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Economic Currents

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Incentives for the Utility

*This post follows up on two previous installments in the Sustainable Energy Blog Series: Embrace Policy Experiments for Demand Response and Four Years to Improve Renewable Energy.

Perhaps the greatest obstacle to a renewable-energy future is that our utility, Hawaiian Electric Industries (HEI), has little or no incentive to transform its operation into a model more suited for renewable energy.  While there has been a lot of hand-wringing and criticism of HEI for its monopoly and slow approval of distributed solar, it’s important to realize the truly unprecedented change they are being forced to undertake.  And worse, the new cutting-edge system they are being asked to adopt will literally undermine its profits. 

Revenue decoupling (PDF) was supposed to correct HEI’s incentives by ensuring that the utility could recover the same revenue toward its operation costs even if they generated less electricity due to growth of distributed solar or improvements in energy efficiency, both of which have factored into higher electricity prices. 

Revenue decoupling does make HEI less vulnerable to improved efficiency and growth of renewable energy over the short run.  But over the long run the utility profits mainly from making new capital investments.  For such investments they receive a nearly guaranteed rate of return that far exceeds low-risk borrowing costs.  If the utility is forced to retire its old power plants and instead buy renewable energy from independent providers—the apparent inclination of the Public Utilities Commission---its rate base and profitability decline.   Thus, even under revenue decoupling, low-cost renewables do not accord with HEI’s interests. 

The larger problem is that the regulatory infrastructure is not conducive to a rapidly changing energy landscape in need of innovative and perhaps distributed solutions.  HEI has little incentive to control costs, much less increase renewable energy in a cost effective manner.

It doesn’t need to be this way.  We can fix regulatory incentives.  But given the novelty of the renewable energy system we are creating, combined with Hawai`i’s geographic uniqueness, it seems unlikely that we can simply borrow a regulatory model from the mainland.  Some are calling for our private utility to be replaced by publicly-run municipality, or possibly a cooperative like the one on Kaua`i.  These models might work.  But it’s not clear how long it would take to transition to these systems, or whether they will bring about the most innovative solutions. 

What’s the fix?  First, the utility needs to have some skin in the game. Full cost recovery via rate adjustments—the current regulatory situation---gives the utility virtually no incentive to be strategic in its management and planning.  Instead, if costs fall due to cost-effective development or contracting of renewables, the utility should get to keep a share of the gains.  The utility’s profits ought to be tied to its cost effectiveness, not the size of the capital outlay. At the same time, if oil prices rise, then the utility should absorb a share of the cost increases, such that it cares about oil price volatility just as its customers do. 

Second, to the extent that the state wishes to favor renewables over fossil fuels, fossil fuels should be explicitly taxed and renewables subsidized.  Such incentives could be made roughly revenue neutral and would be more effective at achieving renewable energy goals in a cost-effective manner than the state’s expensive and seemingly pointless renewable energy tax credits.  Federal credits are more-than-adequate to make distributed generation cost-effective to homeowners, even under revised rate structures.  And we should allow utility-scale and distributed renewable energy generation to compete on equal footing.  Instead of the tax credit, customers should be able to sell all surplus generation to the grid at appropriate real-time rates.

Of course, regulators will need to negotiate a baseline profit level, how the baseline will change over time, the share of overall cost changes born by the utility and passed on to customers, and whether the utility’s share of cost improvements ought to phase out over a number of years.  Regardless of these choices, these kinds of changes in regulatory structure would align the utility’s interests with their customers as well as the state’s renewable energy goals. 

The big, encouraging news is that the cost of reducing greenhouse gas emissions and slowing global warming now looks cheap.  While Hawai`i’s contribution to this global problem is minimal, if we can show the world how to do renewable energy in a smart, cost-effective manner, we could be a true global leader in helping to solve it.  But without smart policy, we’ll only serve the interests of denialists and naysayers who will point to Hawai`i’s renewable energy boondoggle as an excuse for inaction. 

- Michael Roberts


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