Utilities and the Distributed Energy Paradigm Shift

This is the second blog in a series on the growth of distributed energy in the U.S. The first, “The Calm before the Solar Storm,” was posted May 29.

In a move reminiscent of “Who Killed the Electric Car,” we’re hearing grumblings from the investor-owned utility (IOU) industry that advances in distributed energy technologies are threatening revenues. The IOU’s trade association, Edison Electric Institute (EEI), issued a red flag in January with a report titled: Disruptive Challenges: Financial Implications and Strategic Responses to a Changing Retail Electric Business. The “disruptions” boil down to 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. EEI’s “strategic response” is to fight, rather than to adapt to, this evolving energy economy. While EEI is correct in raising a flag on these developing issues, the solutions they recommend are disconcerting from a public-interest standpoint, and naive from the perspective of maintaining competitiveness in an evolving market place. A more sophisticated response to the emerging market dynamics could create real economic value that can be shared by consumers, distributed energy providers and utilities.

The “Game-Changing” Factors
EEI lists a confluence of “game-changing” factors, but the greatest “threat to the centralized utility service model is likely to come from new technologies or customer behavioral changes that reduce load.” More specifically, the rapid cost reductions and advancements in distributed generation (DG) technologies, such as photovoltaics (PV) and battery storage, as well as an increase in energy efficiency (EE) and demand-side management (DSM) programs, are all directly threatening the centralized utility model. Although DG currently represents less than 1 percent of lost load nationwide, EEI is clearly paying attention to market trends in the US, where the installed cost of PV dropped 27% in 2012 alone and the installed capacity for that year increased by over 75% compared to 2011. Similar trends, and associated utility concerns, are occurring in other parts of the world. Indeed, as a recent Rocky Mountain Institute (RMI) blog stated, solar has “officially arrived.”

*For convenience, the remainder of this post lumps DG, EE and DSM into the category of distributed energy resources (DER), even though EEI only uses this term to describe DG technologies.

Utility Business Model Upended
While the majority of the American population views the deployment of distributed generation and increase in energy efficiency as positives for society, IOU’s are less excited. The IOU business model is driven by a financial interest to generate (or buy) and deliver as much power as possible. Higher energy demand means higher investments and higher utility shareholder profits. Minus a few interruptions, this model has worked exceptionally well over the past century. EEI states 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.

DER directly counters the 100-year trend. As these technologies and behavior changes capture increasing “market share,” utility revenues drop and the cost of service is spread over fewer units. EEI contends that this, in turn, will drive up rates and lead to more customers pursuing DER. As EEI warns, “this set of dynamics can become a vicious cycle.” EEI goes on to say that under the worst scenario – i.e., “the ultimate risk to grid viability” – customers would leave the system entirely, by opting to use their own storage combined with a distributed generation resource such as PV. Worse still, utility credit quality will erode due to investors viewing utilities as an increasingly risky venture. EEI compares this “cycle of decline” to that witnessed in other sectors, such as telecommunications and the airline industry.

EEI Proposed “Actions”
In addition to pushing for a roll back of progressive state and federal policies, EEI offers several “actions” for utilities to essentially make DER prohibitively expensive. The short-term solutions revolve around eliminating cross-subsidy biases by adding fees to cover the costs of DER, and to adjust (i.e., reduce) the value provided to DER customers for the energy they offset and/or send back to the grid. Long-term actions would include 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.

What EEI Is Missing
The projected advancements in DER technologies and consumer interests do warrant a re-evaluation of the electricity infrastructure and utility business models. However, the actions offered by EEI to address these challenges are shortsighted and merely prolong the inevitable transition to a modern energy economy rather than figuring out ways to work within it. A deeper analysis would shed light on solutions that meet the interests of not just the utilities and their investors, but those of the public and our economy as a whole. Specifically, EEI is failing to acknowledge how DER technologies are in the public’s best interest; how they can bring value, not just cost, to the grid; and, how they create opportunities, not just threats, for utilities.

It’s in the Public’s Interest
The prospect of a more distributed electricity network offers promise on many levels: economic, environmental, technological and sociological. DER can be beneficial for ratepayers seeking to reduce their electricity bills, and it also creates jobs and economic development benefits that will support both local and national interests. In addition, an increase in DER reduces the water consumption and harmful emissions heavily attributed to the electricity sector. Conventional central power plants account for over 40% of all freshwater withdrawals in the U.S. and over a third of all greenhouse gas emissions. Finally, just as we saw with the advent of the internet and cell phones, 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. The term “energy democracy” is becoming an increasingly achievable goal and one that resonates across political spectrums.

Distributed Resource Value
There is growing recognition that DER provides benefits to not only the public, but also to the power system itself. EEI appears unaware that there are more sophisticated approaches to valuing the benefits of DER on the grid compared to their decades-old methodologies. Accurately assessing the short and long-term costs and benefits of DER is more fair to customers and utilities, and will ultimately support better program design and integrated resource planning (IRP).

One of EEI’s biggest grinds with distributed energy is net metering. Sometimes referred to as “rough justice,” utilities view net metering as the perfect example of how distributed energy is reducing revenues for the utility and increasing rates – through cross-subsidization – on non-DER customers. However, several recent analyses by Crossborder Energy in California and Arizona demonstrated that the benefits of net metering will actually exceed the costs and create net benefits to all ratepayers.

Crossborder’s analyses build off a methodology pioneered by Clean Power Research, which was one of the first groups to take a deeper look at the benefits of distributed resources such as PV. Clean Power worked with Austin Energy in developing a Value of Solar Tariff (VOST), which takes into account the following values that DG solar brings to the grid:

  • 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

The Austin VOST is currently 12.8 cents/kWh for residential solar systems, which, although high enough to incentivize ratepayers to consider going solar, is actually pretty conservative. In a recent Georgia IRP hearing, Karl Rabago – former VP of Distributed Energy at Austin Energy – testified that a meta-analysis he’s conducting on distributed solar valuation methodologies demonstrated that on average, distributed solar would be worth about 25 cents/kWh. Rabago noted even this is conservative because it doesn’t account for environmental, land, water, jobs, and tax benefit factors, which alone could add another 21.9 cents/kWh. And yet some utilities are only willing to pay their avoided costs for solar generation – typically well below 5 cents/kWh!

And, in case you were wondering, this sort of valuation is legal and within the utility’s valuation tool box, as Interstate Renewable Energy Council (IREC) recently made clear in their 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. 

An Opportunity Rather than Threat
EEI calls out the fact that “all industries must prepare for and develop plans to address disruptive threats, including plans to replace their own technology with more innovative, more valuable customer services.” Though hardly any emphasis is given to this concept in the report, it is in fact exactly what utilities should be doing.

Just as utilities are quickly retooling their asset portfolio to align with greater use of natural gas, they need to retool their resource planning to better align with DER. Although EEI highlights a concern with customers eventually opting out of the grid altogether (“the ultimate risk to grid viability”), there’s little debate that some form of central and/or micro-grid will always be needed. Revamping the grid infrastructure to be “smart” enough to handle the inevitable advancements of DER is a challenging but potentially rewarding business opportunity for utilities. Further, rather than watch and complain about the encroaching deployment of PV, storage technology, and electric vehicles stealing utility revenues, why not try to compete in these sectors and provide services and/or resources that meet consumer demands?

From the financial community to advocates, everybody knows the energy times are changing. Some of the smartest people in the country are figuring out ways to reinvent the US infrastructure. RMI released a report following collaborative efforts with PG&E – California’s largest utility – and is now engaged in a multi-year effort to identify issues and solutions involved with increased DER on the U.S. electricity system. In parallel, Princeton hosted a roundtable last month with utility executives, government officials, academics, industry representatives, and various advocacy and consulting groups to discuss the paradigm shift DER is creating. A key theme at the meeting was the need to change the way various aspects of generating and transmitting electricity are valued and priced. The fact that several utilities were engaged in the discussion is promising and gives hope that maybe utilities are coming around to the fact that the best response to this type of “disruptive challenge” is to embrace it, rather than fight it.

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6 Comments

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Keeping eyes open for utility first movers, forward leaners and exemplars to show the rest that DEG can help not hurt them.


Comment by Andy Bochman on June 4, 2013 7:22 pm


Utilities are trapped by the very same regulatory models that sustain them, compounded by a focus on short term financial results. A CEO, faced with a choice of investing in a regulated business with a virtually guaranteed 8% (or so) return on equity and an investment in an unregulated DER business with no guaranteed return whatsoever will choose the regulated investment every time.


Comment by Paul Alvarez on June 5, 2013 11:19 am


It’s kind of hard for utilities to change their revenue model to helping customer obtain “DER” when the utilities are paying customers for it via rebates (such as rebates on solar installations). Last I checked, you have to receive money in order to make money. That being said, customers could not currently afford “DER” if the utilities don’t pay the lions share, much less if we added a cost to it for profit. DER is an artificially proped-up business that is slowly sucking utilities dry. Utilities can only hope that DER gets cheap enough that the customers can afford to pay for it themselves, and then utilities can make a profit on consulting and installing it for them. The the cities will then have to maintain the “central grid” on mostly taxpayer dollars.


Comment by Michael on June 5, 2013 1:05 pm


Thanks for the great overview and generous shoutout!

I imagine utilities everywhere are facing earnings shortfalls (either real or against expectations). And I also imagine that thoughtful review shows that the overwhelmingly major drivers are the recent economic downturn and persistently low natural gas prices. A far distant third, certainly on an order of less than 10% of the problem, are impacts associated with distributed energy resources, like efficiency, demand response, and distributed generation (DER). Over the long run, and certainly if sales pick back up, the benefits of DER will overwhelm earnings losses, as they did for utilities that aggressively pursued them in the past (like SMUD, Austin Energy, and others).

DER technologies, especially solar photovoltaic generation, are classically disruptive in character just as Christensen first described the category years ago. But at a fraction of total system energy, these technologies are hardly disruptive in fact, yet. So the pain some utilities are feeling is not logically caused by the DER that EEI and others point to. Rather, those are just the things they can do something about.

The real problem is, and has been, a business model focused on spinning more meters ever faster–sales of kWh. That is a model highly vulnerable to changes in weather, changes in the economy, fuel price volatility, and even, to a very small degree today, customer by-pass. To be sure, if new and better technologies actually cause stranded costs associated with unamortized investments in outmoded and suboptimal resources, we can deploy legislative and regulatory tools to quantify and address the issue, just as we have in the past. Of course, sound financial economics dictates that we not exclusively tax new technologies with these broader-based costs as that would create economically inefficient barriers to entry and long-term economic inefficiency.

It falls on increasingly affordable and popular solar PV to bear the standard for business model reform in the traditional electricity services arena. Note that solar and other distributed technologies help immunize the utility against the very vulnerabilities they exploit. A host of exciting technology and service options await an opportunity to improve value and lower costs for customers.

New business models will not just sell electricity by the kWh, but will engage and empower customers in meeting the demand for energy services, and will diversify risk throughout a broader portfolio of generation, smart grid, and demand side technologies. New models will be about bills and not just rates, about service and not just supply, about empowerment and not just subscription. Advocates have been making that case for at least the 25 years that I have been involved in the electricity services industry. Let the transformation finally start here. Let it finally start now.


Comment by Karl R. Rabago on June 5, 2013 5:13 pm


like Paul, I also advocate for a KPI or incentive based regulatory regime to at minimum enable utility investments in smarter systems and re-configuring the grid for these changes, however, looking at global PBR regimes, it is no panacea. Regulators and utilities must continue finding space for better holistic thinking a a model that enables more IOU-third party development more like the open-source model


Comment by Matt Futch on June 6, 2013 5:56 pm


You say “The IOU business model is driven by a financial interest to generate (or buy) and deliver as much power as possible. – ” actually this is effect, not drive. Utilities are driven by a financial interest to invest as much as possible, and then to spread that cost as widely as possible. The spreading mechanism is sold units, but the profit imperative is deploying capital. This is very unusual in the business world, but it holds the key to this problem.

Seattle City Light has just figured out a very interesting way to put this to work in a multiple-win scenario- see http://www.en-rm.com/wp-content/uploads/2013/02/Bullitt-SCL_Release.pdf. Press on the subject is gathered at http://www.en-rm.com/announcements.


Comment by Bill Campbell on June 17, 2013 4:03 pm


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