“Change is inevitable, except from a vending machine”
The industry that most closely approximates a vending machine is the electric utility industry. It has remained largely unchanged for the better part of 100 years. But the same technologies that rendered incandescent bulbs glowless, Ma Bell to break up her monopoly family and digital duplication to wind-down the record companies and polarize Polaroid are now poised to do their disruptive duty to the electric utility industry. And the utilities will not go down without a fight. This white paper offers the following perspective:
Technological and government policy changes are transforming the electric utility industry;
Customers will be increasingly served by third-party energy management companies rather than utilities;
The electric utilities will resist changes by demanding changing in how customers pay for electric service and by slowing the rate of technological adoption;
The century-old regulatory compact will have to be revised, if not largely abandoned, for a new one that has yet to emerge.
THE COMING CHANGES
The future is a daunting one for electric utilities given the current trends:
Current expected levels of energy efficiency, demand response, distributed generation, and large scale renewables will only increase
Zero-Net Energy buildings (all new Res in 2020, all new Commercial in 2030) and may become legislated in new building standards;
HVAC standards are increasing and utility appliance rebates are stimulating replacement of inefficient appliances;
Targeted roof-top PVs + lead-acid batteries in CA for commercial, now being promoted by transmission operators;
Aggregators and retail access, along with more appliance/building standards (Fed & state), causing electricity growth to be anemic or negative
Net-energy-metering and pro-consumer policies for renewables, and PVs are become much cheaper – residential rooftop cost-effective now with having fallen in price from $3.80 per watt to .86 per watt in just four years, from 2008 to mid-2012and now being grid-competitive in 16% of the US retail market;
Smart-meter data access becomes available to 3rd parties under Smart Energy Profile 2.0 and Open ADR 2.0 standards, with customer permission (utilities lose control of this also) so that 3rd parties can viably provide more than two dozen utility distribution service offerings now, making the utilities’ distribution side of the business much more vulnerable;
The resulting changes caused by these developments are inevitable. NRG’s outspoken and visionary CEO David Crane spoke at a Wall Street conference recently in which he predicted that changes due to price-dropping solar power and natural gas are coming, and that some customers may soon decide they do not need the electric utility:
“If you have gas into your house and say you want to be as green as possible, maybe you’re anti-fracking or something and you have solar panels on your roof, you don’t need to be connected to the grid at all……When you see a disruptive technology come into your space if you don’t embrace it… the people who try and cling to the past get rolled over.”
He predicted that technologies will develop that will allow for conversion of gas into electricity at the residential level. If this were to occur, one could expect a significant impact on the value of existing generation companies. The long-term impact would be inexorably downward as sales volumes would begin to decline. Similarly, the value of electric distribution utilities would be affected.”
A recent SDCAN analysis reveals that the little that customers know today about when to use power will be wrong in the near future. For example, current TOU pricing communicates to customers that they should avoid using power during the mid-afternoon and, instead, to use power after 7pm. The exact opposite may become true in the coming years. SDCAN has already observed peak getting later because of increased residential air conditioning saturation High PV penetration reduces peak a few percent and shifts peak on rest of system to hour ending 7 or 8 pm. Distribution peak in residential areas is already ending at 7 or 8 pm, so PV now doesn’t reduce residential distribution peak. Moreover, a daily ramp from minimum to peak on a summer day is reduced slightly but concentrated in time to a fairly robust ramp from 5 to 7 pm.
Regulators will have to expect that ramping energy is likely to be much more expensive while commodity energy is likely to be less expensive due to solar penetration. Within five years, SDCAN expects that the peak period will likely be span from 5:00 to 9:00 or 10:00pm for close to 365 days a year, with secondary peak occurring in early morning hours. The result is that customers will need to respond both to new peak period and to very cheap power mid-day. This likely scenario heightens the scenario that residential customers will have difficulty adjusting to changing load shapes unless there is a professional energy management infrastructure in place to manage residential customer consumption.
SDCAN’s vision for the emerging energy industry will be the advent of energy management providers who will be offering new services available to the residential and business markets. These providers will likely be large network-services companies, such as communications companies (cellular and Internet providers), Internet content providers, large, national retailers (such as warehouse or home supply companies) and other retailers with customer service interfaces. The way energy is transmitted to consumers, the way consumers receive their energy use data, the technologies used by customers and the role of the consumer in energy management will change. An essential complement to these changes will be a marketplace where third parties will be providing energy and energy-related services that have not previously been available to residential consumers.
For the residential consumer, whether new rate designs are embraced will be dependent, in large part, upon the success of energy management services. Third-party companies will need to deploy and likely use net-based applications and/or in-home technologies to permit customers to take advantage of real-time pricing schedules. The recent deployment of smart meters creates the platform for third-party energy management companies to access and use real-time data to access marginal tiered prices. This information will allow customers to make more informed decisions about their consumption levels and patterns. And, increasingly, the utilities’ connection with their customers will erode leaving them largely as the electric-network maintenance company. But, and this is a big “but”, these services and technologies will not develop unless regulators allow energy pricing to be clear enough to allow energy managers to create savings for their customers. Rate designs featuring high fixed costs, averaged distribution prices and muddled energy prices will doom the development of a smart grid market for residential and small business customers.
Rocky Mountain Institute has arrived at the same conclusion as other industry observers. This visionary think-tank recently released a report that details how increasing amounts of renewable electricity supplies, creation and execution of programs to improve customers’ energy efficiency, and implementation of new smart grid technologies for better coordination,control, and communication in managing the electricity grid are combining with new technologies and service offerings that give customers unprecedented options in managing their energy consumption, generating electricity onsite, charging electric vehicles, and a host of other activities.
The utility industry’s vision is a different one. Their own think-tank released a report that highlights some of the trends likely to affect U.S. electric utilities in the near future. Its January 2013 report “Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business” reads like a declaration of war. It warns of distributed generation technologies like photovoltaics (PV), as well as energy efficiency and demand-side management programs, all of which are stealing demand and revenue from utilities. It argues persuasively that the investment community is counting upon protection from these changes by regulators. But it points out that utilities need to begin now to change how they charge for electricity and start eliminating any perceived cross subsidies. This is the mantra that has been chanted by California electric utilities for the better part of ten years and it is getting stronger by the day. In the longer-term, the report promotes additional fees and customer advances to recover a utility’s upfront investments as well as identifying new business models and services that can be provided by utilities:
“Recent technological and economic changes are expected to challenge and transform the electric utility industry. These changes (or “disruptive challenges”) arise due to a convergence of factors, including: falling costs of distributed generation and other distributed energy resources (DER); an enhanced focus on development of new DER technologies; increasing customer, regulatory, and political interest in demand side management technologies (DSM); government programs to incentivize selected technologies; the declining price of natural gas; slowing economic growth trends; and rising electricity prices in certain areas of the country. Taken together, these factors are potential “game changers” to the U.S. electric utility industry, and are likely to dramatically impact customers, employees, investors, and the availability of capital to fund future investment. The timing of such transformative changes is unclear, but with the potential for technological innovation (e.g., solar photovoltaic or PV) becoming economically viable due to this confluence of forces, the industry and its stakeholders must proactively assess the impacts and alternatives available to address disruptive challenges in a timely manner.”
But this report didn’t discuss some of the emerging technological changes – both on the supply and demand sides of the equation: Remote or Net-based energy management services, printable high-efficiency photovoltaics, zinc-ion pseudo capacitors, fuel cells, software for electric and thermal monitoring, grid-scale storage based on enormous weights and gravity, glass technology that would concentrate the sun’s rays for energy conversion by a solar panel, and small-scale containerized nuclear fission generation. They are all also coming — far more quickly than the utilities anticipate — and may have more profound impacts than PV.
The parallels to other industries which underwent regulatory restructuring (airlines and telephone companies) are frequently discussed – of course most of those old companies no longer exist. With the advent of demand response, distributed generation – such as behind-the-meter solar, storage, electric vehicles, and increased end use efficiencies, revenues may fall and new tariff structures may become necessary. If tariffs for capacity or kilowatt hours are raised to compensate for declining volumes, the effect may be to drive customers from the grid (especially if storage becomes cost-effective). The term “death spiral” is now actively discussed in utility strategy/war rooms.
Even more revealing is a controversial Harvard Business Review (HBR) article on the topic. The HBR article written by Downs and Nunes in March 2013 suggests that in today’s world, the disruptive innovators often don’t even come from the same industry. They can develop products to enter the market quickly. Large numbers of customers can switch in extremely short timeframes – resulting in what they call “Big Bang” disruption. Much of this disruption lives in the information ecosystem, with pervasive computing and mobile phones. The early innovators – eBays, the Amazons, the IOSs and Androids – rule the platform kingdom (for now) while the next generation of innovators works to build their apps to fit this new and evolving world. The HBR piece warns “Big bang disrupters may not even see you as the competition. They don’t share your approach to solving customer needs. And they’re not sizing up your product line and figuring out ways to offer slightly better price or performance with hopes of gaining a short-term advantage. Usually, they’re just tossing something shiny in the direction of your customers hoping to attract them…” This paradigm may happen more slowly in the electric utilities world than in cyberspace given the utilities formidable legal/lobbying abilities and their regulatory protections.
But what is undeniable is that in a world of cost-competitive solar, as well as increasing end-use efficiencies and emerging technologies, the utilities now are looking at forecasts of declining electric sales for the next twenty years. Moreover, mid-afternoon peak demand is expected to fall if not disappear – peak prices will more likely be in the late afternoon and early morning hours for summer-peaking utilities like SDG&E. It’s a whole new ball game where ramping, not peaking, will be king and increasing number of customers will join the off-grid rebellion and opt to cut their ties with their electric providers.
THE UTLITIES WILL FIGHT BACK
Almost twenty years ago, Peter Schwarz wrote “The Art of the Long View.” In his book, he recommended creating a range of potential scenarios and then working backwards to the present, identifying events and milestones that suggest you are moving more quickly towards one scenario rather than another. This book was almost required reading for electric utility managers about a decade ago – since then, they’ve been mapping out their strategies and waiting for the appropriate time to unveil them to the regulators that control their fates.
While most consumers will view the the deployment of distributed generation and increase in energy efficiency as positives for society, the utilities are less than thrilled. The utility business has largely been a stodgy, regulation-driven oil tanker of a business that moves gradually and expects steady, above-market profits. It has thrived on higher energy demand leading to more investments and more profits. Minus a few interruptions, this model has worked exceptionally well over the past century. EEI acknowledges that the “utility sector has not previously experienced a viable disruptive threat” and has instead had “unfettered access to relatively low-cost capital” due to the confidence that investors place in the regulatory model. Any threat to that model will be viewed dimly.
As the aforementioned technologies and behavior changes lure new customers away from buying power from the utility, the utility revenues drop and the cost of service is spread over fewer customers. The utilities contend that this, in turn, will drive up rates and lead to more customers pursuing alternatives — a death spiral. If this were to occur, customers would leave the system entirely, by opting to use their own storage combined with a distributed generation resource such as PV. While it is unlikely that this will happen, the utilities like to fret about it and throw the scenario in the face of regulators and policymakers. One of their strategies has been to attempt to change rates so that assure capital recovery of stranded assets. For a regulated utility, stranded assets may have resulted from decisions made by the utility’s regulators or required by regulators as a condition of continued service. Utilities are pushing for specific rate designs that provide cost recovery of utility capital investment in the face of some customers either reducing their consumption or leaving the grid outright. Utilities are pursuing things like standby rates, backup rates, exit fees, and natural gas fixed fees for combined heat and power (CHP) customers.
In truth, most utilities have been actively thinking about how to take advantage of their assets and provide energy services to the customer in new ways – for example, whether they should be the providers of PV and storage solutions. Some are considering leasing efficient end-use technologies to customers. Some are considering the increasing flows of information, as the M2M (machine to machine) technologies and platforms develop. Some will attempt to monetized the consumption data and large IT systems that they’ve developed, akin to Google’s monetization of Internet data.
Some are exploring how distributed energy resources can bring value, not just cost, to the grid; and, how they create opportunities, not just threats, for utilities. These alternative demand and supply technologies reduce the water consumption and harmful emissions heavily attributed to the electricity sector. They facilitate the emergence of new classes of energy production and efficiency technology and business processes will provide individuals and businesses with access to new options and more control over their energy use. And they bring economic value (and not just costs) to utility operations, e.g.
- Avoided fuel costs
- Avoided capital cost of installing new power generation
- Avoided transmission and distribution expenses
- Line loss savings
- Fuel price hedge value
- Environmental benefits
Interstate Renewable Energy Council (IREC) recently made clear in their recent report, “Unlocking DG Value: A PURPA-based approach to promoting DG growth.” Utilities can and should be creating values-based tariffs and/or avoided costs that are equal to the value they’re receiving from having DER on the grid.
Some are revamping their grid infrastructure to be “smart” enough to handle the inevitable changes in generation and consumption. Further, rather than watch and complain about the encroaching deployment of PV, storage technology, and electric vehicles stealing utility revenues, they are trying to figure out if they can compete in these sectors and provide services and/or resources that meet consumer demands – largely through their deregulated affiliates.
WHO WILL WIN?
The answer to this question will be determined by the state (and to some extent, Federal) regulators. For the last few years, policy makers have been examining policies that create incentives for renewable energy and new energy technologies. In California, this informal discussion has been on-going since 2004 – shortly after the disasterous California deregulation scheme was blown up by opportunistic energy companies and poor regulatory design. Many of the regulators embrace the concept of performance-based regulation, but no one has figured out how to do it in such a way that the regulations aren’t gamed by the utilities. Like tax reform, everyone talks about it but no one can figure out how to do it.
The questions are manifold and the debate is complex. There are no obvious paths for utilities to profit from the changes. Although there are some enlightened utilities, their current postures suggest that most utility industry companies will resist the dramatic changes imposed by technological changes until they can be certain that they win. “Distributed energy resource technology…can do to electric utility industry what wireless handheld technology has done to the telecom industry. This will be revolutionary,” said Paul DeCotis, vice president of power markets at Long Island Power Authority is quoted as saying.
But while telecom companies were able to offer much desired services—broadband Internet, mobile phone service, and content—but electric utilities don’t have any clear equivalents or core competency to offer these services. Plus, most of the telecom companies of the 1970, 80s and 90s no longer exist. It’s a wretchedly rocky road for these risk averse electric utilities.
One wildcard in all of this is energy efficiency. A very revealing report was issued recently by the ACEEE. The report authors state that household devices, such as TVs, computers, and ceiling fans, and commercial equipment, such as elevators, icemakers, and MRI machines, use 7.8 quadrillion Btus each year – which is more than the primary energy use of Mexico, Australia, New Zealand, or 200 other countries, and is more than the amount of oil that the U.S. imports from the Persian Gulf and Venezuela each year. Many of these devices could be made to use 40-50 percent less energy with existing technology. President Obama has identified establishing new goals for energy efficiency standards as a top priority in his plan to tackle the growing threat of climate change. Consumer devices that often are replaced in two-three year cycles and other commercial equipment like elevators, escalators, and medical devices present a huge energy savings opportunity that could evolve quickly with Federal incentives.
Another wildcard is Section 1.11.D of the Clean Air Act which directs the EPA to create rules for power plant emissions. In doing so, the agency will be clearly imputing the cost of carbon and injecting it into utility costs. This will assuredly force utilities away from coal and natural gas generation and drive towards new, cleaner, generation. California has been on the forefront of this transition — the rest of the U.S. will be forced to follow once these controversial EPA rules are adopted. (Note to politicians: yes, we know this is going to be controversial and some of you will want to shut down government to prevent these rules from being implemented. Please, take some anger management classes before tackling this issue).
Ultimately, basic funding mechanism for utilities needs to change so they have financial incentives to enable adoption of new technologies and encourage customer energy efficiency. The aforementioned Rocky Mountain Institute report was drawn from a Pacific Gas & Electric-sponsored roundtable of industry participants. RMI reports that the participants agreed upon three “key building blocks” for reform:
Better understanding costs and benefits of distributed energy resources
Better aligning economic incentives to customers and the cost/value to the system provided by distributed resources
Revise the utility business model to operate in a distributed resource/high efficiency industry
Their seems to be little dispute over the reality that the regulatory compact that has survived over a century will need to be jettisoned for a new compact that has not yet been drafted and will likely be the product of some very turbulent and bloody crowdsourcing in the coming years. There’s a multitude of questions with very few consensus answers. One thing is certain: very little of this process will ever make the front pages of the mainstream news.
To download a pdf version of this 8-page report, click here.