As part of our cloud advisory engagements, we work with clients to determine their strategic visions and goals for adopting cloud technologies. Cloud adoption in most industries is well underway but the landscape within energy and utilities is a bit different.
This is primarily driven by two factors:
- Utilities’ unique IT organizations, matched with their technical and operational requirements, motivate them to build and deploy their own infrastructure and systems where possible to increase reliability, control, and security instead of relying on third party providers.
- As part of their rate base, utilities obtain return on capital investments; the equipment and assets that enable them to do business and provide safe, reliable, and affordable power. Operations & Maintenance (O&M) expenses do not earn return, only recovery, which strongly encourages utilities to build and deploy their own infrastructure and systems, even if it’s more costly to do so, than a blend of capital investments and O&M spend.
Cloud technology value propositions requires outsourcing infrastructure and system ownership and management. Nearly all cloud service offerings are subscription-based or billed on incremental units of usage (e.g., time, computing cycles). As this consumption of services cannot be tied to a specific piece of equipment owned by the utility, it is difficult to capitalize under current accounting structures.
So, how can a utility realize the benefits of cloud within their current regulatory structure? Also, how can utilities maximize cloud migration functionality to be flexible to expected data management demands while also be compliant with state and federal mandates?
Investing in IT-related cloud services could earn a rate of return in expenses
Across the country, utilities are actively engaged in digital transformation efforts to enhance customer experience as well as improve internal business processes as real-time data becomes much more voluminous and essential to daily operations. As of mid-2019, New York and Illinois public utility commissions have encouraged utilities to invest in IT-related cloud services to support their ongoing IT implementations, resulting in significant increases of customer and operational data involved with each additional smart grid device with real-time communications.
Historically, utilities have utilized on-premises data storage systems. With each additional device being deployed, the utility requires advanced computing capacity and service-based solutions to accommodate the influx of data. The subscription-based nature of cloud services requires this spend to categorized as O&M, therefore the large utilities have lobbied for legislative changes that would allow utilities to earn a rate of return on these O&M costs–eliminating any bias toward capital investments.
Implementation costs associated with cloud computing are dependent on several aspects, including hosting arrangement terms, as some implementation costs can be capitalized and expensed over the term of the hosting arrangement. Moreover, there may be specific instances where implementation costs of cloud migration software and applications may be capitalized for accounting purposes, but not be eligible for inclusion in rate-base, as some cloud migration arrangements defer cash payments; dialogue between utilities and regulators is required.
Regulation may take years, but the time to develop cloud strategy for utilities is now
New York REV initiatives and associated operating investments can offer utilities the benefit of earning a return using current accounting rules. As New York utilities develop and implement IT projects, entering into pre-paid software service contracts for periods of time up to 5 years has proven more efficient and cost-effective.
Illinois has allowed for utilities to treat their cloud services the same as utility-owned IT infrastructure, scaling and adjusting services over the term of those contracts. The utilities must evaluate whether to lease or purchase cloud migration contracts, as returns on leased investments removes the scrutiny of capitalized said costs. The result of this shift would allow for utilities to consume cloud services and potentially complete projects at a lower overall cost than if done so completely with capital investment.
It will take years for the regulatory structure across federal and state jurisdictions to change more broadly, but utilities should start thinking now about cloud adoption. Utilities face a rapidly evolving competitive landscape driven by a range of factors, such as slow load growth and the increase of Distributed Energy Resources (DERs) while at the same time they must ensure the supply of safe, reliable, and affordable energy.
A comprehensive cloud strategy for utilities can provide core organizational building blocks, identify applications for technology proofs of concept, and plan investments in people to build skillsets and roles that support cloud adoption.
Contact us to discuss your cloud strategy for utilities.
Related content: What Is Cloud Strategy