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As Duke Energy’s lopsided attempt at ratemaking reform in North Carolina fell flat two years ago, clean energy advocates didn’t reject the company’s proposal for upfront, multi-year rate increases out of hand.
Instead, many argued that the scheme had to be coupled with guardrails that would protect ratepayers and incentives to ensure the revenue would aid the transition to renewables — not reinforce the status quo favoring more fossil fuels.
This year’s Duke-backed legislation, House Bill 951, purports to include those same guardrails and incentives. Yet clean energy advocates still oppose the complex bill overall and its provision on performance-based ratemaking in particular.
Gudrun Thompson, senior attorney with the Southern Environmental Law Center, said the reason comes down to a well-worn cliché. “It’s a bad answer,” she said, “but the answer is definitely: ‘The devil’s in the details.’”
On balance, those details remove discretion from utility regulators and benefit Duke at ratepayers’ expense, Thompson and others said.
“The purpose of performance-based ratemaking is to balance risks and rewards for both ratepayers and utilities,” said Tyler Fitch, Southeast regulatory manager with Vote Solar. “There are several places in this legislation where the utilities don’t have a downside. They only have an upside.”
An ‘extremely healthy’ industry
The way Duke’s rates are set today took shape more than a century ago, when Thomas Edison-inspired electric companies and local governments promising lower prices were scrambling for market share. Fearing his own electric empire might get overtaken by the government, Chicago business magnate Samuel Insull proposed a quid pro quo between public and private interests.
By sanctioning a monopoly, the government could eliminate duplicative infrastructure such as power lines and allow a few larger companies to achieve economies of scale — bringing soaring costs down. At the same time, it could entice the private sector to build substations, meters, power plants, and other items needed to deliver electricity by allowing investors to recoup their investments with interest. In exchange for captive ratepayers and guaranteed profit, the utility would cede actual ratemaking to public regulators.
The result, Insull said in a speech to what is now the Edison Electric Institute, would be an industry “in an extremely healthy condition.” A study of the arrangement would also find that “users and taxpayers are correspondingly well served.”
For much of the next century, the regulatory compact did put Duke in an “extremely healthy condition.” At first a collection of hydropower plants financed by tobacco magnate James B. Duke, the company took off after World War II — when the growing population and the advent of air conditioners and other electric appliances caused an explosion in demand. Duke — and other utilities with which it later merged — got risk-free, low-interest loans to build a fleet of mostly coal plants, then got paid back at higher interest rates from its ratepayers.
North Carolina’s “users and taxpayers” benefited from the relatively cheap, reliable electricity, which also aided economic development in the state. And to be sure, as David Roberts wrote for Vox, the inducement to “build more stuff” was prudent for a time. “As long as the US was rapidly expanding electricity service to areas that had none,” he explained, “utility shareholder interests and the public interest were aligned. We needed more stuff.”
A misalignment of interests
But these days, Roberts continued, “things have changed.” Indeed, in North Carolina as across the country, the disconnect between the public interest and shareholders’ interests under the “cost of service ratemaking” model has been laid bare.
The utility can’t profit off operating costs, so it has minimized them through sometimes deleterious means, including avoiding air pollution controls on its coal plants and storing its toxic coal ash in wet, unlined pits — where it leaked into groundwater supplies and once catastrophically spilled into the Dan River. Energy efficiency programs have also gotten short shrift, leaving low-income families in the Carolinas with some of the highest energy burdens in the country. Exacerbating this pollution and energy poverty is a phenomenon called throughput bias: Duke earns more revenue if it sells more electrons than predicted.
Just as Insull envisioned in 1898, Duke has also had a powerful financial incentive to build assets — especially large, centralized, fossil fuel-fired power plants traditionally viewed by regulators as cost-effective. This capital expenditure, or “capex,” bias, has helped make the company’s power plants the second-largest source of climate-warming carbon dioxide pollution in the state, according to the U.S. Energy Information Agency.
But these incentives aren’t working in Duke’s favor as well as they once did. Thanks to improved appliance and building efficiency, retail electricity sales are largely flat, making it harder for the company to exceed sales projections or convince regulators that new power plants are necessary. The company is under pressure from shareholders and large energy users such as Apple and Google to shift more quickly and fulsomely to renewables. And the increasing frequency and severity of storms mean the utility is constantly playing catch-up on unplanned, multibillion-dollar expenditures through traditional ratemaking.
“Generally speaking, the future isn’t exactly like the past,” said Vote Solar’s Fitch. “The actual rate case takes a long time and is really expensive. Once we have commission-approved rates that go into effect, they’re outdated already.”
‘It fixes a lot of problems’
Performance-based ratemaking can help complete the realignment of public and private interests. While the traditional model is backward-looking, performance-based ratemaking sets out a return on equity for the utility in advance, with limits to help ensure the utility neither over- nor under-earns. It decouples the sale of electricity from the profit motive, correcting for the throughput bias. And it includes performance benchmarks for energy efficiency, grid resiliency, and other operating measures, lessening the capex bias.
“It fixes a lot of problems with the way we currently set rates,” Fitch said.
Duke attempted just one piece of this package of reforms in 2019: multi-year ratemaking. But without the other elements of performance-based ratemaking, critics said, the multi-year provision amounted to a blank check for Duke — satisfying shareholders’ interests but not that of ratepayers or society at large. The measure failed that summer in the face of bipartisan opposition in the House.
While Duke was pushing its controversial ratemaking bill, the administration of Gov. Roy Cooper, a Democrat, was crafting a Clean Energy Plan to reduce global warming pollution from the state’s utility sector by 70% by 2030. Ultimately released in the fall of that year, the blueprint spurred a marathon of meetings in 2020 between a host of stakeholders, including advocates for low-income customers, clean energy interests, large electricity users, and Duke itself.
“Ongoing work continues to build alignment on the shared objectives that came out of the clean energy plan process,” Duke CEO Lynn Good told investors on a May call. “These shared objectives include North Carolina’s clean energy transition as well as the regulatory reforms that provide for timely recovery of these investments.
Called the North Carolina Energy Regulatory Process — or NERP — these 2020 discussions have been frequently invoked by lawmakers spearheading House Bill 951.
“The beginning of the session, the speaker set up a stakeholder group to see if we can reach an energy reform bill,” said bill co-sponsor Rep. Destin Hall, a Caldwell County Republican, referring to Speaker of the House Tim Moore of Kings Mountain, in a committee meeting last month. “That stakeholder group relied on the NERP process.”
In an earlier meeting, Fayetteville Republican Rep. John Szoka, a lead sponsor of the bill, pointed to an exhaustive report — including draft legislation — produced by NERP at the end of its deliberations. “We used that report as a jumping-off place,” he told fellow committee members, “to put concepts and ideas into legislation.”
‘The pernicious use of the NERP process’
The smaller stakeholder group included roughly a third of the stakeholders involved in NERP — leaving out the Cooper administration, the attorney general’s office, environmental groups, economic justice groups and residential customer advocates.
Among those excluded from the talks, the Southern Environmental Law Center’s Thompson said that the NERP-drafted legislation was itself an attempted compromise between parties. “It was as close as the group could get to consensus,” she said. “It doesn’t necessarily represent what a clean energy advocate would design, or what a consumer advocate would design. It reflects some give and take.”
To be sure, H951 retains much of the NERP legislative language and tweaks some elements to the benefit of ratepayers. But even as the bill name-checks “performance incentives,” “decoupling,” and other reforms popular in clean energy circles, the fine print bends heavily toward Duke.
“You can see the pernicious use of the NERP process and these terms — the way they can be flexed around,” Fitch said. “These terms are really malleable. Especially when it looks like the decks are stacked against ratepayers, it’s really important to understand the details.”
For instance, the NERP group put forward performance incentive mechanisms tied to a long list of certain outcomes, including reducing carbon pollution, helping low-income customers save energy, encouraging the integration of renewables onto the grid, and improving resiliency. H951 explicitly precludes some of these policy goals and omits others.
A provision on page 30 of the House-passed legislation only lists “operational efficiency, cost-savings, or reliability,” as potential outcomes — a narrow list largely aligned with shareholder interests. Further, it prevents policy goals that would exceed state or federal laws and rules, “with respect to environmental standards.”
That language puts out of reach the state’s goal of 70% reduction of carbon emissions, Thompson said. “Those really positive state policies wouldn’t be fair game under H951.”
While H951 does decouple the profit motive from electricity sales, it only does so in the residential sector, where demand is flat and the utility has an interest in making up for lost revenue. What’s more, Duke can still profit off sales related to charging electric vehicles, the one area of residential electricity use that is expected to grow.
H951 would allow rates to be set for up to three years, less than the five contemplated in the draft NERP legislation. But the bill caps potential rate increases at 4% in the second and third year of the multi-year rate plan — a colossal berth, critics say, for the utility to earn profit.
“Four percent per year is more than twice the historical rate,” Fitch said. “If the commission were to authorize anything close to that, it would be a massive cost for ratepayers. It’s like a guardrail after the car has already gone off the road.”
Duke can also earn up to half a percent over its set rate of return in the multi-year rate plan; anything over must be returned to ratepayers. Yet if the utility’s earnings fall one iota below its authorized rate in a given year, it can file a general rate case to recoup its losses.
As does much of the rest of the 50-page bill, the ratemaking section tends to constrain the seven-member Utilities Commission, a panel generally comprised of experts that works full-time and is supported by professional staff.
“H951 is a lot more prescriptive in terms of requiring the commission to do things in a certain way,” Thomspon said, “whereas the NERP [process] is more enabling. It trusts the commission.”
Though the NERP draft legislation suggests the Utilities Commission initiate a full-throated stakeholder process to craft rules to guide performance-based ratemaking, H951 confines the commission only to a “technical conference” of stakeholders, with Duke presenting information and no cross-examination allowed.
And while in general rate cases, the commission can approve the utility’s application along with settlement agreements, stipulations, and other changes, H951 limits the panel to an up or down vote. “It’s just really unrealistic if you think about the way the rate case is usually litigated,” Thompson said.
‘Until we get a policy change’
H951 narrowly cleared the House of Representatives last month and is now moving through the Senate.
Yet for all of Duke’s support and that of most Republicans — who control both chambers of the legislature — it’s not clear the bill can become law as written.
Along with clean energy advocates, its opponents are consumers small and large, including some of the most powerful manufacturing interests in the state. Gov. Cooper has issued multiple statements suggesting he would veto the measure, and the bill gained enough “no” votes in the House to sustain him.
Still, both the urgency of the climate crisis and the threat to Duke’s business model are existential. If not in H951, sooner or later the debate over performance-based ratemaking will come to a head. “These are going to be topics of conversation,” Fitch said, “until we get a policy change.”