OEB innovation initiative faces tough questions
A regulatory initiative designed to help utilities respond more effectively to rapidly-emerging opportunities for innovation has run into several unexpected challenges. When the Ontario Energy Board invited comments on the recommendations of its Advisory Committee on Innovation, and unveiled its proposal for a “Regulatory Sandbox” at a public consultation meeting on January 16, it was immediately assailed by a range of energy stakeholders many of whom believe the ideas need more testing with electricity ratepayers, in part to ensure ratepayers aren’t unfairly exposed to risks from new utility investments in innovation. Although the Regulatory Sandbox is expected to move forward relatively quickly, the Board plans to consult extensively over the next 8-10 months, collecting comments on a wide range of regulatory policy that will determine the treatment of utility investments in innovative technologies.
At stake are questions like what equipment utilities should be allowed to add to their rate bases, to help manage to the growing range of Distributed Energy Resources, as well as what types of energy resources they will be allowed to acquire themselves. Formally speaking, the Board had invited stakeholders to comment on the recommendations of the report of its Advisory Committee on Innovation, released November 22, 2018.
Colin Anderson, the CEO of AMPCO, the Association of Major Power Consumers in Ontario, laid out his organization’s concerns with the Board’s approach on January 17: “A central premise of the session appeared to be that we should all use the Report’s recommendations as a starting point, and then decide how to prioritize our actions from that. AMPCO disagrees with the recommendations advanced by the Committee in the Report. The recommendations appear somewhat prejudiced toward the utility view, and there is little evidence of the consideration of the consumer perspective nor does there appear to be any meaningful focus on electricity affordability and what innovation can do to improve that.
“The Report appears to place primary concern on the wellbeing of utilities. Apparently, utilities alone need consideration in regards to their ability to maintain their returns in the face of electricity sector innovation. We disagree – all stakeholders need consideration. Innovation is not something that is unique to utilities in the electricity sector. In fact, AMPCO Members have been innovating for decades – doing more with less. The difference is – they have done so using their own money.”
Commenting specifically on the sandbox plan, Jay Shepherd, an energy lawyer representing the School Energy Coalition, said “Policies like the sandbox should not be established based solely on utility input, with no input from the customers that are paying the bills. Regulatory exemptions, and assurances of cost recovery, should not be carried out in a secret process, as proposed. The process should be open and transparent, particularly to the customers who will be paying, and to the competitors whose competitive position may be undermined by special deals.”
Observers may be sensing a communication problem as much as a real difference in underlying objectives. A member of the Advisory Committee noted that, “The OEB’s Strategic Blueprint and the ACI report are both very clear that the goal of innovation is to bring value to consumers.”
Why did the OEB take the risk of proposing its “Regulatory Sandbox”? In short, because there is a widely recognized need for more modernized, flexible and responsive forms of regulation. Many regulated utilities for example have expressed frustration that it is a struggle to manage seemingly conflicting demands to minimize risk, often expressed through a heavy burden of rules and regulations, and the almost opposite need to quickly adopt innovative new technologies, options that promise to improve nearly every aspect of the energy system. In principle, with a regulatory sandbox, the OEB can facilitate innovation by quickly reviewing proposals and selectively relaxing some of the normal rules and regulations in a specific area for a limited period of time. A proposal from an energy company to try out a new technology and/or a new business model, something that would normally require wading through a lengthy set of applications and approvals, might be reviewed by the regulator internally using the Sandbox approach, and allowed to proceed on a limited basis after only a few weeks. If the experiment succeeds, the Board will have a well-studied example to use for designing and implementing formal regulations on a wider basis.
Whenever a regulator says it wants to try an experiment that would lighten up regulation and ease the way for innovative energy businesses, it’s generally expected that the regulated companies and people with new business ideas will be very interested. However, in this case a variety of groups are sounding the alarm that further steps will likely be needed to ensure the consumer’s interest is adequately protected in the new proposals. Although these challenges to the OEB’s proposals were anticipated by a number of energy analysts, the sharply contrasting views likely came as a surprise to anyone without specific experience in the regulatory history of Ontario’s power sector.
There’s more than one way to prepare for innovation
Consumer representatives believe that the most critical current issue turns on the risk that decisions affecting customer electricity bills might be made without being fully reviewed or tested by the affected parties, overlooking the existing regulatory process that’s designed to balance the interests of customers and shareholders. An OEB official acknowledged on January 16 that the sandbox mechanism could be used to lift some of the normal checks and balances that apply when a utility asks permission to make a risky investment. Because electricity consumers ultimately have to pay all the cost of these investments, regulators are normally very cautious about what they approve.
Another issue was raised by stakeholders at the January 16 meeting. AMPCO and others noted that some of the innovative new investment anticipated in the energy sector will likely displace existing infrastructure that hasn’t reached the end of its expected useful life. Some of the existing investments may actually be sidelined and create what is commonly known as “stranded costs” resulting from underutilized assets. In a regulated industry, this stranded cost often becomes the responsibility of the ratepayer, raising utility bills and distorting choices made by energy users. Regulators have often struggled with stranded costs, recognizing that a fine balance has to be struck. It’s not always possible to avoid stranded costs, but regulatory decisions inevitably have an impact on how large they are, and who has to bear them. The new concern raised is that zealous pursuit of innovation could increase or accelerate the stranding of these costs, whereas excessive protection of existing assets could limit the market opportunities for new businesses and their investments. Paul Murphy, Chair of the Advisory Committee on Innovation, expressed a personal view that “the causes of potential stranding issues are not limited to investments in innovation – given the past decade of flat or declining demand, a significant portion of conventional utility assets are probably under-utilized relative to what was expected.”
In addition, Mr. Shepherd and others asked the OEB to determine if additional professional expertise might be required to enable it to properly assess the many proposals for innovation that could come through its doors. One of the Board’s options for strengthening its initiative would be to add external stakeholder representation to sit on the internal sandbox application review committee alongside Board staff.
Limits on the scope of a utility’s business
Ian Mondrow, an energy lawyer with Gowling WLG, explains that two sets of rules govern what utilities can do with money they invest on behalf of consumers. The Ontario Energy Board Act, 1998, restricts the business activities of regulated distributors to “distributing electricity”, which means the business of, and infrastructure for, conveying electricity at distribution level voltages to customers. He notes that, “There are exceptions where the activity supports conservation, efficient electricity use, or the promotion of cleaner energy sources, but generally, historically, legislation and regulation has required that the distribution business be ‘standalone’. Other activities can be carried on through an affiliate of the regulated distributor, subject to the protections provided by the affiliate relationships rules on transfer pricing and protection of utility customer information that are intended to protect distribution customers and competitors from any unfair advantage of subsidy from the regulated business to the competitive business. Those affiliates are now unconstrained in the types of business that they can engage in.” The second set of rules is embodied in the Affiliate Relationships Code.
In 2015 the legislation was amended, and the Ontario Energy Board now has the authority to authorize distributors to engage in business activities other than distribution, in “special circumstances” and if those circumstances “so require.” Mr. Mondrow says, “This relatively new authority has not yet, to my knowledge, been tested or elaborated on. But as worded it would seem to be a rather limited one, and using it to repeatedly sidestep the application of conventional regulatory principles could be seen as a stretch.”
So as long as the “innovation” proposed by distributors relates to the activity of distributing electricity, that should fall within the traditional legislative and regulatory “envelope” of permitted activities, he concludes. “Going outside of that traditional ‘envelope’ is uncharted territory and would really alter the fundamental principle that these regulated utilities should stick to their knitting to protect customers from risk and competitors from undue advantages by virtue of the regulated public utility franchise.”
Jim MacDougall of Compass Energy Consulting notes that projects eligible for the sandbox must involve testing of a new product, service or business model not widely in use in Ontario and for which there is no funding available at this stage. “We are not going to see utilities pursue net metering or customer based battery storage as a result of the sandbox initiative, and we have to trust that OEB staff will encourage innovation by utilities in the provision of utility services, and perhaps even the piloting of non-wires alternatives.”
In all likelihood, the Ontario Energy Board will soon be considering how to determine the terms under which existing principles of regulation and utility customer risk protection can appropriately be relaxed in implementing its Regulatory Sandbox proposal while continuing to protect utility customers.
Working out a path forward
Is it reasonable to conclude that in this area of innovation, energy consumers face a zero-sum game, and that when their utilities entertain new ideas this will inevitably entail risks that will be at odds with fiscal prudence or create challenges for risk management? Of course many technology proponents make the case that it wouldn’t be prudent for common carriers to equate the postponement of change with minimizing risk. Great fortunes have been lost by overlooking historic changes. Think of Kodak. Even for the most prudent of companies, examining new ideas is a fundamental part of risk management.
Accepting that some form of risk is inevitable, even in risk-minimizing utilities, it’s possible that an increasingly important responsibility for the regulator will be to determine how much risk utilities should accept, and by extension how much risk utility ratepayers should be required to accept, to ensure that current energy system technology options that benefit customers are readily adopted.
However, another resolution may be possible. Some would say that risk does not have to be shifted significantly to consumers because monopoly utilities can be regulated differently from independent competitive companies. Perhaps competitive entities can be offered more options in terms of regulatory relief because they will not be financing their experiments with ratepayers’ money. It may be that utilities should be incented to focus primarily on being facilitators of innovation, leaving others to be risk-takers and the actual proponents of innovation.
Kathleen Kauth, Director of Transactive Energy for Peak Power, addressed the Stakeholder Forum meeting with a comment that seemed to capture a key concept for many: “The question is not how we are going to innovate. It’s what are we going to do in the midst of our customers innovating.”
When DER infrastructure matures
Mr. Mondrow notes that the same rules that limit the activity of regulated electricity distributors also preclude other companies from distributing electricity without being subjected to licencing and rate regulation. “This barrier to innovation by unregulated companies will also need to be examined during the Board’s review of innovation policy.” While any business that conveys electricity to consumers needs to be licenced and regulated, it may be that in some circumstances these regulations could be different, and lighter, to enable, for example, micro-grids or neighbourhood energy systems.
No doubt the OEB and many proponents of innovation will continue to advance and develop the proposition for a regulatory sandbox in Ontario. In doing so they may have to find ways to address the concerns about utility customer protection and stranded costs, as well as the limits applicable to engaging in certain types of energy services on a regulated basis, and on an unregulated basis.
A number of parties appear to believe that there is a growing need to more clearly delineate what types of innovation investments can be made by utilities (with costs recovered from their customers), and where the risks and costs of innovation will have to be borne by proponents and their investors in the competitive market.
Clearly, decisions with significant consequences are in the offing. Electricity consumers are entering a new era not just in terms of the new technology-enabled services available to them, but in the way the funding and delivery of those services are managed and overseen.
For more information:
The OEB Advisory Committee on Innovation
The OEB Innovation Sandbox
A version of this article is available on LinkedIn at this location.