Existing regulated renumeration models create unintended financial hurdles that may inhibit utilities from adopting cloud solutions and realizing the benefits of using cloud-based software.
As cloud computing technology has matured, so too has the market for cloud services, which now covers the entire spectrum of electric utility services, operations and value proposition. Primary drivers of cloud adoption by utilities often include the increased flexibility, security and agility available through cloud computing arrangements. Such arrangements may also offer the potential for lower costs, higher security and increased efficiency, relative to traditional IT systems that are owned and managed by utilities.
Unfortunately, current economic regulatory models can disincentivize the adoption of cloud services by Canadian electric utilities because cloud investments fall outside of the rate base. This is due in part to remuneration models used by regulators that allow for rates of return on capital assets owned by utilities but not for subscription-based services and related implementation costs treated as operating expenses, which are not eligible for a return.
Existing renumeration models thereby create unintended financial hurdles, which may inhibit utilities from adopting cloud solutions and thus realizing the benefits that many other industries have experienced using cloud-based software.
Industry associations initiate study
The Canadian Electricity Association (CEA) and the Canadian Gas Association (CGA) engaged KPMG in Canada to evaluate challenges and opportunities associated with the capitalization of cloud services by Canadian electric utilities; and to develop a series of potential options for Canadian regulatory tribunals to consider when undertaking policy development and/or rulemaking on this topic.
Both associations view this as “an important first step in addressing the transition to new complex and expensive computing facilities which are often beyond the competence of individual utilities in terms of both capital and technical resources” - Energy Regulation Quarterly
In the consultation process, KPMG interviewed stakeholders. Several key messages were identified:
- Near unanimous consensus that Canadian utilities should be allowed to defer cloud costs and earn a regulated return (consisting of a debt and equity return) similar to on-premise IT investments.
- To date, few Canadian utilities have directly approached their local regulator and sought permission to defer expenses associated with the use of cloud solutions.
- Cloud will be a key enabler of innovation in the utility sector and may be associated with many of the new, emerging services for a “smart” grid and Distributed Energy Resources.
- There’s a broad spectrum of cloud adoption across Canadian utilities.
- Canadian utilities acknowledge they would have to move to the cloud sooner or later.
The report provides regulators with six alternative policy options to consider when setting rates to recover cloud expenses. Based on KPMG’s analysis and the specific assumptions used, the report finds the alternative options have considerable potential to ensure that shareholders do not face an earnings disincentive when moving away from traditional in-house projects. In summary, they can be a valuable tool for regulators who want to encourage the move to alternative computing arrangements.
Determining accounting treatment for technology implementation costs requires significant judgment and collaboration between accounting and information technology professionals.
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Jonathan M. Erling
Executive Director, Global Infrastructure Advisory
KPMG in Canada
Partner, Audit and Accounting Advisory Services
KPMG in Canada
Amol A Khale
Partner, Technology Risk Consulting
KPMG in Canada