By Jake Brooks
The Ontario Energy Board released a direction-setting decision on April 3 confirming that electricity distribution rates in Ontario will soon have to follow new rules, a change designed to clear the path for investments in energy efficiency, renewables and other customer initiatives that reduce consumption. Titled, “A New Distribution Rate Design for Residential Electricity Customers,” the Board’s policy will likely have wide-ranging impacts on the electricity system in Ontario, spread over the 4-5 years that it will take to implement.
Brian Hewson, Senior Manager of Strategic Policy at the OEB, says, “This policy change is about preparing for the future, addressing the transformation in the electricity sector, in particular customers’ new demands on the system. It’s about ensuring the distributors are able to respond to customers’ expectations for greater reliability, and have the flexibility to adapt to new technologies that customers want.”
The primary driver underlying the new policy is a growing recognition that the energy system is changing dramatically: New technologies for energy efficiency, generation and storage are making it possible for attractive investments to be made closer to the retail end of the electricity spectrum, rather than always being structured as large-scale investments sited at high-volume utility centres.
“It has long been a problem that local distribution companies incurred risk every time a customer found a way to save energy or make their own power,” said APPrO President Dave Butters. “The Board is to be commended for finding a way to alleviate these barriers to efficiency and self-generation, while ensuring revenue stability for distributors.” Many observers believe the decision will allow electricity distributors to entertain an unprecedented range of new proposals for generation, load management, storage, microgrids and other kinds of infrastructure. The development proposals could come from within the utility, from its customers, from entrepreneurs with innovative ideas for deploying new technology, and from consortia with multiple players.
Electricity distribution rates typically represent 20 – 25% of the consumer’s bill in Ontario, covering the cost of the local wires, poles and billing systems. The rest of the bill is for the electricity commodity itself (approximately 50-60%), bulk power transmission and grid operation (15-20%). The Board’s recent decision affects distribution rates for residential and low volume customers only. However it plans to move on and make the rates for larger customers, and for gas customers, consistent with the new policy. In fact, the OEB launched a new policy process on May 28, and is developing similar proposals for other rate classes, to reflect the overall policy direction of ensuring that a greater share of distribution costs are collected through fixed charges.
Although Ontario is one of the first jurisdictions to move definitively in this direction for electricity, the Board’s rate design decision is in line with international developments and changing marketing practices for other types of services. In a number of similar sectors the cost of delivering a commodity is fixed, while the cost of the commodity itself varies according to consumption and other factors.
“It made no sense to have the local distributor losing money every time a customer found a way to save energy or operate more efficiently,” Butters said. With this type of policy, generally known as “revenue decoupling,” the local utility can facilitate customer innovations, or at least operate neutrally towards them, without damaging its own income stream. Fearing uncontrolled growth in certain new technologies – and a sizeable erosion in distribution revenue that could conceivably put the reliability of the local grid at risk – some distributors in Ontario had proposed significant additional fees for customers who generated their own power, and many others were worried that increasing levels of efficiency might impact the costs that would have to be collected from future customers. With revenue decoupling, these problems will in all likelihood become relics of the past.
Some may see this as a watershed moment in utility history, when local utilities became facilitators of a changing suite of energy services, rather than quasi-monopolistic vendors who also owned the only distribution channel for a single essential service.
In its announcement, the Board said, “Under the new policy, electricity distributors will structure residential rates so that all the costs for distribution service are collected through a fixed monthly charge. This change will help achieve three main objectives:
1. It will enable residential customers to leverage new technologies, manage costs through conservation, and better understand the value of distribution services.
2. It is a fairer way to recover the costs of providing distribution service.
3. It will provide greater revenue stability for distributors, which will position them for technological change in the sector, remove any disincentive to promote conservation, and help with their investment planning.”
Although the direct and short term impacts will be felt by residential consumers, the more significant longer term impact will be noticed by everyone: Distributors will be able to accommodate all kinds of innovative technology proposals, from self-generation and microgrids, to energy storage and demand management. If the right financial conditions are in place, local utilities could transform themselves from simple distributors and retailers into finely balanced, highly-efficient networks of resources incorporating all sorts of specialized, value-adding businesses.
The Board’s policy will likely encounter controversy. A range of customer groups and energy sector stakeholders were consulted as the Board prepared its policy. Several of them voiced concerns and some will likely continue to do so. Some utilities raised doubts because certain classes of customers will likely see increases or decreases in monthly bills that will be difficult to explain. An environmental group objects to the policy because they believe it will reduce one of the incentives for conservation. Some LDCs are wondering if the change will affect their ability to meet their mandatory conservation targets. The Board has recruited stakeholders to a new working group on planning related to the policy. A significant communication initiative is expected later in the year when further details are available.
Electricity rate expert Richard Ford of Sageline Consulting acknowledges that the new rate design may encounter resistance from certain customers who experience rate increases. However, “the savings from having the additional options at their disposal will eventually outweigh any costs incurred in the short run,” he says. Further, fixed distribution charges may lead to conditions that would significantly reduce the likelihood of overbuilding grid capacity in the future. That kind of change could mean even greater savings for consumers in the future, he believes. “This decision is in line with OEB policy and practice – making high level decisions that act in the best interests of the customer while striving to be fair across all classes of customers.”
The new rate design policy will certainly have different effects in different areas. Each distributor will still design its own rates, propose its own infrastructure upgrades, and respond to proposals from its own unique set of customers and entrepreneurs. The Board will not be reviewing every investment. But it is safe to assume that the range and scale of new investments will grow significantly. In fact some distributors are already considering proposals from the private sector that would produce significant new investments.
Board decisions are usually intended to be long-term and direction-setting. Minor refinements are possible but a fundamental change of course is unlikely. Going forward the Board wants to make sure LDCs have no financial disincentive to accommodating energy efficiency, renewable energy, or net metering. They also intend to provide revenue certainty to LDCs and a greater degree of fairness to customers, recognizing how the costs and benefits of distribution services actually operate. On these principles the Board is very firm.
The Board has outlined the key program principles it hopes to impress on stakeholders. High among these is that the proposed change to a fixed charge structure for distribution rates will be revenue neutral. No additional money will be collected in total. Other key points highlighted by the OEB include the following:
• The rate structure is designed to be fair to all customer classes, to investors and to LDCs.
• The change will create revenue stability for distributors and cost stability for customers, assisting with planning.
• The change will facilitate all kinds of grid modernization, whether initiated by the distributor, by its customers or by other parties. This is highly important as estimates for the amount of grid modernization needed in the next 10 years range from the billions to the tens of billions.
• The new rate structure will reduce customers’ cost exposure to short-term weather related changes.
• It will not necessarily reduce distribution charges for those who stay connected while reducing consumption. (Using less electricity doesn’t mean that poles or wires are less expensive.)
Key long term benefits are outlined as follows:
• Residential customers will have more opportunity to take advantage of new technologies emerging in the market.
• Distributors will be able to ready their grids for smart grid and green energy initiatives in a financially sound way.
Board staff acknowledge that the new rate design policy will not cause a mass migration to innovative new technology overnight. In fact, distributors have been studying smart grid and green energy improvements for years and in many cases have found ways to integrate the most attractive of the new technologies into their systems already. However, as distributor applications for grid renewal increasingly rely on substantial new infrastructure investments to facilitate efficiency, smart grid and renewables, the obstacles to making such investments, or working with others to do so, will be substantially reduced if not eliminated. It might be said that, with this decision, the Board is making innovation part of the regular business of maintaining the grid for Ontario’s electricity distributors.
Mr. Ford points out an inconvenient fact of life for those in the rate-setting business: “There is no perfect way to set charges. Every charging structure is a compromise between the interests of all customers. This also means that for any specific change there will be individuals who are better off or worse off than before. Focusing on changes is not usually the best way to evaluate a policy change. The important consideration is whether the change is beneficial overall for existing and for future customers.”
The Board is being careful to take a measured approach and leave time for mid-course corrections. It said, “We will implement the change gradually to help customers whose bills will be increasing. Over the next four years, the fixed monthly rate will increase gradually, and the usage rate will decrease gradually. By 2019 there will only be a fixed monthly rate for distribution services and no usage rate or volumetric charge per kWh. As a result, the OEB will be able to remove the current restrictions on net metering and customer-owned renewable generation. The OEB also intends to remove the standby rate when the new rate policy is implemented for commercial customers. These changes will help promote greater adoption of renewable generation and net metering.”
Some believe that the initiative carries the same kind of opportunities and difficulties familiar to those who propose tax reform. There is much work ahead, both in working out the detailed design of the new low volume rates, as well as with related rate redesign initiatives for larger volume consumers and natural gas customers. While the new rate structure could produce an impressive range of benefits, it is clear that the challenges of transition are significant – and related debates over change management may well occupy the attention of utilities, regulators, customers and investors for some time.
See also the related story “Utilities prepare for future of change, ” IPPSO FACTO, June 2014.