Smart grid regulation: Why we should switch to performance-based regulation


Editor's note: Paul Alvarez is a consultant with deep experience evaluating smart grid performance. As you'll read, he claims that smart grid investments are different than any other investments a utility makes. As a result, they require new cost recovery approaches. I think this is perhaps the single most important issue facing our industry, so I asked him to share his opinions. Please use the Quick Poll and/or comment form at the bottom of the page to agree or disagree. -- Jesse Berst

Do we need a new cost recovery model?

If smart grid investments really are different, do they demand a different cost recovery model?  One based on performance rather than investment?  One that provides performance rewards as well as shareholder risk?  Regulators in both Oklahoma and Ohio have approved performance-based smart grid cost recovery approaches.  If my interpretation of these commissions’ orders is correct, IOUs forfeit some or all of their returns if anticipated O&M savings are not achieved. At the same time, they get the opportunity for returns above the authorized rate if actual O&M savings are higher than anticipated.  There are many other potential performance metrics that could be considered, including distribution line losses, demand response per customer, and, of course, reliability.


Capital investment does not (by itself) make a grid smart. The value comes from the manner in which utilities make use of smart grid data and capabilities. Therefore, performance-based cost recovery would better motivate IOUs to pursue the difficult and critical organizational, operational and regulatory changes required to maximize smart grid value than the traditional capital investment incentive approach.  Granted, performance-based cost recovery can be difficult to execute. Even so, an open, non-litigious dialogue between IOUs and regulators that tackles this issue would be a strong step in the right direction from customers’ perspectives.          


Paul Alvarez is President of the Wired Group, a distribution business consultancy with a focus on smart grid benefit quantification and performance measurement.  He has led teams that have completed comprehensive, independent evaluations of smart grid deployments for Xcel Energy (SmartGridCity) and the Ohio PUC (Duke Energy’s Ohio deployment). For smart grid reference work, case studies, links to benefit and performance measurement resources and more, visit


More on smart grid regulation…

How the traditional regulatory process can inhibit grid modernization (and why change needs to be on the table)

Ratemaking landmark: Illinois approves new way to set electric rates