Strangling Smart Grid or Greasing the Skids: Federal Uniformity-vs-State Rights

Ever since the beginning of public utility regulation there has been tension between the role of the Federal Government and the States.  So far States have fared well in this checks and balances contest of wills.  The Federal government’s focus on interstate commerce and the wholesale market rules, regulations and safety requirements to enforce a level playing field between the states has been a two-steps forward, one-step back game of jurisdictional assertion.

Today the issues of Federal versus State jurisdiction are playing out in the evolution of smart grid, the advance of renewable energy resources, and the scalable potential of energy efficiency and demand response.  There is much at stake in the outcome of these contests.

The States as Laboratories View

In one corner are the states and those who believe that the flexibility to try new things and adapt conventional wisdom to the practical facts on the ground argue against Federal uniformity in many areas of energy regulation.  The practical reasons for this fragmentation are driven by the very fragmentation of the energy industry:

  • Wholesale electric markets are fragmented across three grid structures: Eastern Interconnect, ERCOT, and the Western Electricity Coordinating Council.  FERC has jurisdiction over the wholesale operation of these grids, commissions the regional transmission organizations that operate them across state lines and sets wholesale competitive energy rates.  But supply choices, plant and transmission siting, routing and other CAPEX issues are state controlled.
  • Retail energy sales are regulated state by state.  But by tradition retail energy sales are regulated by states even if some utilities operate across state lines and are required to separate their system into state jurisdictional units. Some states like California decouple rates from unit sales of commodity energy so that jurisdictional utilities get rewarded by operating their system reliably, efficiency and in the public interest rather than a focus on commodity energy sales.  Most states, however, still compensate regulated utilities with a rate of return that is based, in part, on invested capital in the rate base and, in another part, by sales of commodity energy.  Different approaches get different results.
  • Renewable Energy in the Utility Portfolio.  How much renewable energy is required in a utility’s supply plan and portfolio depends upon the state.  While California might have a 33% RPS standard other states might have none.  While states with lots of sunshine might favor solar energy other states in the Midwest might not.  Similarly, there is little market for offshore wind in Iowa or Nebraska even though they have tremendous overall wind potential.  Thus the state by state variability of regulation makes sense.
  • Smart Grid is about much more than smart meters.  The promise of smart grid is that the overall electricity network can be made more efficiency, more reliable and more cost effective by optimizing its performance, improving the use of technology to manage its volatility and using real-time measurement and pricing to give customers appropriate price signals to encourage demand management in times and at points of congestion to help stabilize and optimize the system.  So far the states are taking the lead in smart grid by authorizing installation of millions of smart meters and the Federal Government has subsidized such installations with Federal stimulus money.  Both sides are deferring to another time the heavy lifting of making the rest of the smart grid function.  The heavy lift involves setting interoperability standards for equipment and procedures, designating national interest electric transmission corridors, and introducing dynamic pricing to rate structures.

The Federal Uniformity View

Those who favor the Federal uniformity view of market futures tend to paint the need for such command and control action in terms of good and evil.  We can’t achieve the market penetration of renewable energy resources unless there is easy access to markets for often remote renewable resources—is one common argument.  Another is the critical infrastructure protection of homeland security argument that we must secure the power grids and energy infrastructure from future attacks and only the Federal Government is capable of doing that. Except the unwillingness of the Federal Government to enforce Federal law on the border to regulate access and illegal immigration has given the states a powerful argument that they must stay vigilant because the Feds just are not reliable.

While much of the debate over Federal uniformity is political there are some serious issues that must be decided before we know the answer to the transformation questions facing the energy industry today including the following:

  • Scalable market potential for renewable energy resources.  Achieving the full potential for renewable energy resources requires broad access to markets by developers and utilities seeking to procure such resources.  When California adopts a law requiring utilities to procure a certain percentage of resources from instate suppliers that creates a problem for out of state suppliers’ access to the California market giving rise to a Federal interstate commerce clause issue.
  • Both Renewable Energy and Smart Grid require interstate transmission.  When the wind blows in Wyoming and the market for that wind energy is in California—or Atlanta—but you can’t get it to market—that’s a problem.  Organized Federally-supervised markets help but do not solve the complexity that involves in interstate electric transmission, environmental compliance, wholesale market rates and renewable integration into the regional power grids. Fragmentation works against scaling both smart grid potential and renewable energy market penetration, discourages investment and drives up the price.  Both the Federal and State Government subsidize renewables because it is easier to spend our tax money on subsidies than to resolve the jurisdictional disputes between states and the Federal government.  This is nuts!
  • Dynamic Pricing is the Achilles Heel of Smart Grid.  Our politicians and regulators profess support for smart grid as a means of living into our more efficient, less polluting energy future.  Except the dirty secret of that promise is it requires moving away from average cost pricing and stable energy rates toward dynamic pricing where end users are subjected to price volatility enough to get us to change our sinful, wasteful ways and turn the light off when we leave the room.  While volatility is great for renewable energy and smarty grid gadget vendors—as customers, ratepayers and voters we hate volatility.  That is what the Bakersfield Effect lesson has been all about—scaring the bejesus out of utilities, their regulators and politicians seeking to gain ‘attaboy’ credit from voters for the latest subsidy or smart meter installation only to get kicked in the teeth for also bringing volatility and price spikes to our utility bills.  My bet is that there is no better than a 50/50 chance that smart grid will succeed because regulators and politicians will be unwilling to risk ratepayer and voter wrath from introducing dynamic pricing regimes that are volatile enough to get demand response.  PG&E is now testing the limits of customer acceptance for dynamic pricing and its tiered rates are being scaled back for fear that unless something is done to quell the rebellion in Bakersfield and elsewhere on the warm side of the hills—the entire lab experiment with dynamic pricing might be thrown out.

Getting the Federal uniformity is akin to our childhood belief in the tooth fairy leaving money under our pillow.  Getting the states to give up their jurisdictional authority over the things that really matter most to regulators and politicians on the hook to potentially angry ratepayers and voters is like pulling teeth.  All those TV commercials like trying to persuade us that “it’s time” to go face the music—and the drill—will not convince us that we should do it until the pain gets so bad we can’t take it anymore.

So what?

Be thankful for the competition between Feds and our States.  It tends to kill off the worst ideas, slow down the stupid ones, and punish those who try to change it.  Is this a great system—or what?