“This is no longer a vacation. It’s a quest. It’s a quest for fun.” — Clark Griswold
I hope you’ve been enjoying our road trip to Utility Land. (If you’re just joining us, start here.) We have arrived, at long last, at our destination. We face the big question: How can we make utilities work for us in the 21st century?
Let’s recall the basic shape of the problem.
Right now, electric utilities come in two flavors: They are either vertically integrated, which means they own both power plants and transmission and distribution (T&D) lines, or they are deregulated, which means they own only T&D. Either one can be investor-owned or publicly owned (municipal). So there are four varieties overall, but it’s worth noting that the majority of U.S. ratepayers still pay their bills to investor-owned, vertically integrated utilities.
Regardless, for almost all utilities the problem is the same: The regulatory structure in which they operate incentivizes them to sell more electricity. They make long-term investments in power infrastructure and then charge customers a per-kilowatt-hour rate based on “cost plus” pricing, i.e., a rate that covers the cost of the investments plus a reasonable return. (For municipal utilities, the returns go back to the city or county rather than to investors.)
You see the simple incentive created by this arrangement. If the utility sells more kilowatt-hours than expected, it must make more investments, thus increasing its returns. Conversely, if customers start buying fewer kilowatt-hours, the utility risks having its investment costs stranded.
All of the blooming, buzzing innovation happening in distributed energy, at the distribution edge of the grid, is geared toward reducing the kilowatt-hours customers need to buy, through utilities, from distant power plants. Ergo, distribution-edge innovation and the basic incentive structure of utilities are at odds. That is the nut of the problem.
The nut of the solution, then, is to wean utilities off of the need to sell more kilowatt-hours. That is, to understate the matter considerably, easier said that done. But let’s say it nonetheless.
What needs to happen
To wean utilities off kilowatt-hours, regulators must do several things simultaneously:
1. Establish a transition plan that ensures utilities can recover costs from their existing investments while adapting to the new model. It’s important that this be done in as transparent a way as possible. Utilities are being asked to rebuild a large and expensive airplane that’s already in flight. They made investments under a particular regulatory regime, and if they’re being asked to adopt a different one, they are owed support during the inevitably turbulent changeover.
2. Finish the work of restructuring (misleadingly known as “deregulation”), breaking up vertically integrated utilities and creating competitive power generation markets. The regime under which most U.S. electricity consumers operate, paying the same party for both electricity and grid services, has long outlived any rationale. Utilities should maintain ownership and management of the one area where they have a true natural monopoly: the grid. Elsewhere, both in large-scale generation and on the distribution edge, competitive private markets should drive innovation.
3. Integrate demand-side and distributed resources into utility resource planning, which is the process every utility goes through to determine the investments it will need to make over the next planning period. Right now utilities mostly ignore distribution-edge activity, so they don’t plan for its effect on demand. That means utility customers are often double-charged: they pay for distributed resources and the infrastructure that such resources should have rendered unnecessary. Accounting for all resources, central and distributed, supply and demand, is called integrated resource planning, which is just as boring as it sounds, but incredibly important in practice.
4. Come up with other ways for utilities to make money, ways that can, if not supplant kilowatt-hour sales, at least substantially supplement them. To open up these new revenue streams, utilities will have to get more nimble and take more risks, but just as importantly, their regulators, public utility commissions (PUCs), will have to get more flexible. It will always be important that utilities ensure reliable, nondiscriminatory, and reasonably low-cost service. But reliability must be redefined to include more than redundant generation capacity, nondiscriminatory must be redefined as a floor rather than a ceiling, and costs must be redefined to include more than the price of kilowatt-hours. PUCs must give utilities the leeway to experiment and innovate.
Now, all four of these are important, but it’s the last one, No. 4, that’s the real heart of the problem. If that can be solved, the rest can be managed. So let’s take a closer look at it.
What utilities can offer
How can utilities make money if not (only) by making big investments in infrastructure? If customers are buying and managing more and more of their own power, is the utility just a useless intermediary, destined to wither? You sometimes hear this kind of thing from distributed-energy enthusiasts, but I don’t think it’s true.
As I wrote in my last post, it is important to make the grid more resilient through “nodal architecture,” in which the nodes that make up the network are semi-autonomous and can island off from the larger grid in case of accident or attack. But just as important as the autonomy is the interconnection, which enables positive network effects, in energy just as in information or trade. That can’t happen if small-scale generators go off-grid.
As distribution-edge systems mature, we’ll need the grid more than ever, which means utilities will be more essential than ever. As the entity sitting at the center of a complex, multi-dimensional web of transactions, a utility can provide services that no one else can. Here are a few.
There are many more participants, services, and values involved in electricity markets than there once were; they are evolving into much more complex organisms. Where once there were a handful of central station power generators managed for one-way supply, now there are (or will soon be) thousands of small-scale generators and smart demand-side technologies bouncing power around multi-directional networks. Where once power prices were a blunt monthly average, now some utilities are choosing time-of-use pricing that varies over the course of a day. Where once there were only utilities, now there are all sorts of third parties aggregating and selling a variety of energy services. Where once reliability of supply was the paramount and near-exclusive concern, now it is joined by concerns about carbon content, voltage quality, geographic source, and democracy of ownership.
What can utilities provide for these complex new markets? In a word: structure. As any student of Adam Smith can tell you, healthy markets boast a few key features: easy entry and exit, good information, and transparent pricing. Utilities can provide all that.
First, as grid manager, the utility can serve as a kind of common platform or clearinghouse where every purveyor of energy or energy services can register, find out who else is selling what, and transact.
Second, utilities and their regulators can set and enforce common interconnection standards among various pieces of the energy system. This will become increasingly important as software takes over.
Third, perhaps most importantly, especially in the short term, utilities and their regulators can determine the value of various energy services. What is access to the grid worth? What is the value of distributed solar power? (This is what the whole net-metering fight is about.) What is the value of demand response, or power smoothing, or peak shaving? What is the value of avoided costs, infrastructure investments that don’t have to be made? What is the value of generation capacity, even if it is idle most of the time, serving as backup to variable renewables? What is dispatchability worth (this will be important to energy storage)?
And so on. These services must be evaluated fairly and objectively and the information must be made available on a real-time basis to all market participants, who will use it to strike deals among themselves. For any system like that to work, pricing information must be trusted and accessible without discrimination.
2. Aggregation and reliability
The main role of utilities has always been to provide reliable power. In an age of climate change and distribution-edge innovation, that task will become considerably more complex and difficult. There will be intense pressure to lower carbon emissions, which will mean phasing out central-station power plants, beginning with coal plants. And there will be intense pressure to integrate thousands of small-scale energy and energy-service providers.
In order to aggregate distributed resources into reliable service, utilities will need to be omniscient, aware of which providers, services, and customers are on- or off-line at any given moment. Supply and demand will both fluctuate constantly, but must be seamlessly matched. That kind of juggling will require ubiquitous sensors, sophisticated software, and a great deal of organizational agility.
I don’t think it’s impossible. If utilities are losing the brute-force effectiveness of multiple backup fossil-fuel plants, they are gaining new tools as well: dispatchable energy storage and microgeneration, demand response, and islandable microgrids. There’s much more to say about reliability, but I don’t want to go down a rat hole, so let’s keep moving.
3. Fairness amidst differentiation
For the last century, electricity has been a pretty egalitarian (not to say socialist) affair: It’s available to everyone equally and everyone pays the same rates. As electricity markets become more like actual markets, customers will inevitably demand differentiated services (some will want higher quality power, some cleaner power, some cheaper power) and also provide differentiated services. With competitive markets come unequal outcomes.
Put more bluntly: Distribution-edge innovations are likely to be available first to those with the most money.
In this environment, utilities (with PUCs’ stern encouragement) can act as an extension of the social safety net, ensuring that a base level of affordable power is available even to those without fancy solar panels and energy-management software.
Utilities have lots of big assets, which means they have big balance sheets, which means they have access to cheap capital. Right now they are sharply restricted in where they can invest that capital. Every investment must be, in the parlance, “used and useful.” That hyper-conservative standard tends to discourage strategic investing in cutting-edge technologies and services.
I don’t think we’d want to go so far as having utilities act as venture capital investors, but PUCs could certainly loosen the reins a little bit and allow utilities to provide much-needed low-cost capital for distribution-edge technologies that are trying to scale.
Customers are not used to dealing with energy generation, storage, and management. But they are used to paying a utility bill. One can easily imagine utilities serving as a single point of contact with customers. A service provider, rather than bill the customer separately, could contract with the utility to charge customers via their familiar monthly utility bill (on-bill financing, it’s called).
Anyway, these are all services that utilities can provide and, more to the point, charge for. These are the new revenue streams. (Though of course return on infrastructure investment will remain a piece of the puzzle.)
So this is the new model for utilities: Rather than building a delivery system for electricity-as-a-commodity, they will be managing (and participating in) sophisticated markets for energy services. The utility will be the platform, the aggregator, the traffic cop, and the trading floor. If these sound more like information services than infrastructure services, it’s no accident. As I’ve been saying, energy is acting more and more like information. The power grid and the internet are bleeding into one another.
Notice that I haven’t said anything about whether utilities of the future should be investor-owned or public. My strong preference, for all kinds of reasons, is for public utilities. But I don’t think this is a vital distinction; what I recommend could be done under either ownership structure.
Whether they are private or public, I do think it’s worth being honest about the fact that a utility like the one I describe is probably going to be smaller than utilities of today. It’s not going to be the giant, capital-intensive, boringly low-risk investment of yesteryear. There’s going to be a lot more IT, more services, a more diverse portfolio, more dynamism and risk, but fewer big machines.
It won’t be easy to get there. The more you know about utilities, the more you understand just how difficult it will be. But the first step, what I’ve tried to do with this post, is to envision the end state, the future we’re trying to achieve: a truly smart, nimble utility that serves as a guide for customers through the exciting but oft-confusing world of energy democracy.
Wouldn’t that be cool?