Imagine a possible future in which distributed energy resources have become competitive with grid power in price and performance. In this future, solar panels, batteries, smart appliances and a host of other technologies are all selling well, helping customers produce, store and use electricity more efficiently, reducing the amount they buy from their utility.
Now imagine you are a utility executive or regulator in that future. You have two strategic options facing you.
In one, utilities evolve to play a major role in using distributed energy resources (DERs) to provide services to their customers, with a major presence in sourcing, financing and operation.
In the other, these functions are increasingly performed by competitive firms using largely decentralized digital technologies, and the utility focuses on providing and maintaining the distribution and grid networks. The utility depends on DERs to entice its customers to remain connected to the system and help the utility keep its costs at sustainable levels.
Which strategy should the utility executive choose? And what guidance can regulators provide?
These questions are at the center of a paper by Steve Corneli and Steve Kihm, published as part of the Future Electric Utility Regulation series from Berkeley Lab. Corneli, until recently, was senior vice president for policy and strategy at NRG Energy. Kihm is a principal and chief economist at Seventhwave, an energy think tank.
Starting from first principles of regulatory economics, Corneli and Kihm first ask whether the concept that has underpinned utility regulation for over a century -- namely, the notion that a distribution utility is a natural monopoly -- will still be valid in a future where distributed resources are cost-competitive with many utility services.
Their view: Don’t count on it.
“Just as the independent power producer opened electricity generation to competition, so are new distributed energy resources opening the provision of local electric service to competition,” they wrote. “And as the natural monopoly rationale erodes, new regulatory paradigms are needed.”
According to Corneli and Kihm, “The fact that natural monopolies are defined by the lack of economically competitive alternatives, and that DERs appear likely to offer such competitive alternatives in the future for many of today’s utility services and customers, is central to the entire debate.”
Customers have had a choice of electric provider for almost two decades in some regions of the United States. But the increasing maturity of DERs offers even more options, potentially including whether to stay connected to the power grid.
In economic terms, demand for grid power is becoming more elastic. If prices get too high, customers will increasingly turn to these new alternatives.
This has implications for regulators as well as utilities. If customers have more choices, there will be “a limit on how high utility rates can be set without being self-defeating in terms of failing to collect sufficient revenue,” they pointed out.
“Quite simply, higher costs of providing an ‘essential’ service cannot necessarily be collected from customers if they can readily reduce consumption or turn to other providers in response to higher prices. As a result, customer willingness to pay will become a much more significant factor in rate-setting and utility cost recovery,” they wrote.
This creates a conundrum, according to Corneli, speaking on a webinar marking the release of the report. “The social value of the network will remain, but the ability to recover ever-higher costs will be limited since customers have competitive choices and are less willing to pay for network connectivity.”
But there is a way to solve the problem, he said.
“Customers can help lower the cost of the grid and they can be incented to remain attached to it by actually getting paid for the distributed energy products and services they are selling to the distribution utility. This is what the concept of 'prosumers' really means.”
Increasingly, DERs can deliver services that have traditionally been the sole domain of power companies, like voltage support and frequency regulation, peak shaving, generation and capacity. Customer ownership will reduce the need for utilities to invest in providing those services.
The bad news -- for utilities -- is reduced growth in rate base, and thus limited growth in their overall return on their assets. On the other hand, “The good news is that this will help utilities keep their revenue requirements low -- low enough that increasingly price-sensitive customers will pay for it,” they wrote. “This could help prevent the so-called death spiral, by keeping utilities’ expenses from exceeding their increasingly limited revenues.”
“Utilities will be forced to look for ways to decrease the cost of their distribution networks and increase their value to customers,” explained Corneli. “DERs actually offer a perfect way to help do that,” since the capital investment will come from customers and third parties and lower the utility rate base.
Corneli thinks that attracting non-utility capital and operating capability will “lower costs for everybody,” and should be a priority for regulators.
Role of the utility
So what is the role of the utility when traditional utility services can be provided by other means?
To find answers, Corneli and Kihm time-travel to 2030 and look back at the evolution of the industry.
Corneli sees the distribution utilities playing a diminished role as DER markets evolve.
In the future world, “Distribution utilities still provide the essential service of delivering capacity and energy from the bulk power system to end-use customers,” he said. “But customers buy far less of both than they used to,” because of their increasing reliance on DERs.
Still, utilities can remain profitable, even though that profit is earned on a less capital-intensive rate base. The key to profitability, Corneli said, will be for utilities to attract non-utility investment in DERs and distributed energy services by customers and third-party providers, both to reduce the utility’s costs and increase the attractiveness for customers to remain plugged in to the utility’s distribution network.
Kihm has a different vision. He sees “substantial utility benefits from managing DERs. Therefore, rather than being diminished in scope, I see electric utilities keeping pace with industry changes and often leading the pack in that respect.”
Looking back from 2030, Kihm sees two strategies that emerge: the energy services utility and the integrating utility.
Under the energy services model, the utility is more active and provides DER services to its customers. To succeed, they rely on “bundling of services with a strong dose of relationship marketing,” according to Kihm.
“Certain utilities were early adopters of the energy services approach, offering customers a menu of options before significant competition arrived,” he said.
He cites the Wright-Hennepin rural electric co-op in Minnesota as an early example. In 2016, the utility already offers community solar, remote control of appliances, and home security systems. They even give away electric water heaters that can only operate during off-peak hours, to encourage peak reduction and fill in during low-usage periods.
Under the other model, the integrating utility controls and coordinates DERs owned by customers and third parties, dispatching DERs to maintain reliability.
Kihm sees the incumbent utility having a distinct home-turf advantage that will likely allow it to play a significant role in deploying and integrating DERs. “Utilities have a huge information and technological advantage over other parties in terms of integrating resources. This is almost certain to be [capitalized upon] by the utility of the future.”
A key regulatory question today is whether utilities should be allowed to own and operate DERs. Many utilities today argue that they are the best suited to actually own and operate such devices, even if they are located in customers’ homes and businesses. But Kihm sees the regulatory debate being “more about the role utilities should play from a public policy perspective, not necessarily about the role that best suit[s] utility interests.”
“It’s not a slam dunk that the utility would want to compete,” he said during the webinar. "They may not think they can win the game; they might ask, ‘If we can’t, why are we doing it?’” Besides, he said, regulators in some states simply may not allow it.
"Even if utilities could do it well, they may not be able to make any money at it as a regulated utility. They’d be up against some of the world’s biggest and best companies. And even if they can match the competition’s prices, traditional cost-of-service regulation is poorly suited to incent competitive, innovative services," said Corneli. Performance-based regulation (PBR) that rewards utilities for better achieving regulatory goals could provide an additional incentive for utilities to get involved. (PBR is explored in another paper in the Berkeley Lab series.)
Kihm sees the utility industry in the future being much more heterogeneous than it is today, with different business models at play. “I see a patchwork quilt of strategies,” he said.
Corneli sees more radical change from competition and decentralization. He draws a parallel with how Google Maps provides traffic congestion management, while governments own the infrastructure of streets and highways.
“Integration of DERs may not be a utility function,” he said. “It may be handled by smart apps, smart DERs, smart appliances, smartphones and smart systems optimizing it for people. That alternative is much more transformative, and more like the mashup of telecom, internet and mobile computing.”
Despite their somewhat different views of the future, Corneli and Kihm agree that as the cost of DERs plummets, the utility natural monopoly will weaken. Future regulators and utility managers will want to focus on where utilities still have significant cost advantages over competitive alternatives, and on how to create the most customer value by incorporating DERs in a smart and disciplined manner.
They also agree on the importance of social benefits that could result from enhanced coordination between utilities and other electric industry participants, including DER owners and aggregators. Today’s electric industry relies on a high level of coordination at the wholesale level, where large regional transmission organizations, vertically integrated utilities and regional reliability coordinators manage both competitive and utility-owned generation.
Similar coordination approaches that support both utility and competitive roles can be developed for customer-hosted DERs. This focus on value -- for the customer, the distribution system and the entire grid -- will encourage customers to remain connected to the distribution system to help lower its overall costs and to continue to pay for it.
Lisa Schwartz is the energy efficiency team leader in the electricity markets and policy group at the Lawrence Berkeley National Laboratory.