state's investor-owned utilities (IOUs) say reduced revenues could hinder urgent investments in distribution system infrastructure upgrades.

Connecticut's PBR

Chair Gillett said that, similar to Hawaii, Connecticut's Phase One goal is to begin a new comprehensive regulatory transformation with key goals and foundational considerations, linked to utilities' priority outcomes.

The final decision reports that goals include improving utility operations, achieving public policy goals, enhancing customer service, and ensuring rates are reasonable, fair, and affordable. The report acknowledges these goals "may require" new utility investments, thus hindering affordable rates in the "short term," but adds that "tension between regulatory goals is inherent to utility regulation."

Chair Gillett said: "Connecticut's governor and legislators want this regulatory reform because of dissatisfaction with high electricity rates, but they also recognize that achieving state policy goals requires infrastructure investment." She added that investors and stakeholders in Hawaii noted during PURA's introductory workshop that "certainty, predictability, and clear rules" help the investment community make commitments.

Connecticut stakeholders are deeply engaged in discussions on the first docket of PBR Phase Two (Docket 21-05-15RE01), examining how utility revenues are earned and distributed. According to the Phase One decision, this docket may guide "the remainder of the PBR investigation" and the state's future utility regulation. But most stakeholders believe it raises sharp disagreements about whether utilities and their customers are adequately protected, and there seems to be no simple solution.

The overall process is divided into three phases, expected to be completed by the end of 2024. Discussions on performance metrics, scorecards, and performance incentive mechanisms (PIMs) have begun as part of the second docket of Phase Two (Docket 21-05-15RE02). Concepts for the initial integrated distribution system planning (IDSP) design are being developed in the third docket (Docket 21-05-15RE03).

As national interest in PBR elements, especially PIMs, accelerates, regulators, utilities, and other stakeholders in many states are undertaking related work that provides reference for Connecticut, Gillett and others said.

PBR in other states

The North Carolina Clean Energy Technology Center (NCCETC) October 26 grid modernization policy update shows at least 24 state-level regulatory PBR actions. But Autumn Proudlove, NCCETC's Deputy Director of Policy and Markets, said many other states' ongoing PBR efforts are far narrower in scope than Connecticut's.

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

Shannon Laun, Vice President and Director of the Conservation Law Foundation (CLF) Connecticut, said the main lesson from other states is a warning: PBR "is unlikely to be effective unless there is a comprehensive shift from cost-of-service rate-making to a comprehensive performance framework."

But Connecticut has learned other important lessons from other states.

Gillett said: "Just as New York and Hawaii are still working to improve performance mechanisms, we want to build a PBR framework that allows for adjusting PIMs or adding PIMs." She added: "The purpose is to communicate to all stakeholders that they can expect changes and how to seek them."

Claire Coleman, Consumer Counsel for Connecticut's Office of Consumer Counsel, added that Illinois' equity provisions demonstrate how PIMs can drive equitable performance.

Matthew McDonnell, Partner, Executive Vice President, and Head of Consulting Services at Strategen Consulting, said: "Connecticut is improving on Hawaii's work, adding equity metrics and incentives that Hawaii deferred." McDonnell served as legal advisor to the Hawaii Commission and now provides the same service to PURA.

McDonnell said: "In Hawaii, skeptics said PBR works for distribution utilities, while in Connecticut, they say Hawaii shows PBR works for vertically integrated utilities, but PBR can be designed to fit any market structure."

Recent Phase Two discussions have raised a question many stakeholders believe could determine the direction of Connecticut's PBR: Should utilities be subject to PIMs for outcomes over which they have limited control?

Major debate: Control

Analysts agree that the debate over which outcomes utilities can influence may be critical, as it was in Hawaii.

Chair Gillett said: "It is clear there are differing views on whether utilities should be subject to PIMs for outcomes they believe they cannot control. The purpose of this docket is for each stakeholder to provide persuasive evidence supporting their position."

Jennifer Potter, Director of Regulatory Innovation at Strategen, said Hawaiian Electric's concerns about control "demonstrate the need for additional PIMs" to create revenue opportunities for utilities "based on performance rather than traditional cost recovery." Potter served as a commissioner on the Hawaii Public Utilities Commission during the development and approval of Hawaii's PBR.

Lindsay Griffin, Northeast Regional Regulatory Director at Vote Solar, and CLF's Laun acknowledged that utilities' concerns about control and financial interests are understandable. Connecticut's Office of Consumer Counsel agreed in an August filing that PIMs require utilities to have some control over outcomes. But Consumer Counsel Coleman added that requiring 100% control would diminish the potential of PIMs to drive results.

Eversource Energy's Horton said traditional cost-of-service rate-making prevents "excessive rates for customers" and also prevents "rates so low that utilities become financially unsound." He added: "PBR with these goals can align utility incentives with state policy and customer concerns."

But Horton said if PURA's PBR framework "includes penalties for items utilities cannot control and cannot quantify against a baseline for measurement," it would be "punitive." He added that Eversource estimates that the costs of generation, transmission service, and achieving policy goals mean only about 25% of customer bills are within the distribution utility's control.

Horton said penalties and rewards for managing that 25% "are absolutely acceptable, but it is unclear whether that is PURA's intent."

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

Chair Gillett responded: "Once PBR is in place, and stakeholders realize it benefits utilities and their customers and achieves Connecticut's policy goals, PURA's rating will improve significantly." She added: "Meanwhile, the sky has not fallen; Eversource just reported record profits."

Gillett continued: "But it is important not to expect rates to be lower than today's levels." Modernizing Connecticut's aging infrastructure requires significant capital expenditure, but "PBR can keep rates lower than they would otherwise be because utilities will have incentives to achieve the best outcomes for customers."

Daniel Canavan, Vice President of Regulatory Affairs at Avangrid subsidiary United Illuminating, said the "first of four core principles" in the company's PBR design is that "for outcomes where PIMs require utilities to invest resources, time, and effort, utilities must have control." United Illuminating is the smaller of Connecticut's two IOUs.

Canavan said PIMs "should also be based on objective metrics" and "tracked over time," as new metrics could be distorted by "unique events." He added: "PURA should be cautious in using customer resources to achieve outcomes that have not been proven through cost-benefit analysis to deliver benefits exceeding costs."

Consumer Counsel Coleman and CLF's Laun both agreed that sufficient data is needed to set PIM baselines.

Laun continued: "Stakeholders do not want utilities held responsible for things they cannot control, although 100% control may be too demanding." But she added that the threat to utilities "is not entirely clear," because "PBR only negatively affects utilities when they fail to meet performance standards."

Other stakeholders believe utilities' concerns about control reflect skepticism about the feasibility of eliminating the financial certainty of returns guaranteed by cost-of-service rate-making.

The real debate: Money

PURA's Phase One decision calls for a paradigm shift to balance utilities' preference for capital expenditures (which earn return on equity, ROE) and less capital-intensive performance-oriented spending.

Mark LeBel, Senior Associate at the Regulatory Assistance Project (RAP), said part of regulation is making utilities operate more like "competitive enterprises." LeBel is the lead author of a new RAP study on PBR's potential. He added: "A higher ROE is only good policy if utilities earn it."

LeBel said if utilities perform well, "they should expect to earn more than the cost of equity and reward investors," but if they "perform poorly, they should expect only the cost of equity, or perhaps even less."

Eversource's Horton said discussions about lowering ROE and replacing it with PIMs are "troubling." He added that it is unclear whether this would provide utilities with a market-competitive ROE that would "attract investor capital."

Horton said incentives balancing capital and operating expenditures "do not necessarily increase utility earnings." He said it "adds a new return component" that may not favor affordability and makes IOUs' financial position less attractive to investors.

Horton continued that PBR could make "attracting the capital needed to upgrade Connecticut's aging infrastructure difficult." If PIMs are insufficient to meet utilities' revenue requirements, infrastructure failures could cause PBR to "collapse under its own weight."

Strategen's McDonnell said utilities' concerns about their revenue requirements are legitimate. "Hawaii took nearly two years to develop its revenue mechanism," and Connecticut "may spend significant time in the next phase of the proceeding" to address this concern.

But Strategen's McDonnell continued: "The goal of PBR is to protect utilities' financial integrity while accurately calibrating risk between utilities and customers." "This does not mean zero utility risk" or "relieving utilities of the responsibility to earn PIMs through high-level performance."

McDonnell acknowledged that PBR requires utilities to face more uncertainty about revenue requirements than traditional regulation. He said ensuring guardrails against unexpected outcomes can allow them to focus on understanding risks and opportunities in performance rewards and penalties.

McDonnell said PURA understands the importance of utilities' financial integrity. "The cost-of-service revenue requirement is the starting point for building a PBR framework that allows utilities to learn to secure earnings through PIMs."

Chair Gillett said: "Utilities' financial stability and integrity are important to PURA because state law requires it to recognize how this affects utilities' service to ratepayers." "But I am an active regulator because regulators with different regulatory philosophies are needed to achieve the policy goals of the governor and legislature."

Gillett continued: "PBR will provide the certainty and clarity investors want and need to work with utilities." She added: "When PBR is fully implemented, Connecticut utilities' credit and financial positions will remain stable or improve, as was the case with Hawaiian Electric."