Defenders of the electric grid status quo have long argued that always-on baseload power generators like coal and nuclear plants are essential, and that variable renewables like wind and solar will remain bit players in power generation.

They argue this for several reasons: The grid isn’t designed to accommodate them. They’re too expensive. Or they aren’t reliable enough, so they require 100% backup from conventional power plants at all times. An essay by former utility CEO Charles Bayless in the September 2010 issue of the Edison Electric Institute’s Electric Perspectives magazine details the utility view of these issues nicely.

But one by one, those arguments are being knocked down.

A recent data roundup by renewable energy industry analyst Paul Gipe shows that variable renewables are meeting much larger percentages of grid power than previously thought possible in some European countries. Wind provided nearly 20 percent of Portugal’s power and 30 percent of Denmark’s in 2012. Wind and solar combined contributed more than 18 percent of Spain’s power and 11 percent of Germany’s in 2011. (More recent data shows that renewables now provide about 25 percent of Germany’s total grid power, and as much as 50 percent of its peak power.) A study by German engineers found that its grid can handle up to a 40 percent share of renewable power without needing much storage or baseload power for backup.

The price argument is falling too, with various banks and researchers forecasting that solar will be cost-competitive in much of the world by 2020.

Now the reliability and stability arguments, which were the main focus of Bayless’ essay referenced above, may be about to lose their potency too, as large facilities and small communities start looking to microgrids to supply a level of service that utilities have been unable to provide.

A microgrid is simply an independent power grid that is able to balance generation and consumption within itself -- just like the big grid does, only on a much smaller scale. It could be as small as an offshore oil rig, or as large as a military base or a small town. It might use storage to buffer renewable generation, or it might simply fire up a fuel-burning generator.

Some microgrids are replacing expensive and polluting fuels like diesel and kerosene in places that have never had access to reliable grid power, like Africa, India, Brazil, and Haiti. Others, like the ones at Fort Bliss, Texas and the Food and Drug Administration’s White Oak research facility in Maryland, are being built where grid power is available, but where the cost or risk of an outage is high enough to justify the expense of being able to “island” from the main grid and be self-reliant.

Several university microgrids have served as critical disaster recovery havens in the aftermath of natural disasters, including a 13.4-megawatt system at New York University-Washington Square Park, a 3.6-megawatt system at Utica College in New York, a 1-megawatt system at Tohoku Fukushi University in Japan, and a 37-megawatt microgrid at Cornell University in Ithaca, New York. The Cornell system is powered by a dual-fuel combined heat and power (CHP) plant that can burn natural gas or diesel, plus a 1-megawatt hydropower generator and a small solar installation.

Microgrids are big-ticket items, but for those who can afford them, they seem to be reasonable investments. The $71 million White Oak project is expected to save the FDA about $11 million a year. The return on the roughly $60 million Cornell University project [PDF] is expected to be “consistent with the long-term rate of return of the endowment and in the range of 8 percent to 10 percent.” For a military base, of course, being self-reliant is “priceless.”

Despite the new buzz about microgrids, the market is just getting started. Microgrid expert Peter Asmus of Pike Research has identified 405 projects in the pipeline globally, and he expects deployment to rise from $10 billion in 2013 to more than $40 billion annually by 2020.

In addition to universities and military bases, islands are natural microgrid candidates because they’re typically dependent on expensive liquid fuels to run their generators. At the recent Pathways to 100% Renewables Conference, Asmus noted that as of 2011, solar is cheaper than diesel for any island, and mentioned two islands that are now pursuing the microgrid strategy. El Hierro, a Spanish Canary Island off the coast of Africa, has become the world's first 100 percent renewable energy island by replacing its diesel generators with a microgrid powered by an 11.5-megawatt wind farm, 11.3 megawatts of pumped hydro storage, and solar PV and solar thermal systems. And Graciosa Island, off the coast of Portugal, expects to have a microgrid on-line by the end of 2013, with 65 percent of its supply provided by renewables.

A new threat, or a new business model?

Microgrids represent another aspect of a theme I have been exploring at Greentech Media: the transformation of utilities (see “Can the Utility Industry Survive the Energy Transition?” and “Adapt or Die?”). Like distributed generation, microgrids present both an opportunity and a threat to the way utilities do business.

“While utilities have shown institutional biases against the entire concept of microgrids for decades, extreme weather events and the growing recognition of microgrids as potential sources of demand response resources are building engineering and cultural support for these systems in a variety of settings,” Asmus said in April.

Utilities may be more friendly to what Asmus calls “virtual power plants” (VPPs). VPPs may or may not have generation or storage capacity, so they cannot island, but they do have software to remotely and automatically dispatch and optimize generation, demand response, and storage in a single, secure web-connected system.

VPPs and microgrids could become valuable partners for utilities by relieving overstressed and congested points on the grid, reducing the need for building new generation and transmission capacity, and making it easier to manage voltages at grid extremities. Integrating VPPs, microgrids, and more renewable power into the grid requires more advanced grid management software, but it can squeeze a lot more utility out of both conventional and renewable generators, which is cost-efficient.

On the other hand, if deployed at scale with storage capacity, microgrids could reduce the need for large amounts of baseload overcapacity sitting idle just in case it’s suddenly needed. Instead of needing to suddenly ramp up 1,000 megawatts of power to compensate for an outage elsewhere in the grid, a network of microgrids could simultaneously reduce demand and export power to the grid in a distributed fashion, while maintaining the required frequency and voltage parameters.

In other words, microgrids could meet both the reliability and stability criteria that Bayless argues can only be met by baseload generators. This would cut into the generation and the distribution revenue streams that are critical to the calcified utility business model, as well as the profit associated with constructing large capital projects.

“When we propose a microgrid, we consider four business case scenarios,” Steve Pullins, CEO of Tennessee-based Horizon Energy, a microgrid design and development company, told Fortnightly magazine. “We consider maximum savings, maximum renewables, grid independence, and maximum diversity. The difference in cost between the maximum savings and grid independence scenarios isn’t very large.”

With the virtues of favorable economics and self-reliance at their backs, microgrids seem poised to gain market share and become a competitive threat that utilities can neither bury nor ignore. Pullins sees 24,000 sites in the United States as potential prospects, with perhaps 300 microgrids being built by the end of 2015.

But utilities will have to consider carefully how best to address that threat. If they try to foist their stranded asset and network maintenance costs on a declining user base, it could prove counterproductive by pushing more consumers to consider microgrids.

As Pullins observed, “This isn’t microgrids challenging the regulatory model; it’s customers challenging that model. Utilities shouldn’t have misplaced aggression against microgrids.”

Instead, utilities should actively encourage microgrid development and seek to integrate it into their business models as a low-cost way of ensuring reliability, grid stability, capacity, and energy. Instead of delivering as much power as possible at the lowest possible cost, they should refocus on delivering the service levels customers want, with appropriate dynamic pricing mechanisms.

Ultimately, the transformation to distributed generation and grid management will require regulatory reform as well, so that groups of businesses and residents can create microgrids. In that, too, the utilities will need to be active and supportive participants. 

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Chris Nelder is an energy analyst and consultant who has written about energy and investing for more than a decade. He is the author of two books (Profit from the Peak and Investing in Renewable Energy) and hundreds of articles, and has been published by Scientific American, Slate, the Harvard Business Review blog, Financial Times Alphaville, Quartz, the Economist Intelligence Unit, and many other publications.