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Utility of the future: Future of utilities

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EEnergy Informer

The power industry, traditionally considered a safe investment bet for widows and orphans, is no longer safe for either. In fact, its fundamental relationship with its customers – defined by the copper wire that connects the two and the meter that measures how much juice is flowing to customers’ premises – is no longer as secure as it used to be. Customers with rooftop PVs are now feeding juice to the grid, at least part of the time. Moreover, there is speculation that just as millions of phone customers cut their land lines when they went wireless, utility consumers may someday be able to cut the cord – or rely on the grid far less than they do today.

rsz_screen_shot_2014-05-30_at_111739_amCutting the cord may not be as easy in this case, but that should not stop utility executives from worrying. The real fear is that consumers may buy little from the suppliers, using the distribution network mostly to balance their variable generation and consumption. As the cost of self-generation – notably from rooftop solar PVs – continues to fall increasing numbers of consumers are becoming prosumers, generating some or most of the juice they need, astonishingly at prices that match or beat the grid-supplied variety.

The incumbents who have collectively invested untold billions in the US – trillions globally speaking – in a massive infrastructure to generate, transmit and distribute the juice to customers with the time-tested assumption that they will always be there and will consume more forever, are now scratching their heads in total disbelief.

As Jon Wellinghoff, the former Chairman of the Federal Energy Regulatory Commission (FERC) and currently a partner at Stoel Rives LLP observes, it is as if everyone were to stop drinking milk. All the investments made by dairy farmers in cows, milking facilities, processing and distribution network would suddenly become worthless – a massive stranded cost with little hope of recovery. This analogy and much more may be found in a forthcoming volume edited by this newsletter’s editor – further described at the end of this month’s issue.

To be sure, things are not likely to be quite that drastic or sudden for utilities but the milk analogy serves to focus the mind on potential future challenges. By any metric, the threat of distributed energy resources (DERs), broadly defined to include energy efficiency (EE), demand response (DR) and distributed generation (DG) is real and imminent, and it is likely to become more pronounced as the cost of DERs continues to fall relative to utility retail tariffs, especially in high price areas.

In this case, it is not that people will stop drinking milk, but they may start milking their own cows and goats, buying less from the dairy farmers. Some may produce more than sufficient milk, selling the surplus to the local supermarket or dairy farm who must take it under current net energy metering (NEM) laws now in effect in 43 states in the US (map below) – and equivalent schemes in Europe, Australia and many other places.

In most cases, prosumers receive arsz_screen_shot_2014-05-30_at_111952_am
credit equivalent to the prevailing
retail tariffs, which can be quite a lot in places like California, Hawaii or New York. Even if no credit is given, every self-generated kWhr represents a big saving for a consumer in, say, Copenhagen, Sydney, Berlin or Tokyo where retail tariffs are high and where a myriad of taxes and levies are included. European retail tariffs, for example, average around 18
€cents/kWh (graph on page 9), and go as high as 31 €cents/kWh in Copenhagen, slightly less in Berlin (approx. 25 and 43 US cents/kWhr).
Australian tariffs, historically low by international standards, have
nearly doubled in the last 5 years, making them among the highest among OECD countries.

The same happens if consumers invest in energy efficiency. While no direct credit may apply, every kWhr conserved is a kWhr not consumed. The net effect of more DERs is shrinking utility revenues, negligible in many places but noticeable and growing elsewhere. And that is bad news if you are on the receiving end. Since the revenue shortfall must be recovered through higher tariffs on the remaining customers, i.e., those who cannot or do not – for whatever reason – invest in DERs, resulting in the dreaded death spiral scenario described in Edison Electric Institute’s widely circulated report on disruptive technology, described in June 2013 issue of this newsletter.

The fundamental problem facing the incumbents is that the industry’s business model, devised and fine- tuned over a century, is based primarily or exclusively on fixed tariffs applied to volumetric consumption. If net consumption flattens or falls due to the expected rise of DERSs, revenues flatten or fall while costs, mostly fixed, continue to rise. Bad news indeed, especially in jurisdictions where there are little or no fixed or connection charges, as is currently the case for residential consumers in California.

rsz_screen_shot_2014-05-30_at_112312_amThese developments have not escaped the attention of regulators and policy makers who must make sure retail tariffs remain just and reasonable, the lights stay on and the reliability of the grid is not compromised. Like the industry, they must be in a state of shock, no doubt digesting the rapidly changing environment around them and contemplating how to react. In virtually every state and country, the regulators ultimately set the rules by which the industry and the new entrants must play. But as with all disruptive technologies, the regulators are surprised not only by the rapid pace of change, but frustrated by their inability to predict, control, or influence it.

Take SolarCity’s PV leasing business, which appears to be thriving. It allows customers the option to install solar PVs on their rooftops with virtually no upfront investment. Never mind that the middleman is making good money in the process – as middlemen always do. So long as investment tax credits (ITC) and net energy metering (NEM) laws are in place, such companies and business models will proliferate, largely outside the traditional reach of the regulators.

What has gradually dawned on the regulators is that the traditional rules that once kept the industry in check are no longer applicable because the industry’s fundamentals, from generation to distribution and consumption are changing. Fast forward to 2020 and beyond and it is easy to see a future where the tail is wagging the dog – where DERs and renewable generation turn the industry’s upstream infrastructure into a gigantic battery, increasingly used for balancing variable generation and consumption and for providing reliability.

In April, New York’s Public Service Commission (NYPSC) started a proceeding that is likely to be repeated in the coming months across the country. Similar issues have to be debated and settled in other countries facing identical challenges.

rsz_screen_shot_2014-05-30_at_112834_amNYPSC’s proceeding titled Reforming the Energy Vision or REV, (following article), is a good start in outlining what the problem is. It poses a number of sensible questions but falls short on solutions or regulatory approaches – perhaps because New York’s regulatory commissioners and their staff have always played the role of second-guessing the actions and motivations of a passive and slow moving industry, acting as an arbitrator and auditor of their finances.

To its credit, the NYPSC acknowledges this fundamental shift in regulation where it discusses a shift from traditional input- to outcome-based ratemaking. It even refers to OFGEM, the UK’s regulator, who has introduced a new scheme called Revenues set to deliver strong Incentives, Innovation & Output or rsz_screen_shot_2014-05-30_at_113259_amRIOO, replacing
traditional rate of
return (ROR)
regulation currently
prevalent in the US and
many other
jurisdictions.

As this editor sees it,
the challenge of DERs
and disruptive
technology does not fit
the regulators’
traditional paradigm,
just as it does not fit the
business paradigm of
the industry. Stuff is happening at an accelerating pace, mostly outside their comfort zone and beyond their zone of control.

Reading some parts of the NYPSC order reminds one of the saying that if the only tool you have is a hammer, everything begins to look like a nail. The NYPSC, with its hammer is desperately looking for a nail – which in this case is nowhere to be found.

 Perry Sioshansi is president of Menlo Energy Economics, a consultancy based in San Francisco, CA and editor/publisher of EEnergy Informer, a monthly newsletter with international circulation. He can be reached at fpsioshansi@aol.com

 

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