Why Use a Sandbox?

Utilities are risk-averse. Utility costs are reviewed and approved for inclusion in retail rates for customers. Costs incurred by investor-owned utilities that are not recovered through retail rates are borne by shareholders, impacting profitability and their ability to make needed investments in the future. In approving costs, regulators must consider whether customer rates are just and reasonable and provide the utility a reasonable opportunity to earn a return on investments that are prudently incurred and used and useful.

This creates a strong incentive for utilities to invest in well-proven technologies. Innovative projects or investments may lack a strong evidence base that utilities can use to demonstrate to regulators and consumer advocates that the investment will be beneficial to customers. In addition, some advanced grid expenditures — e.g., software as a service or customer-owned energy storage systems — typically do not provide an opportunity for the utility to profit. That creates a lopsided risk equation, in which the utility’s only upside is recovering their costs, and the downside could include cost disallowance or penalties. In addition, the ability to pass costs onto customers reduces the utility's incentive to innovate in ways that will bring down business costs and improve profitability overall.

• Sandboxes can create upfront assurances that cost recovery will be allowed for projects that conform to identified expectations.
• Dedicated funding amounts create more certainty of funding availability.
• Sandboxes may exempt utilities from traditional “used and useful” cost recovery practices.

• Innovative financing programs can help to support riskier and costly upfront investment.

In a competitive marketplace, businesses are pressured to innovate in order to remain cost-competitive and offer services that are attractive to customers with many choices. Regulation aims to mimic some of these effects, but as industry incumbents, utilities do not face the same competitive pressures, limiting innovation. Any incumbent business — that is, a company that holds a large portion of the industry's market share — typically does not offer innovation and disruptions. There is a strong incentive for utilities to maintain the status quo that has historically offered them a stable business environment.

• Sandboxes can invite third party applications, reducing the effect of utilities as gate-keepers to innovation.

• Multi-year rate plans incentivize cost control.
• Policy directives and vision statements can encourage a focus on third-party solutions.

Lengthy regulatory timelines are not conducive to innovation, testing, and quickly scaling successful technologies and practices.

Utility regulatory commissions increasingly face new mandates, legislative priorities, and timelines, and they often are under-resourced. This hinders timely consideration of new technologies and programs. In some cases, delays can render innovation proposals moot, as new technologies become available in the meantime.

Adversarial regulatory processes also can hinder innovation. Lack of collaboration between stakeholders can limit creativity and cause proceedings to take longer than necessary. In addition, it is challenging to establish a more flexible regulatory construct such as a sandbox when there is a lack of trust between stakeholders. Stakeholder support is a foundational requirement for establishing a regulatory sandbox.

Regulatory lag also can contribute to the utility's lack of interest in innovation. While multi-year rate plans (MYRPs) support financial efficiency by allowing utilities to identify cost savings that they can keep until rates are reset, this incentive to reduce spending can reduce spending on innovative projects. Further, utilities experience a gap between when they expend funds and when they recover those costs.

• Sandboxes can be designed with time-limited review periods for projects or may not require Commission approval for projects.
• Upfront stakeholder engagement on sandbox objectives can reduce disagreement on specific programs or approaches.
• Advisory councils and clear scoring criteria or go/no-go criteria can reduce process uncertainties.

• Policy directives and vision statements can reduce friction amongst stakeholders.
• The track-then-act approach can lead to better understanding and consensus across parties.

The traditional utility business model can impede the desire to make significant investments in R&D and scale successful pilots and demonstrations beyond a testing phase. While R&D is foundational to innovation, utilities invest a disproportionately small percentage of their budgets in R&D.

Pilot programs, both for utilities and in other sectors, frequently do not progress to full-scale programs. Reasons include the following:

• Lack of, or unclear terminology. Lack of clarity and understanding over what constitutes a pilot, demonstration, field study, or other test can create uncertainty over the purpose and scope of projects and cause approval and implementation delays.
• Design flaws. Poorly designed pilots can lead to misleading, biased, or inconclusive results. Utility reporting on pilot results also may lack clear metrics to determine successes or other critical outcomes and impacts.
• Lack of process for scaling. Utilities and regulatory processes often do not establish pathways for successful pilots and demonstrations to scale.
• Lack of information sharing. Lacking awareness of demonstrations conducted in other jurisdictions, utilities may conduct pilots that other utilities already have conducted, reducing the value of the results. Even with such awareness, utilities and regulators may want to collect jurisdiction-specific data.
• Disputes. Pilot programs and demonstrations can get caught up in disputes between parties.

Ultimately, pilots have not consistently led to actionable results for decision-makers. These challenges and lessons apply to sandbox design as well.

• Clear exit strategies from Sandboxes help to ensure that successes are carried through to full deployment.

• Well-designed demonstrations and pilots lead to useful and actionable information.

• Sandboxes deploy technologies on a limited basis and aim to assess how more proven technologies will function in a specific jurisdiction.

• R&D includes early stage assessment of the capabilities of new technologies.
• Demonstrations and pilots test the technical and commercial feasibility of new ideas.
• The track-then-act approach leads to better information for decision-making.

• Sandboxes collect data on new technologies to compare with status quo.

• Direct regulatory changes may include unique ratemaking treatment for stranded assets, such as securitization.

In many cases studied, a single leader within an organization (such as a utility executive, Commissioner, commission staff member, or legislator) drove the development of the jurisdiction’s sandbox. Moreover, leaders set a tone for innovation and create an environment where new ideas and disruptions are invited.

While an organizational champion is an important ingredient for success, it is important to guard against favoritism by the champion for certain technologies or programs.

• Not directly addressed.

• Utility organizational changes can create internal champions and allocate resources towards innovation.
• Policy directives and vision statements focus activities toward ambitious outcomes.

• Regulatory sandboxes create an evidence bank for new technologies and services that can be cited in future innovation applications in the state as well as other jurisdictions.

• Innovation hubs, incubators, technical assistance, pitch fests, and information sharing tools are designed to support information sharing and relationship-building.