Right now, most utilities can make their regulated rate of return on their expenditures for building their own new servers, but cannot make the same return on costs they pay for cloud services.
Utilities are able to earn a rate of return on capital expenditures, their physical assets that endure over time like pipelines, meters, power plants, and other energy infrastructure. They do not earn a rate of return on operating expenses, things like fuel and maintenance costs. These “pass-through” expenses are costs that are passed on to customers, but from which no return is made. In-house server farms are expensed as capital expenditures, while cloud services are counted as operating expenses. This makes building their own servers more financially feasible than spending the same amount, or even somewhat less money on cloud services. Because of this, public utilities are very slow to enter this space, regardless of whether or not it would be prudent for their data flows and security for them to do so.
Most industries at this point have made the switch from building their own server farms hosted on-site, to the lion’s share of their data being stored in the cloud. Removing barriers to this technology from public utilities would allow them to decide if the cloud is the best data solution on an individual basis, and divorce smart data management decisions from those about rate of return. Removing this skewed incentive would allow utilities to better serve their customers, and could also save both the utility and its customers money. Solving this incentives problem would help spur innovation, improve reliability and security, and decrease costs for both utilities and their customers.
The world is quickly moving into the cloud. Because of economies of scale, technology companies that offer cloud services are able to improve their product much more quickly and consistently than a utility can improve its own servers.
Reliability and Security
Utilities perform an essential function, and could be a target for all sorts of nefarious activity. In the modern age, data security is as imperative to continued operations as physical security. Because of this, security is paramount to any data storage decision. But just because cloud storage is off-site, does not make it any less secure. In fact, businesses have experienced a 51 percent higher rate of security incidents in on-premises data centers than those in the cloud. Cloud services providers are able to have larger teams dedicated exclusively to data maintenance and security than a utility trying to operate its own data center can dedicate to the task. Because of this specialization, they are able to innovate faster, and maintain more secure systems.
The risks of “gold plating”, utilities making investments in superfluous new capital in order to earn their return, without regard for whether the new capacity or infrastructure is necessary would not be elevated by this new policy. The National Association of Regulatory Commissioners (NARUC) points out that “regardless of how cloud computing is treated for regulatory accounting purposes, regulators will still examine whether the investment is prudent.” So, a change to this expensing system would not have a deleterious effect on delivery, because decisions would still receive the same oversight that they always have.
The decision to shift to cloud services is far easier for a utility to make if those services are able to be expensed on the same time-scale as hardware like servers which fulfill the same purpose. Evening the playing field between these technologies will allow decisions to be made based on the technology needs of the utility, not on which system will earn a better rate of return. This would also save customers money. This incentives problem causes utilities to choose to build their own servers even when it may be more efficient or less costly to use cloud services.
When that incentives problem is removed, utilities will make more prudent decisions and both the utility and its customers will have lower costs.
Changing the Policy
Because utilities are regulated at the state and federal level, there are a lot of moving parts in any attempt to change how they’re regulated, and an expensing change is no exception. In 2016, the NARUC adopted a resolution on this issue. A few states, New York and Illinois have both taken action to treat cloud services and on-premise servers similarly. The Federal Energy Regulatory Commission (FERC) has begun to work on making the change as well.
The resolution adopted by NARUC “recognizes that utilities best serve customers, society, the environment, and the grid by making software procurement decisions regardless of the delivery method or payment model” They recognize that the data management landscape is shifting, and policy that once made sense is now outdated. Because of this, “the resolution encourages State regulators “to consider whether cloud computing and on-premise solutions should receive similar regulatory accounting treatment, in that both would be eligible to earn a rate of return and would be paid for out of a utility’s capital budget.” This action by NARUC shows that a shift in this policy has broad support among state Regulatory Utility Commissioners.
In December 2017, the Illinois Commerce Commission initiated a proposed rulemaking “relating to the regulatory accounting treatment of cloud-based solutions.” The rulemaking process is nearing completion with a proposed second notice order released on May 8th. In a letter to state regulators on May 9th, Advanced Energy Economy, and seven Illinois utilities asked regulators to finalize the rule change. If the rule change becomes final,
“public utilities will therefore be indifferent to implementing cloud-based solutions – instead of, for example, building more mainframe solutions – which they may have otherwise not selected due to outdated regulatory treatment. Whether a computing solution is cloud-based or on-premises, it must be a prudent investment and its cost reasonable in amount to be recovered in rates. The proposed Part 289 does not change this bedrock principle of Illinois ratemaking. Cloud-based computing solutions provide benefits to customers and can serve the same functions as on-premises computing solutions. Proposed Part 289 simply makes the accounting rules technology-agnostic and removes the disincentive to invest in cloud-based systems as opposed to on-premises systems.”
The Illinois rule would allow both prepaid and pay-as-you-go expensing of these services, meaning that utilities could expense more flexible services the same way that they typically expense set-investment infrastructure, which would allow them to potentially save money by not over-paying ahead of time for data capacity that is never utilized.
It is likely that the Illinois rule will become final in the near future, ensuring that cloud computing and on-premises servers receive the same treatment in terms of expensing.
Unlike Illinois, New York does not allow pay-as-you-go expensing for cloud services expenditures, but it does allow expensing of pre-paid services. Although this is less flexible than pay-as-you-go, and does not allow utilities to fully capitalize on the innovative potential of cloud services, it is still a step in the right policy direction. This determination was issued as a declaratory statement by the New York Public Services Commission in May of 2016.
On February 20th, FERC issued a draft Notice of Inquiry (NOI) which opened up a comment period “on the potential benefits and risks associated with the use of virtualization and cloud computing services in association with bulk electric system operations, as well as whether barriers exist in the Commission-approved Critical Infrastructure Protection (CIP) Reliability Standards that impede the voluntary adoption of virtualization or cloud computing services.”
The draft NOI sought comments on:
- “The scope of the use of virtualization and cloud computing services.”
- “The potential benefits and risks associated with virtualization and cloud computing services.”
- “The potential impediments to adopting virtualization and cloud computing services resulting from the CIP Reliability Standards.”
- “Potential new and emerging technologies beyond virtualization and cloud computing that responsible entities may be interested in adopting.”
The comments were due on April 27th, and reply comments were due on May 27th.
The role of the cloud in data storage is rapidly growing, and in order to remain technologically up to date, utilities need to follow suit. When crafting and updating expensing rules, regulators should take the new data landscape into account, and give cloud services the same treatment as on-premises data infrastructure receives.