Unprecedented weather events force IOUs, regulators to work collaboratively on cost recovery
As America’s investor-owned utilities seek to protect their ratepayers by recovering the higher costs associated with ever-increasing severe weather events and unforeseen emergencies like the pandemic, many of the commissions that regulate them know that making utilities bear the brunt of all such costs will only harm the ratepayers in the long run.
With forecasters predicting another above-normal Atlantic hurricane season this year and the continuation of intense wildfires in the West, electric companies across the country are focused on expanding their resiliency and grid hardening strategies. According to Deloitte’s 2022 Power and Utilities Industry Outlook, in the first three quarters of 2021, the United States experienced 18 weather and climate disasters with losses exceeding $1 billion per event, which included wildfires, hurricanes, ice storms, and floods brought on by climate change.
Recognizing that such severe weather events are beyond a utility’s control, commissions generally build a baseline level of normalized storm costs into rates, said John Quackenbush, president of JQ Resources LLC, a consulting firm in the regulated utility industry that works to bridge the gap between the regulatory and investment communities.
And due to the increasing instances of severe storms, there’s growing regulatory recognition that severe storm costs require innovative regulatory treatment that, in turn, requires collaboration between regulators and utilities, said Quackenbush, who served as Michigan Public Service Commission (PSC) chairman from 2011 to 2016.
“After the requisite level of regulatory scrutiny for prudency, customers are well-served by regulators who allow full recovery of storm costs through innovative accounting practices, such as deferral of storm costs for future recovery,” he said. “Cost recovery is important to customers because it clarifies whether the regulator welcomes grid investments that will benefit customers.
“Cost recovery also influences utility investors and their willingness to provide capital for future utility infrastructure investments, and at what cost of capital,” said Quackenbush, who also served as a managing director and senior investment analyst at UBS Global Asset Management covering electric, natural gas, and water utilities from 2001 to 2011.
Quackenbush added that while customers value reliability and resilience, they also realize that severe weather events will periodically interrupt their service.
“A collaborative effort between regulators and utilities will help to minimize storm outage frequency and duration,” said Quackenbush. “Severe weather events provide regulators with the opportunity to clarify that they truly value reliability, resilience and a modern grid as much as customers do.”
State utility commissions that also work in collaboration with the utilities, consumer groups, public counsel, and other interested parties in an open and transparent manner are better equipped to also educate and inform the public about the challenges associated with extreme weather and other impactful events, according to Ronald Brisé, practice group leader for governmental affairs at the Florida-based Gunster law firm for business.
“They play a vital role in planning for these types of events, working with all stakeholders to understand all the dynamics involved,” Brisé told Daily Energy Insider. “Commissions must develop recovery mechanisms to address consistent patterns of severe weather events, as well as unforeseen circumstances.”
Brisé, a former commissioner, legislative leader and senior executive with more than 20 years of experience in telecom, energy, utilities, government and business, said that regulators are engaged in a constant balancing act of balancing the need for the provision of safe, reliable service at reasonable rates in a manner that is fair, just and reasonable to both the consumer and the provider, which should have the opportunity to earn a fair return on its investment.
“That is a challenge when there are unforeseen circumstances and severe weather events,” said Brisé, who after serving in the Florida Legislature was tapped to serve on the Florida PSC, where he served multiple terms, including as chairman. “The commission has the responsibility to use all the regulatory tools at its disposal to minimize the impact on all parties involved.”
COVID-19-related costs, in fact, provide an example of regulators and utilities coming together in an extraordinarily collaborative effort, said Quackenbush. “Pandemic-related costs related to the moratoriums on utility shut-offs were widely deferred for future recovery,” he said. “Many commissions are now addressing recovery of those deferred costs in current rate cases.”
Customers also want the utility response to severe storm outages to be swift and strong. “A financially healthy utility is better equipped to respond to severe storms than a utility that is under the threat of punishment for spending on storm recovery,” said Quackenbush.
Working well together
There are several states that have done well in creating a constructive regulatory environment, each addressing the weather challenges that are most likely to affect them, according to Brisé and Quackenbush.
“Most states tend to be reactive, but still encourage reliability and resilience by providing full storm cost recovery,” Quackenbush said. “Recent positive examples include the Energy Strong initiative in New Jersey and the Distribution System Improvement Charge mechanism in Pennsylvania.”
Brisé and Quackenbush agree that Florida is an excellent example of collaboratively developing a series of regulatory tools to keep up with extreme weather issues as a result of the 2004-2005 hurricane season, and proactively addresses severe weather-related risks by grid hardening and pre-funding storm restoration costs through a proactive storm reserve.
“There is a storm reserve charge that is collected and used for storm-related expenses and reviewed by the commission on the yearly basis in clause hearings,” Brisé explained about Florida. “There is a storm protection plan and cost recovery clause where all storm hardening and preparation expenditures are included and reviewed by the commission during Storm Protection Plan Cost Recovery clause hearings.”
New Jersey implemented similar measures after Superstorm Sandy, said Quackenbush, who added that Florida — along with Louisiana, Mississippi, and Texas — are states that routinely allow securitization financing for the recovery of prudently incurred storm costs.
“These efforts serve all stakeholders well in hardening the grid to help reduce the impact of future events on customers,” he said.
As another example, Quackenbush said that during his time chairing the Michigan PSC, it became evident that wind storm damage was becoming more frequent and more severe across Michigan.
“Continuous improvement analysis indicated that the root cause of many outages was falling dead trees from outside the utility’s right of way,” he said. “In response, we approved a vegetation management program that went beyond just trimming branches in the right of way to proactive removal of dead trees outside the right of way.”
More recently, he said, the Michigan PSC approved ramped-up vegetation management programs that include the capitalization of certain vegetation management costs in a seven-year Enhanced Tree Trimming Surge program.
On the flip side, both Brisé and Quackenbush said states that present a challenging environment for storm cost recovery include California, Massachusetts and Connecticut.
Protecting ratepayers
The former commissioners both explained that the regulatory compact grants the utility a monopoly territory in exchange for providing safe, reliable service at affordable rates subject to regulation, while regulators provide the utility an opportunity to earn a fair return for its investors.
“If regulators prevent full storm cost recovery through regulatory provisions that limit recovery and endanger the opportunity to earn a fair return, commissions may inadvertently be harming the interests of customers, inhibiting reliability, and sending an ironic message that a utility and its investors are at risk of getting punished for swiftly and efficiently incurring storm recovery costs,” said Quackenbush. “Increased cost recovery uncertainty is not in the best interest of customers.”
In fact, if expenses are prudently incurred in operations, a utility should expect to be able to recover them regardless of the condition under which they are incurred after a prudency review by the commission and ensuring due process, Brisé said.
“The compact is broken if the risk can be shifted without cause and due process,” he said. “Just to be clear: if the costs incurred are prudent, they should be recovered; if they are imprudent, they should be disallowed and if the utility breaks a rule or the law they should be penalized.”
And customers, not just investors, benefit by having a financially stable utility with earnings and cash flow sufficient to attract capital on reasonable terms, said Quackenbush.
“The lack of adequate cost recovery serves as a constraint on the utility’s ability to cost-effectively finance upcoming clean energy and advanced grid investments that benefit customers,” he said. “Investors assess higher risk to utilities that do not receive full recovery of prudently incurred costs, and require a higher return in order to provide capital to those utilities.”
Increased financing costs caused by regulatory uncertainty, Quackenbush said, are ultimately borne by customers. “Prevention of full storm cost recovery works to the detriment of the reliability and resilience that customers seek,” he said.
