California's challenge in balancing utility profits with public interest highlights the potential benefits and challenges of adopting UK-style performance-based ratemaking.
Proposed performance-based ratemaking, prevalent in UK policy, may not effectively address California’s energy affordability crisis.
In Sacramento, calls for reducing California’s high electricity rates have become increasingly urgent. Consumer advocates are scrutinizing utility profits, arguing that utilities' operational decisions exacerbate the affordability crisis while generating significant returns. This growing concern about misalignment between utilities' profit motives and public welfare has led several states to explore alternative regulatory frameworks, notably performance-based ratemaking. With the UK’s successful implementation of this model over nearly a decade, California is evaluating whether a similar approach could help alleviate its energy pricing challenges.
Understanding Performance-Based Ratemaking in the UK
In the UK, the performance-based ratemaking framework—known as RIIO (Revenue = Incentives + Innovation + Outputs)—aims to align utility profits with socially beneficial results. Under this system, regulators set clear output goals for utilities, such as improving customer service and reducing power interruptions. Utilities can earn additional profits by exceeding these performance targets while facing penalties for underperformance.
The structure of this regulatory approach includes establishing cost targets that span multiple years; in the UK, this currently encompasses a five-year period. Regulators assess the necessary expenditures for utilities to meet performance benchmarks, incentivizing them to seek efficiency. If utility expenditures exceed forecasts, profits diminish. Conversely, if utilities manage to control costs effectively, they can retain part of the savings, translating to reduced customer bills in subsequent phases.
Possible Applications of the UK Model to California
Reflecting on experiences as a regulatory advisor at California's Public Utilities Commission (CPUC), I envision a performance-based ratemaking system offering notable advantages over the current cost-of-service regulation in California. The UK model’s emphasis on collaborative, holistic goal setting promotes clearer communication regarding performance and alignments across stakeholders.
The UK’s approach necessitates an initial comprehensive dialogue among policymakers, utilities, and other stakeholders about priorities and performance metrics over the upcoming period. In contrast, California's current regulatory procedure often operates in silos, leading to fragmented priorities and spending decisions. A consolidated, broad-scale planning approach could enhance responsiveness to observed regulatory recommendations advocating for a more unified review of utility expenditures.
Another key feature of the UK framework is its commitment to consistent public reporting of utility performance. Transparent metrics allow the public to assess utility outcomes compared to peers and historical performance levels. While CPUC mandates annual performance reports, there is room for improvement through clearer, adaptable metrics that can effectively communicate utility performance across critical areas of operation.
Challenges of Implementing Performance-Based Ratemaking in California
Despite the benefits, several challenges raise concerns about the applicability of performance-based ratemaking in California. The state has a history of unsuccessful attempts at implementing such frameworks, often attributed to difficulties in establishing effective measurement and clear goal-setting processes. Previous attempts in the late 1990s and early 2000s were undermined when utilities manipulated reports on reliability and customer satisfaction to secure shareholder incentives.
Evaluations of the UK model also revealed challenges. Some utilities, for instance, met performance targets simply because they were based on outdated information, thus benefiting from favorable conditions not reflective of actual performance. Additionally, utilities often possess an information advantage, as they have greater insights into their costs and operational efficiencies than regulators.
One major drawback of performance-based ratemaking is its dependence on accurate forecasting—a complex endeavor given California’s emerging climate dynamics and policy shifts. Factors like wildfire risk management have significantly influenced utility expenditures in recent years. The unpredictability of federal and state policies further complicates forecasting, making it hard to ensure a fair evaluation of utility performance metrics. Under these conditions, external influences may determine whether a utility achieves its targets more so than its internal practices or innovations.
While I see potential advantages in adopting performance-based ratemaking, I recognize that its immediate implementation in California may not be feasible. Observing how this framework continues to evolve in the UK and other U.S. states will be useful, as future reforms, grounded in these insights, could eventually serve as a foundation for utility regulation in California.
By focusing on ensuring that utility profits align with public benefits, a more equitable and sustainable energy system may be within reach, positioning California to better manage its complex energy landscape.
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Suggested citation: Campbell, Andrew. “Getting Utility Profits to Align with Public Benefits” Energy Institute Blog, UC Berkeley, March 17, 2025, https://energyathaas.wordpress.com/2025/03/17/getting-utility-profits-to-align-with-public-benefits/
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