Utility of the future: Future of utilities

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 a
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.