Kauffman on REV: Creating a 21st-century grid with clear price signals, utility incentives and collaboration

As Chairman of Energy and Finance in the office of Governor Andrew M. Cuomo, Richard L. Kauffman, New York State’s “energy czar,” leads REV – Reforming the Energy Vision – the state’s comprehensive strategy to build a cleaner, more resilient and affordable energy system. Recognizing his vision and leadership, the Smart Electric Power Alliance (SEPA) and the Solar Energy Industries Association (SEIA) recently honored Kauffman as their 2017 Solar Champion during the opening session of Solar Power Northeast in Boston. Due to an inconveniently timed snowstorm, Kauffman did not actually attend the conference in person, but did participate in an online session with SEIA CEO Abigail Ross Hopper and Tanuj Deora, SEPA’s Executive Vice President. The two organizations were cosponsors of the event. The following article is an edited version of Kauffman’s remarks, which provide a concise overview of the goals and challenges of REV, and insights into the process of changing utility business and regulatory models.

The goal of the New York State energy policy — Reforming the Energy Vision, or REV — is to change regulatory and financial structures to build a 21st-century grid. For too long we’ve been rebuilding the old, central-station production system, which is not the grid we’re supposed to have today. The 21st-century grid is a hybrid that has both central station power and distributed energy resources (DERs), where electrons flow in more than one direction, and supply and demand are dynamic.

REV is complex, comprehensive and ambitious, but I’d like to boil it down to two key drivers. The first driver is clear price indicators to DER providers to deploy these technologies in grid locations where all customers benefit — not only the DER customers themselves, but all customers. The second driver is migrating financial incentives for clean energy deployment away from one-time grants funded by ratepayers.

What this means is that the traditional compensation system for utilities —  that is, “rate-basing” of utility infrastructure — leads to financial and energy inefficiencies. In this respect, New York State is not different from other locations in the country. The average capacity utilization of the system is 54 percent — a low number relative to other major capital-intensive industries. In other words, we are paying year-round to maintain a system that can meet peak demand, and ensure service and reliability, for the hottest days of the year.

The rate base approach serves as a disincentive to innovation and is a deterrent to deployment of DERs. It runs counter to the potential benefits of distributed technologies, which in certain locations, will reduce or shift load, leading to less need for traditional infrastructure – the historic foundation of utility profits.

Only 6 to 7 percent of a customer’s electric bill in New York State represents utility profit; the rest is a pass-through cost on which a utility earns no money.  Again, if you compare the utility industry to other capital-intensive industries, the economics are really upside down. For every other capital-intensive industry operating in competitive markets in the last 35 years, the focus has been on reduction of costs, trying to drive innovation and being very efficient in the use of capital. The inverse is true in the case of the utility industry – compensation has been based on the amount of capital deployed. This is not a fault of the utilities, but rather a relic of past policy and regulations.

Similarly — and another vestige of long-standing regulatory policies — utility spending on research and development (R&D) in New York State is only two-tenths of one percent of revenue. Do we really think that no value can be obtained from R&D in the sector?  Of course not — and, again, I don’t think it’s very different in other states.

Read SEPA’s report on how New York and California are leading the nation in energy system transformation here.

So with these two drivers — pricing signals for DERs and changing financial incentives for utilities — we can unlock the energy and financial inefficiency of the old system and leverage it for the new system. We can use the cost envelope of customer electric bills — the 93 to 94 percent of those bills that are pass-through costs — to finance the energy system of tomorrow.

We can‘t expect the changes to happen overnight. But I see increasing progress as utilities begin to explore that 93 to 94 percent as a meaningful profit opportunity.

This new system is going to be more affordable, it will give customers more choice and value, and will be cleaner. Focusing on DER price signals and changing financial incentives for utilities will create a self-sustaining, market-based approach for solar and for the DER market generally, and it will provide economic opportunities for utilities.

REV and the Brooklyn-Queens Neighborhood Project

So how is REV working on the ground in New York State? Is it really changing things? The best-known example is Consolidated Edison’s (ConEd) Brooklyn-Queens Neighborhood Project.

The challenge here was using non-wires alternatives — and DERs — to meet growing demand for power in the area. The business-as-usual, inefficient solution would have been to build a very large substation costing about $1.2 billion and, like the rest of the system, having around a 54-percent capacity utilization. With REV, ConEd opened the procurement process to the market to see what alternative approaches might work here. What came back was a range of options including solar and storage, demand response, cogeneration and energy efficiency.

What else can DERs do? Find out in SEPA’s DER Capabilities Guide, here.

These combined solutions will cost a couple hundred million dollars rather than $1.2 billion, so all customers will save money. Less peak power — the most expensive power — will be purchased from the wholesale market, and far fewer greenhouse gases will be emitted. It isn’t perfect, but it has provided pretty good compensation for ConEd, and as a result, other utilities and jurisdictions in the state are considering non-wires alternatives and turning to the market for innovative solutions.

Of course, a lot of questions remain. Exactly what is the locational value of specific DERs and how should it be determined? What’s the transition from old to new valuation methods?  What’s the infrastructure that’s going to be needed to enable this kind of approach? All these issues need to be discussed.

Business models and the internal culture of utilities and DER providers must also evolve. But we’re making meaningful changes, and I’d like to share some lessons from New York State — about how we’ve been able to make so much progress in such a relatively short time — based on understanding the differences between the private and public sectors.

The art of really good energy policy

Most of my career has been in the private sector, which is profit-oriented by definition.  Your principal objective is to develop a plan you think will achieve certain results; you get the resources, and you execute.  The public sector is more complicated because you may have many objectives and many, well-organized stakeholders. They all press their case, but that means, as regulators and policy makers, we only know what’s going on based on input from businesses that may see things in a very narrow, self-interested way.

Another key difference, in the private sector, cash is oxygen.  If you can get the cash and your business grows, you can get more of it.  It’s an economy of growth. In the public sector, budgets and cash are limited and getting more so. It’s an economy of scarcity. At the end of the day, regulators vote, and one side or the other wins. What this means is that policy is not a jigsaw puzzle; the pieces don’t fit together, and the art of really good policy making is getting what you can get when you can get it in the hope that over time you can make progress toward a long-term solution.

So here’s the lesson from New York.  No one was actually completely happy under the old system, even though we have decoupling and a restructured market. Utilities were not happy because they were not participating in growing parts of the market, and they could see that overtime they would face erosion in their business.  Solar companies and other innovative energy companies weren’t happy because they felt that they could do more if the state increased support for them.

Even fossil-fuel generators were unhappy because yearly peak demand for electricity has been growing, meaning their power plants are increasingly idle for more of the year. That, in turn, means their revenues have been coming more from capacity payments as opposed to energy sales and usage — and energy sales have been the usual route to provide a long-term incentive for capital formation.

Under REV, we’ve created a space for solar and the DER industry and utilities to collaborate. They’ve not agreed on everything, of course, but at a big-picture level, they’re working with a common purpose — to drive DER deployment to the most cost-effective locations on the grid and to figure out ways to make the solar business more market-based. In other words, the main driver for solar deployment should be economics rather than regulatory compliance.

I want to stress here that the goal of REV, and New York State energy policy in general, is not necessarily to make solar work for every customer right now. The economics are not going to pencil out for every customer in every location in the state. The bigger, more difficult challenge is to drive DER deployment to locations where these resources will have the most value. Over time, this approach will make solar accessible for more and more of our residents across the state, while also creating system-wide cost savings.

Collaboration is also key for SEPA’s Blueprint for Energy Market Reform here.

Collaboration is critical to bridging that gap. Where cross-industry collaboration can have the most impact is in helping regulators think through some of the big policy questions and the different tradeoffs we have to make to find common ground across these different stakeholder groups and issues. We understand that you’re not going to agree on everything, but if you’ve been able to stake out a lot of common ground and we’re down to a few issues where we understand what the tradeoffs are, it’s much easier for us to make the call.

We all need to accelerate innovation if we’re going to build the energy system of tomorrow. This kind of collaboration among stakeholders can, I know, seem frustrating at times but it is the path for accelerating the pace of change. But, if a collaborative approach can succeed in New York, it can succeed everywhere.