By Rick Hornby
Rick Hornby has reviewed and testified on smart grid business cases in several jurisdictions, including the BGE case for the Maryland Consumer Advocate. He wrote this response to our recent story on how to avoid a BGE-style screw up when building a business case
I certainly agree with the importance of a positive business case. However, a convincing business case will not necessarily ensure regulatory approval. Regulators also want to know whether the proposed cost recovery equitably shares the financial risk of the project between utility shareholders and ratepayers.
The BGE case is an excellent example. The regulators required a reasonable cost recovery mechanism in addition to a positive business case. Most expert witnesses who testified in the BGE proceeding, including myself, concluded that BGE had a positive business case. Almost all witnesses agreed that projected benefits would exceed projected costs, even if they disagreed on the amount.
But the key word in the last sentence is “projected.” There is financial risk associated with any smart grid project. No one knows for sure whether actual benefits and costs will match the projections. As with any utility project the question arises as to how the financial risk (and reward) should be shared between utility shareholders and ratepayers.
In its June 21 order, the Maryland Commission did not reject BGE’s application because its business case was not compelling. Instead, the Commission rejected the application because BGE was proposing a cost recovery mechanism that would place most, if not all, of the financial risk on ratepayers. The Commission states its position on page 53:
Nothing in this Order should be construed as a vote of “no-confidence” in smart-grid technology’s ability ultimately to lower energy bills, improve customer service and relieve peak-time pressure on the transmission and distribution infrastructure. Our desire that BGE share the risks associated with such an investment at this juncture is in no way an indication that we believe an investment in AMI ultimately will prove unwise. We simply think it more equitable that BGE and its ratepayers venture into this relatively unknown territory as partners. (emphasis added)
Scott Hempling, Executive Director of the National Regulatory Research Institute (NRRI), stated that the June 21 Order issued by the Maryland Commission “…exemplified effective regulation” for five reasons of which three relate to the equitable sharing of financial risk. (Smart Grid Spending: A Commission’s Pitch-Perfect Response to a Utility’s Seven Errors, Director’s Monthly Essays on Regulatory Quality.)
In July 2010, BGE submitted a revised application. It contained essentially the same business case and minimal changes to the original cost recovery mechanism. In its Aug. 13, 2010 order, the Maryland Commission stated that it would approve BGE’s application, but not because of any change or improvement in the business case. Instead, the Commission conditioned its approval on BGE agreeing to a cost recovery mechanism under which BGE shareholders would bear a portion of the financial risk. In specifying that cost recovery mechanism, the Commission stated on page 49 that “As with any major infrastructure investment, however, BGE’s customers deserve appropriate protection against bearing all of the project’s technological and financial risks.”
BGE subsequently agreed to use the cost recovery mechanism specified by the Commission. (As an aside, decoupling was not an issue since BGE has had a decoupling mechanism in place for several years).
Rick Hornby is a senior consultant with Synapse Energy Economics.
