Last week, Consumers Energy filed a new $456 million electric rate hike request just months after regulators approved a $276.6 million rate increase — the largest single rate increase in decades. The increase, which went into effect in May, will raise electric rates for residential customers by nearly 9%. DTE customers are faring no better, with a $242 million rate increase that went into effect last month and another $474 million one requested.
In the wake of these relentless increases, Michiganians are asking why.
Politicians point to executive salaries, accountability issues, political donations and data centers for driving these increases. These certainly contribute to the problem, but they only tell part of the story. The truth is, utilities aren’t hoodwinking regulators or pulling a fast one. They’re simply leveraging a system that fundamentally and perversely fails to incentivize behavior that benefits ratepayers.
Utilities make money by building physical infrastructure. They operate under cost-of-service regulations, which means the rates we pay are set by the utility’s total cost to provide service. That cost consists of operating expenses and capital investments. Operating expenses include wages, maintenance, fuel costs and taxes, and are recovered dollar for dollar if regulators agree that those dollars were spent prudently.
On the other hand, when utilities build things like new power plants, poles and wires, they recover the cost of building those capital investments plus a guaranteed profit, called a rate of return. In short, the more utilities spend on building infrastructure, the more profit they earn — and the more we have to pay.
As a result, when problems like frequent outages arise, utilities tend to prefer expensive, capital-heavy solutions, such as building new power lines, over simple maintenance solutions like trimming trees around existing lines. This isn’t corruption, but a predictable outcome of the way utility profits are designed.
To reduce electric rates, or at least slow the incessant increases, we need to realign utility incentives. Utilities should make money by providing reliable service and savings for customers.
One way to do that is by establishing performance-based incentives. The Michigan Public Service Commission, which regulates utilities, is exploring how bonuses and penalties can push utilities to provide better service. The Commission’s focus on improving reliability and affordability by pressuring utilities to do more tree trimming is already making a difference, but that kind of pressure should be systematized rather than be at the whim of the commissioners.
Implementing performance-based incentives will require careful calibration to ensure they are significant enough to influence utility behavior. For example, utilities should not be rewarded for meeting basic service obligations. Instead, financial incentives should be reserved for exceptional service, while penalties should apply to substandard performance.
It’s also important that these mechanisms not contribute to the problem by incentivizing utilities to build capital projects that provide only marginal benefits. Capping rewards once a satisfactory level of performance is achieved, or creating a buffer zone between penalties and rewards, can recalibrate the incentive structure. By tying each utility company’s financial performance to outcomes rather than inputs, performance-based incentives can align utility motivation and accountability with customer satisfaction.
A second way to reduce residential rates is to encourage more competition in the power sector. Michigan’s utilities hold a monopoly over the distribution of electricity, but not the generation of that electricity. However, utilities often prefer to build new power plants themselves rather than buy energy from a third party because they earn profit on those capital investments. In Consumers Energy’s last integrated resource plan (IRP), which is a regulator-approved 15-year vision for how the utility plans to meet changing energy needs, the utility was required to acquire roughly 50% of new generation from sources not owned by Consumers.
DTE’s split was 65% utility-owned and 35% third-party owned. Both utilities always propose 100% utilityownership in their IRP filings, and it is only through the advocacy of Michigan EIBC and Advanced Energy United that the MPSC restricts their ownership shares.
Consumers and DTE will file new IRPs this year that will determine Michigan’s energy portfolio for the next decade and a half. By requiring a higher percentage of third-party ownership in the IRPs, regulators can spur more competition, driving down electricity prices and residential rates.
Rising energy bills are a burden to Michigan households. And as long as utilities profit from building and spending more, electricity prices will keep going up. If we want lower bills, we need a system that aligns incentives with customer outcomes, rewards reliability and saves money.
Dr. Laura Sherman is President of the Michigan Energy Innovation Business Council.
This article originally appeared on The Detroit News: To make energy affordable, realign utility incentives | Opinion
Reporting by Laura Sherman / The Detroit News
USA TODAY Network via Reuters Connect
By Laura Sherman | USA TODAY Network
