The Problem
The traditional utility business model is governed by cost-of-service (COS) regulation. Under COS, utility profits are tied to spending: regulator-approved rate hikes allow them to recuperate investment and operating costs, plus an additional margin of return. COS became prominent in the 20th century, when expanding access to electricity was imperative, but today it means utilities have an incentive to undertake expensive projects and increase usage rather than to deliver energy more efficiently, reliably, and cleanly. As a result, utilities often do a poor job containing costs, undertake wasteful projects, and resist green energy deployment.
The Solution
Performance-based regulation (PBR) can change how utilities make money to better align their incentives with the public interest. There is no single formula for PBR — frameworks vary from state to state — but they typically combine adjustments to the core revenue mechanism along with targeted incentives.
It is important to note that utilities fight hard to co-opt PBR to their advantage, resulting in financial bonuses for behavior regulators should already be enforcing. For this reason, well-designed PBR must not only include incentives but also impose penalties when utilities fail to hit metrics. Connecticut, which became the second to implement a comprehensive PBR framework in 2023, provides an example of such a carrots-and-sticks model.