In an upcoming article in the July 2018 issue of the Wiley journal Natural Gas & Electricity, NERA Managing Director Dr. Jeff D. Makholm examines a new and evident resurgence of interest in incentive regulation, stemming from a period of regulatory change evidenced by an uptick in scholarly literature on “utility of the future” initiatives and the Reforming the Energy Vision (REV) initiative in New York. Dr. Makholm notes that all regulation of investor-owned utilities is incentive regulation. Regulators cannot compel investors to provide the capital to render public services; a profit incentive must be included. All such regulation embodies incentives in some form. The question is what those incentives are, which institutions support these incentives, and how they change over time.

Dr. Makholm explores three phases of incentive regulation for electric utilities throughout history:

• Incentive Regulation 1.0: Prudence standard evolving with targeted incentives
• Incentive Regulation 2.0: RPI-X regulation from the United Kingdom
• Incentive Regulation 3.0: UK’S RIIO, New York’s REV, and other innovations

For US and Canadian energy utilities, the most path-breaking phase remains Incentive Regulation 1.0, which, decades ago, defined the basic incentive features and investment protections for the investor-owners in energy utilities (at a time when such companies in most of the rest of the world were controlled by governments). Incentive Regulation 2.0 was spurred by the post-privatization British invasion of RPI-X. But it was unsuitable for North American purposes until it was rewritten to meet the US and Canadian regulatory burden-of-proof standards. In its recast form, while such regulation resonated with US and Canadian telecom companies, only a few states and provinces used those methods for electric utilities. Incentive Regulation 3.0 is another incremental enhancement, employing new kinds of treatment for incremental capital additions in the RPI-X formula (in those places that use it) and incremental incentives around capitalized expenses and returns/rewards for targeted innovative services.

Makholm, Jeff D. (2018, July). - Incentive Regulation 3.0 for Electric Utilities. Natural Gas & Electricity 34/11, ©2018 Wiley Periodicals, Inc., a Wiley company.