Selected Performance Incentive Mechanisms to Ensure a Just Energy Transition
Explore different strategies governments can take to incentivize better performance from energy providers.
By
This blog is a companion piece to “Overcoming Secrecy in the Energy Transition,” which explores barriers to an equitable energy transition through Power Purchase Agreements.
Affordable and reliable energy is essential to economic growth. When signing public contracts to buy energy, governments should create clear, public incentives to ensure that utilities perform well along different dimensions such as cost, reliability, and environment. These incentives must also be public and understandable.
This blog provides an overview of key incentives that governments can use to encourage better performance of the energy sector.
Financial Incentives
Problem: Utilities have limited motivation to improve on key public interest outcomes like reliability, emissions reductions, or equity.
Solution: Financial incentives (positive or negative) based on metrics such as reliability, distributed energy resource (DER) interconnection time, peak demand reduction, and greenhouse gas reductions. An example of the use of incentivized equity metrics was under the Brazilian government’s “Luz para Todos,” (Light for All) initiative, which provided subsidies directly to companies that expanded electricity into underserved rural areas.
Open Government Approaches to Support Reform:
- Public tracking of performance targets
- Disclosure of penalty or reward structures
- Stakeholder engagement in setting priorities
Scorecards and Metrics
Problem: Utilities may not be held accountable for performance in areas that matter to the public if there’s no visibility into outcomes.
Solution: Scorecards help track utility performance on specific, quantifiable measures, which may be paired with targets to evaluate effectiveness without direct financial impact. Such dashboards or metrics may be carried out by third-party experts.
Open Government Approaches to Support Reform:
- Publicly available performance dashboards, metrics, and targets
- Standardized metric definitions
- Regular third-party reviews
Decoupling
Problem: Utilities have a built-in incentive to sell more electricity, which undermines efforts to promote energy efficiency and distributed generation, like rooftop solar.
Solution: Decoupling floats utility revenue to ensure it remains consistent regardless of energy sales, removing the incentive to sell more power. Profits can be sunk into efficiency gains, rather than electricity generation.
Open Government Approaches to Support Reform:
- Public disclosure of revenue adjustments
- Independent audits of utility cost structures
- Transparent reporting on energy savings
Multi-Year Rate Plans
Problem: Regulators often set rates on an annual basis. If they do this, they may tend to focus on short-term cost recovery. This may tilt their decision-making toward investing in things that pay off immediately, rather than longer-term gains.
Solution: Sets a revenue cap over a longer time period (typically multiple years) to encourage utilities to lower operational costs over time. The benefits that might accrue include lower prices, more predictable prices, more energy, and higher reliability. Evidence is still emerging about how and when this approach achieves these benefits, as early experiments have had mixed results.
Open Government Approaches to Support Reform:
- Public access to multi-year rate plan (MYRP) proposals and assumptions
- Transparent methodologies for forecasting demand and cost
- Routine, disaggregated reporting on actual vs. projected expenditures
- Inclusive consultation processes that allow civil society, consumers, and technical experts to weigh in
- Regulatory audits at the end of each period to evaluate performance and recalibrate for the next cycle
Earnings Sharing Mechanisms
Problem: When utilities overspend or underspend, they may petition a regulatory authority to increase their compensation. This means that, when they underspend, they potentially are creating what in the tech world is referred to as “technical debt.” If they overspend, they may ask for compensation, which may come as a surprise to ratepayers and public authorities.
Solution: Earnings sharing mechanisms create a “deadband” or amount of acceptable losses or earnings. Anything outside of this band goes back to ratepayers either as profits or losses. This can encourage utilities to avoid excessive earnings or losses, increasing predictability.
Open Government Approaches to Support Reform:
- Public disclosure of profit-sharing and “deadband” formulas
- Transparent annual earnings reports
- Regulatory oversight of cost allocation
Cost Trackers and Rate Adjustment Clauses
Problem: Utilities often face unexpected or fluctuating costs due to fuel price changes, regulatory compliance, or extreme weather events. To recover these costs without waiting for a full rate case, many regulators allow utilities to use cost trackers or rate adjustment clauses — mechanisms that authorize rate changes outside of the normal budgeting process. These tools provide financial stability for utilities to help deal with volatility. But their overuse presents serious risks. If overused, they reduce pressure on utilities to manage costs effectively and limit public scrutiny, especially when rate adjustments are automatically approved or poorly communicated.
Solution: Regulators, ratepayers, and consumer watchdogs need full transparency on the categories of expenses covered by each tracker and mandatory public disclosure of the amounts collected. They further need clear regulatory criteria for when trackers can be applied. Ideally, these would also include third-party verification of claimed costs and opportunities for public comment before rate adjustments are approved.
Open Government Approaches to Support Reform:
- Making tracker data available in machine-readable formats and visual dashboards can also empower watchdog groups and journalists to monitor trends and advocate for ratepayer fairness over time.
