Dozens of startup companies from all around the world met in Washington, D.C. last week to compete for funding as part of the startup incubator 1776’s second annual Challenge Festival.

Sixteen energy-specific companies took part in the competition, pitching efficiency applications, analytics solutions and distributed energy technologies. There were also a handful of companies working on drones, electric-vehicle charging and weather-related applications that could serve the energy industry.

The Edison Electric Institute (EEI), the association of U.S. investor-owned utilities, was a top sponsor of the event.

At a time of tremendous industry transformation -- which some believe is threatening the very existence of century-old utilities -- EEI used the event to showcase its desire to deal with that change.

In his address to the conference, Anthony Earley, president and CEO of Pacific Gas & Electric and former EEI chairman, said that non-traditional players will be equally important as utilities in modernizing the grid.

“Utilities are not going to create this future alone -- even if we wanted to, we probably can’t. Our role is going to be about providing the means to integrate all of this innovation,” said Earley. “We believe the companies that will be successful at that will be the ones that reach out and develop robust partnerships.”

Startup companies are continuously coming up with new ideas for how to improve the grid, "and our companies are starving for that,” said Brian Wolff, executive vice president of public policy and external affairs at EEI, in an interview.

"Being able to look at some of these new innovations we can integrate on the grid and actually bring them to market is -- it’s just stupid, it’s so exciting," said Wolff.

"I look at them as partners for the future"

Wolff helped to judge the energy-specific semifinal that saw two American startups, Radiator Labs and BaseTrace, each earn $50,000 and progress to compete for the $150,000 grand prize. Radiator Labs was recognized for its unique Wi-Fi-enabled technology designed to improve the efficiency of existing radiators. BaseTrace was selected for its application of DNA tracer technology to track the movement of industrial fluids for enhanced environmental monitoring.

While Kenyan produce distributor Twiga Fruits was the overall winner of Challenge Festival 2015, Radiator Labs was among the three finalists leaving with valuable business connections. Semifinalist BaseTrace is already conducting demonstration tests with Virginia-based power provider Dominion Resources (an EEI member company) to use its tracers to detect leaks at nuclear facilities.

“As I was sitting there hearing pitches throughout the day, I kept thinking, 'Yeah, these are today’s innovators, but really what I’m seeing over the last four years is that these are our partners,'” said Wolff.

“Not only did I look at them as partners for the future, but they’re looking at us to be able to acquire them and bring them in, and be able to use and integrate their technologies,” he added. Very few companies are going to be able to mass-market a new energy product or service entirely on their own, Wolff said.

Several utilities have made direct investments in cleantech startup companies through their deregulated arms. Duke Energy, for instance, acquired a majority stake in the commercialsolardeveloper REC Solar earlier this year.

A regulated utility could potentially also buy some or all of a startup company, depending on the type of investment, said Wolff. This could either be done as part of a utility’s regular upgrade investments or could be rate-based if approved by the utility’s public service commission.

Utilities have acquired small companies in the past, but only recently has this activity picked up, said Wolff.

“I think you’re going to be seeing a lot more of not just consolidation within our industry, but also a lot more acquiring of companies to add to [utility] portfolios,” he said. “Companies in efficiency, companies in demand response, companies with renewable offerings -- I think you’re just going to see more and more of it.”

Utilities also frequently partner with startups, which has helped companies like Nest, C3 and EnerNOC get to scale. Pacific Gas & Electric, for example, invested $60 million in SolarCity in 2010.

Now even Tesla is looking to partner with utilities. Tesla CEO Elon Musk, who is a keynote speaker at EEI’s annual convention next month, views utilities as his company's biggest customer for its new battery business.

“Elon Musk is looking at us and thinking, ‘I can sell a ton of batteries to you people that can be at community-scale,'” Wolff added. “The fastest-growing part of our business right now is utility-scale solar (representing 33 percent of new installed capacity last year). If we have utility-scale solar plus a big battery, [we] can provide electricity to an entire community that way. Not just one home at a time.”

Overall, regulated utilities are investing around $90 billion in new technologies and services each year, most of it aimed at enhancing the distribution and transmission network.

"They may not be the highest-value acquirers for profitless but growing companies"

While promising, partnerships between utilities and startups aren’t exactly easy to create.

First, energy startups need to grow and attract enough capital to get to a point where they’re in a position to partner with a utility. To do this, they have to combat the notion that cleantech is a risky investment, said Jennifer Garson, an analyst at the Department of Energy, who spoke at Challenge Festival last week. That's a challenge in the risk-averse utility sector.

Energy startups also often have to go through an expensive third-party validation process to prove their technology works, Garson said. Meanwhile, utilities want to know their partners are able to comply with a strict set of industry codes and standards.

Acquisitions are tough, too. Whether it’s on the deregulated or regulated side of the utility business, there are challenging cultural and structural shifts that have to take place in order to bring in a new technology or service.

Also, from a venture capitalist’s point of view, utilities don’t usually make for the best buyers. The market is currently seeing large utility holding companies -- companies that may own IOUs, but are not regulated in the same way as IOUs -- as the main entities investing in energy innovation companies, according to Abe Yokell of RockPort Capital Partners. Some have also shown an interest in acquisitions, he said, but there hasn’t been a great deal of activity to date.

Yokell said he could see the holding company of an IOU as a potential acquirer of an energy startup, but not necessarily an acquirer likely to pay a high price.

“There are only a few holding companies that are willing to pay for technology companies. Most of these holding companies are publicly held, and their public investors are investors in long-term stable growth and dividends, so the idea that they would be exposing their shareholder base to a higher-risk (albeit higher-reward) activity can be problematic,” he said. “These groups are used to valuing cash flows, not valuing technology startups with negative cash flows. In other words, they may not be the highest-value acquirers for profitless but growing companies.”

Risk appetite, regulatory hurdles and monopolies

Regulated utilities have other issues. If a regulated utility were to directly buy an energy startup, it would have to prove to regulators that the acquisition is in the public interest -- potentially inciting backlash. While some believe that regulated utilities should, in general, be given more freedom to take on risk, others believe that allowing regulated utilities to rate-base investments in new technologies is monopolistic and would slow change.

“We feel very strongly that any time the utility is going to enter into the market, they should be coming in, if they’re going to be competing directly, as an unregulated subsidiary,” said Scott Hennessey, director of policy at SolarCity, speaking at the 1776 event.

“If they’re going to be competing for the same customers as us, then they shouldn’t have the advantage of their monopoly franchise and all the power that comes with that,” he added. “I think that allows for the best innovation -- the best innovation comes from competition.”

Regulated Arizona utilities Tucson Electric Power and Arizona Public Service have both been granted permission to offer limited rooftop solar programs. Initially, these programs will operate through partnerships between the utilities and local solar installers. But if given approval, these regulated utilities could feasibly make more significant investments in smaller companies to help grow their business.

Today, however, most utilities are focused on outreach. They're working to change ratepayer perceptions that utilities are dispensable and complacent. At the same time, they're making connections with startups, laying the groundwork for them to become tomorrow’s utility partners.

“Utilities need to embrace their customers as partners and collectively...explain what it is we’ve been doing, talk to them about what their needs and desires are, and then learn to find ways to partner with others," said Tammy McLeod, vice president of resource management for APS, who also spoke at the Challenge Festival.

"Other companies [are needed] to continue to provide the resilience to the grid that our customers expect of us, and to incorporate new technologies and new energy sources they’re interested in trying out. It’s a widespread conversation that needs to occur," said McLeod.

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Join us at Grid Edge Live 2015 on June 23-25 in San Diego for a deep dive on utility grid modernization.