Award Penalty Mechanisms
An APM is designed to strengthen performance incentives in targeted areas. It is sometimes for this reason called a targeted performance incentive. Basic components of such mechanisms include a key performance indicator (called an “output” in Britain), a performance appraisal that compares the utility’s value for the indicator to a benchmark value, and a mechanism for adjusting utility rates to reflect the performance appraisal. Here are some common performance areas targeted by APMs. *Reliability (e.g.Multiyear Rate Plans
MRPs are the most common approach to PBR around the world. An MRP features a moratorium on rate cases which typically lasts three to five years. An attrition relief mechanism (“ARM”) adjusts rates or revenues automatically between rate cases to reflect inflation and other changes in business conditions. Some costs are typically addressed separately using cost trackers. Some MRPs feature earnings sharing mechanisms that share surplus or deficit earnings between the utility and customers when the return on equity deviates from its target. Plans may also feature an efficiency carryover mechanism that incentivizes long term performance gains and discourages the opportunistic timing of expenses by permitting the utility to keep a share of cost savings (or absorb a share of high costs) when rates are trued up to cost at the end of the plan. Since infrequent rate cases lessen concerns about cost allocations and cross-subsidies, MRPs can permit regulators to sanction greater marketing flexibility. Most MRPs also include APMs to balance incentives for cost containment with incentives to pursue other goals (e.g. reliability or energy conservation) that matter to customers. The design of the ARM is a key issue in a proceeding to approve an MRP. Several approaches to ARM design are well established. *An index-based ARM is developed using industry price and productivity research and is calibrated to produce superior returns for superior productivity performance. This approach was developed in the United States but is more popular today in Canada and countries overseas. US utilities that have operated under index-based ARMs include Boston Gas, Central Maine Power,Precedents
In North America, MRPs have been especially popular where utilities need marketing flexibility. Such plans have helped railroads, oil pipelines, and telecommunications utilities provide a complex array of services to markets with diverse competitive pressures from a common set of assets. Most of these plans featured index-based ARMs called "price caps". Early papers encouraging the use of input price and productivity research in ARM design include Sudit (1979) and Baumol (1982). MRPs are also favored for energy distributors in most populous provinces of Canada and are increasingly popular for gas and electric utilities in the United States. Overseas, the privatization of many utilities in the last 20 years has forced governments to choose a regulatory system. The majority have chosen MRPs over cost of service regulation. Regulators in Britain, Australia, Germany, the Netherlands, and New Zealand are recognized MRP leaders. The British approach to MRP design dates back to the early 1980s. The latest version of this approach, called "RIIO" (Revenue = Incentives + Innovation + Outputs), has been implemented for gas and power transmission utilities and will begin for power distributors in 2015. The heart of the RIIO system is an MRP, which the British call a "price control". A revenue cap ARM has an RPI - X formula. The typical plan term is 8 years. Since the ARM is based on multiyear cost forecasts, the regulator must carefully review utility business plans. Statistical benchmarking and independent engineering studies loom large in cost appraisals. 30 months is typically required to process a RIIO application. There are APMs for a wide range of outputs. Special cost trackers fund innovative projects.Outlook
Recent developments have increased the potential usefulness of MRPs in US electric utility regulation. *Slower volume growth due to conservation, slow economic growth, and increasedAlternative definition
PBR is sometimes defined more narrowly as that subset of IR in which mechanisms are calibrated using statistical research to yield superior (or inferior) returns for superior (or inferior) performance. One example of PBR that conforms to this definition is an MRP with an index-based ARM that is calibrated so that utilities earn superior (inferior) returns for productivity growth exceeding (falling short of) the industry norm. Another example is an APM for reliability that uses a benchmark reflecting industry norms. Such approach is called regulatory benchmarking. If properly applied, benchmarking presents new incentives for a regulated firms to behave efficiently. However, regulatory benchmarking is subject to many issues. For instance, regulated companies may be motivated to short-term savings which result in postponement of investments, which may result in the deterioration of quality of service. Also, the quality of data is crucial.References
{{Reflist *Baumol, William J., "Productivity Incentive Clauses and Rate Adjustment for Inflation", ''Public Utilities Fortnightly'', July 22, 1982. *Joskow, Paul L., "Incentive Regulation for Electricity Networks," ''Journal for Institutional Comparisons (CESifo DICE REPORT)'', 2006. *Kaufmann, Lawrence and Lullit Getachew, Matthew Makos, and John Rich, "System Reliability Regulation: A Jurisdictional Survey", May 2010. *Kaufmann, Lawrence and Mark N. Lowry, "Alternative Regulation for North American Electric Utilities." 2006. ''The Electricity Journal'' 19 (5): 15-26. *Kaufmann, Lawrence and Mark N. Lowry, "Performance-Based Regulation of U.S. Electric Utilities: The State of the Art and Directions for Further Research". Palo Alto: Electric Power Research Institute, December 1995. *Kaufmann, Lawrence and Mark N. Lowry, "A Price Cap Designers Handbook". Washington: Edison Electric Institute, 1995. *Laffont, Jean-Jacques and Jean Tirole, "A Theory of Incentives in Procurement and Regulation", The MIT Press, 1993. *Littlechild, Stephen C., "Regulation of British Telecommunications' Profitability: Report to the Secretary of State", (London: Dept of Industry, 1983). *Lowry, Mark N. and Matthew Makos, and Gretchen Waschbusch, "Alternative Regulation for Evolving Utility Challenges: An Updated Survey," 2013. Edison Electric Institute. *Lowry, Mark N. and Lullit Getachew, "Price Control Regulation in North America: Role of Indexing and Benchmarking," 2009. ''The Electricity Journal'', 22: 63-76. *Lowry, Mark N., and Lawrence Kaufmann, "Performance-Based Regulation of Utilities", ''Energy Law Journal'', Volume 23, No. 2, 2002 *Ofgem. "Strategy Decision for the RIIO-ED1 Electricity Distribution Price Control," available at https://www.ofgem.gov.uk/publications-and-updates/strategy-decision-riio-ed1-overview. March 4, 2013. *Sudit, E. Fred. "Automatic Rate Adjustments Based on Total Factor Productivity Performance in Public Utility Regulation", in ''Problems in Public Utility Economics and Regulation'', (Michael A. Crew ed., Lexington Books, 1979). *The Regulatory Assistance Project, "Performance-Based Regulation for Distribution Utilities", December 2000. Public utilities Regulation