Barbarians at the Gate of the Utility Smart Grid Future

The strategic advantage of America has always been its uncanny ability to reinvent itself and adapt to a future it designs or is confronted with often in near real-time along the way.  By embracing change and celebrating it by investing in R&D, rapidly adopting new technology, and unleashing it for good or ill to enable entrepreneurs and average citizens alike to change their business or change their lives, we have set ourselves apart from others bound by traditions and given ourselves permission to continually change the rules of the game of life.

The current health care debate is the latest example of the clash of transitions at work.  As America faced the threats of World War II it mobilized to face the enemies.  To attract workers to build the armaments of war industry used benefits like health insurance as a magnet.  That legacy of group health insurance plans socialized (in a good way) the efficient coverage of millions.  But as our industrial base was displaced by globalization the group plan strategy began to break down and more workers were uncovered.  The private insurance market was fragmented and state by state coverage requirements made aggregation difficult and costs high. Our choices were wholesale competition across state lines and more individual choice of plans or greater centralization with a single payer plan run by the government.  We are now engaged real-time in the civics lesson du jour of deciding which way to reinvent America’s health care system.

On the energy front, we face a similar process of reinvention in the face of rising prices, disruptive technology, and changing ideas about how to produce energy to meet our future needs in ways that are clean, reliable and sustainable. On this battle front the question we face is what business model makes sense in the face of these changes?  Having already decided to inject wholesale competition into the power generation part of the business we now face the need to address the disruptive technology implications of smart grid, renewable energy and the policy goals of reducing greenhouse gas emissions while still assuring a reliable power supply at prices we can afford.

Factors Reshaping the Smart Grid-enabled Utility Business Model

The traditional utility business model that served us well for 100 years is being reinvented before our eyes.  It gave us reliable energy and stable average cost rates and a referee in the form of the state and federal regulators to act as traffic cops.  But we didn’t have much choice in fuels and a commodity-based one size fits all approach to delivering electricity.  Regulators forced utilities to buy more renewable energy, clean up power plants, diversify fuels and encourage us to use energy more efficiently.  That system, just like the industrial group health plan model, works when you have a few hundred players. But the changing needs of competitive markets and changing lifestyle patterns of home and work are demanding utility business model changes just as they have the health care model.

In October 2009 I wrote describing a convergence of market, economic, environmental and regulatory forces underway that is changing the way investor owned utilities see renewable energy from something they must do to satisfy their regulators to something they MUST do to survive.

I described ten factors that lead me to this conclusion:

  1. Renewable Portfolio Standards are here to stay.
  2. Carbon emissions constraints are likely to happen.
  3. Consolidation is sweeping the wind and solar manufacturing industry.
  4. De-coupling rules are limiting earnings growth from commodity energy sales.
  5. Efficiency and Demand Response regulations open the door to aggregators.
  6. Home Area Network (HAN) technology threatens control of customer gateway.
  7. Congress allows utilities to earn investment tax credits on renewable generation.
  8. NIMBY is likely to limit or kill most new transmission construction.
  9. Without transmission access renewable energy developer failure rates rise.
  10. Maybe a distributed generation business model based upon renewable energy owned by the utility is not such a bad place to be for an investor owned utility.

I argued that this convergence of forces is engaged in a battle to kill the economies of scale for large central station generation and turn the traditional utility business model on its head in favor of a more distributed generation approach to energy delivery. I said that while wind has captured the most renewable energy market share to date, it is solar power that is the more pernicious threat to the utility business model because it represents the foundation for a distributed generation alternative to the traditional utility. The only thing standing in the way is cost.

In January 2010 I added customer aggregation as an additional threat to the utility business model. There are a growing number of examples of this threat at work including:

  1. Energy Management Companies like EnerNOC, Comverge, Bloom Energy or Google Energy aggregating commercial and industrial customers with demand response, efficiency and self-generation or storage to reduce their grid footprint;
  2. Wind and Solar Power Generation top capacity additions in most markets to rapidly grow the market share of renewable energy and are becoming mainstream with some states on a path to soon achieve their renewable portfolio standards targets;
  3. Smart Meters Market Share is rapidly growing because of Federal stimulus funds opening the door for promising new energy management players to use the data to manage costs, improve efficiency and deliver better services than the utility offers;
  4. Direct Access Returns in California’s decision to re-authorize direct access for those C&I customers this year a decade after the California energy crisis shut it down;
  5. Proposition 16 on the June 2010 California primary ballot supported by PG&E to raise the bar for municipal aggregators to require a two-thirds vote for most such actions fearing a loss of control over the gateway to customers and growing costs to integrate all the new vendors and manage the reliability of the delivery system;
  6. Wyoming and Oregon Reduce Wind Subsidies to reflect the mainstream nature of wind energy and a recognition that the States cannot forever afford to subsidize renewable energy but must force it to compete on a level playing field.

How will the traditional utility business model change?

Customer aggregation is indeed a potential threat to the utility business model, but the real threat is not the muni challenge but this same convergence of forces that is likely to bring us smart grid, Home area networks (HAN), efficiency and demand response services and the quest to be more responsible energy consumers.

In short, the real threat is from services firms who see the potential profit from leveraging energy information from smart meters with energy efficiency/demand response/distributed generation to game the dynamic pricing rates structures likely on the horizon to control the gateway to customers. Meanwhile, aggregating commercial and industrial customers around energy efficiency, energy management, green building solutions and the like proves the concept.

So why is this a threat to the local utility? Because few utilities are customer centered enough to help clients save money and thus energy because most are still in the business of selling energy as a commodity. PG&E rates are decoupled so PG&E profits from the effective management of its portfolio against performance targets not commodity energy sales.  So why is it pouring $35 million into Proposition 16 to discourage customer aggregation?   Because it fears that all the new vendors flooding into a smart-grid enabled market will bleed away customers and leave PG&E stuck with overhead cost and little opportunity for growth.

Stages of Utility Transition

The transition process to a new energy business model is underway and it will likely take time to unwind the old ways and invent the new ways of doing business.  Smart meters, direct access, renewable energy and net metering, demand response and energy efficiency and management services vendors are all part of the lab experiments underway today.  The scientific method tells us this trial and error process will take time and not every big idea will pan out.

We do see trends and a few speed bumps in the road ahead.  I think a useful way of categorizing the signposts to our new energy business model future might be the following:

Stage 1:  Consolidate New Technologies into Energy Management Solutions.

As smart meters get installed and utilities are forced to disgorge the meter data to vendors we should expect to see a rush of new energy management companies offer services—first to commercial and industrial customers to turn that meter data into actionable services to improve energy efficiency, take advantage of demand response and dynamic pricing plans that trade control over time of use for lower costs of energy. Corporate energy customers will also seek to use these technologies and services to green their footprint, reduce emissions and use the bragging rights for competitive advantage.  There will be an accelerating consolidation of vendors of networks, sensors, gadgets and software as the market seeks to offer more complete end-to-end solutions to customers.  Cleantech investors will either double down or cash out in this consolidation phase.

Utilities have already suffered the loss of the industrial and manufacturing base.  Fuel demand for power generation is now a larger sector of the energy market than industrial load.  But energy management solution vendors will directly attack the commercial load of the utilities.  This will be a mixed blessing.  On the one hand, utilities will benefit greatly by reducing peak demand through efficiency and demand response that energy management firms will use to make money taking a piece of the savings from their commercial clients as payment.  And utilities can also benefit if commercial customers invest capital in self generation from rooftop solar and other renewable energy options again reducing the utility peak load.  But diminishing the revenue share of the commercial class will shift more of the overhead cost burden to the residential class and thus putting upward pressure on rates.  Even in a decoupled rate structure cost allocation will add pressure to utility rates already going up because of renewable energy procurement, emissions reduction, efficiency and other regulatory or legislated program costs.  Direct access in California will enable C&I customers to avoid higher utility costs, but they must invest capital and share energy savings with energy management vendors to do so.

Stage 2: Dynamic Pricing to Redesign Rates Before it Gets Ugly

The investment in smart meters and energy management programs is useless unless utilities transition to dynamic pricing to redesign rates to create the incentive to change energy use patterns in order to avoid higher energy costs.  Rates will still go up—way up, but customers who believe they can control some of that rising cost by improving energy efficiency, demand response or just using less energy overall will be less likely to revolt—so goes the theory.

We will soon enter a stage of regular and substantial rate case increases as utilities face the upward cost pressures of RPS subsidies, efficiency and demand response program costs and rebates, smart meter costs and other normal inflationary or other cost increases. Regulatory lag will slow down some of these spiraling costs, but not for long.  And the move to dynamic pricing structures sets up the world dynamics in a weak economy—rate design wars as interveners challenge the rate structures proposed and charges of unfairness and gouging get mud on everyone involved.

Because state regulators and legislators do not want to see ratepayer storming the state house with cell phones and YouTube videos some efforts will be made to allow pass through costs that slowly dribble into effect rather than force the utility to save up big cost exposures and dump them into rates all at once.  But as PG&E and Oncor experiences attest in California and Texas—it will be difficult and can get ugly. I’ve called this the Bakersfield Effect to describe the anger over rising utility rates on the brightest, shiniest object around—-the smart meter.  It’s not fair, but it will always be convenient.

Dynamic pricing changes everything. By freeing customers to take actions to reduce consumption and take control of their energy costs by behavior changes don’t be surprised that they will do so.  And that customer decision sets up demand for a vast array of new products, services, and choices for customers as well as new business opportunities for both utilities and outside vendors.  The challenge for the utility is to decide what it wants to be when it grows up in this dynamically priced competitive business environment.

Stage 3: The Customer Controls the Gateway to the HAN Future

Better technology, more information about using, dynamic pricing and plenty of choices is going to be both liberating and terrifying for most residential utility customers.  To be honest many customers probably like the way things are—until their energy bills spike higher.  But vendors realize that the traditional utility business model forced residential customers to take a one-size fits all commodity product in isolation.  Now the convergence of a more competitive energy market with dynamic pricing and access to smart-grid enabled technology sets up the greatest opportunity for market share growth since the Oklahoma Land Rush.  Vendors can make the energy management pain point for customers go away by bundling energy with communications, information, entertainment, security and other services targeted to fit the lifestyle segments in play.  These vendors not only want our energy spend, they want our wallet share for phone, internet, cable TV, Netflix, Tivo and a score of other services.

Have you looked at the competition between Comcast and AT&T or Verizon for bundled services lately?  This is the shape of things to come for energy management services—and more.

Forget to turn your lights off when you left home for work?  There’s an App for that!

The greatest fear of traditional utility companies is that they will lose control of the gateway to residential customers just as they have lost the industrial load, and soon the C&I load to energy management firms BEFORE they can liberate themselves from the constraints of traditional regulation and seek to enter new markets.

The reality is that traditional utilities are not well suited to meeting the needs of customers for bundled solutions and cool products.  It is the same fear MaBell faced when customers and regulators revolted over charging outrageous long distance rates and $12 per month for a land line to our homes and the monopoly business of a century drained through the hourglass of time at double speed.  Now, of course, we get long distance for “free” in our monthly minutes bundle but we pay an average of ten times the month cost of the old traditional MaBell service—but we have fun doing it on our iPhones.

Stage 4: The Search for Equilibrium

We do not know how long this transition to the utility future will take or what its shape will yet be.  The Utility business model of the future will be formed by the interplay of these converging forces and tweaked through these stages of transition.  But we do know a few things.

Real-time grid operations are here to stay unless energy storage takes off big time, the power grid will continue to be an instantaneous ecosystem of networks, supply sources, sinks, wires and equipment that requires constant 24/7 monitoring and control to assure the reliability we require.  Nothing less than perfection is acceptable performance for the grid.  As our regional grids are able to synchronize and transport energy supply more efficiently the complexity will grow along with the demands on the system.

Utility Business Model Concepts Drawing Board

So what might the “utility” of the future look like?

We don’t yet know, but here are four ideas to keep you up at night:

  1. Wires and Pipes Energy Delivery Company. So while many new players want to bundle services and do deals someone must actually deliver the juice!  One utility business model for the future will certainly be the traditional wires and pipes energy delivery company being paid for its deliveries.  Rate regulated delivery service fees.
  2. Energy Balancing Platform Company. Beyond that the options for power generation of baseload and mid-merit supply is another option for merchant generators or regulated utilities to create a stable platform for renewable energy, demand response, energy storage, PHEV and others to plug into a more competitive distributed energy ecosystem acting as the load balancing entity of old but doing so by selling that service to energy management companies to mitigate their grid costs. Unregulated generation and services.
  3. Distributed Energy Market Maker.  Beyond facilitating supply options like the energy balancing platform company above the distributed energy market maker seeks to remake its entire energy portfolio by enlisting its customers to be partners in the enterprise.  It provides capital, engineering and construction services, operational support, maintenance and other services.  It would encourage energy storage, PHEV net metering and other programs to enlist its customers into being active or passive energy providers as well as consumers.  This utility could still provide some generation on its own but its focus is to creates the most inclusive DG system possible and become the conductor of the DG orchestra in order to retain control over the gateway to customers.  It uses that gateway to offer vendors and other service providers as platform to offer additional services and collect fees from managing the distributed market for all.
  4. Branded Energy National Customer Aggregator.  In competitive power markets across the country getting attention and gaining market share is the game.  Solutions providers can market and support blocks of customers offering segmented services packages of energy, communications, information, entertainment, security and other services.  But in a fragmented and consolidating business there is need for a few big players who use their energy or utility brand to gain market share.  They deliver their services through other vendors or the local energy delivery company but manage the gateway to customers and use that gateway to grow the business.

So what?

The traditional utility business model is under assault by a convergence of forces being accelerated by smart grid, renewable energy, emissions reduction and the cost of paying for all of it.  What will the utility of the future look like?  We are in the midst of inventing that now—join the party.