Business case for DER and utility

Climate and energy are critical, massive, and complex issues.  Whatever we talk about, it will be just a small piece of the overall puzzle and, by definition, unbalanced.  This post collects some tidbits that point to an underlying trend, focusing on the most commonly asked question “is there a business case for smart grid?” This trend suggests an indispensable role for distribution utility of the future.

Accelerating pace of DER (distributed energy resources)

I’m pleasantly surprised by the NYT report today (Dec 1, 2014) that one of the world’s largest investor-owned electric utilities, E.On of Germany, has decided to split itself into two, one focusing on the less (!) risky business of renewables and distribution, and the other on the more risky conventional generation business of coal, nuclear and natural gas.   “We are seeing the emergence of two distinct energy worlds,” E.On’s CEO said.  In case you think this is an irrational impulsive move, a financial analyst estimated that of E.On’s 9.3 billion euro in pretax profits in 2013, more than half came from the greener, more predictable businesses. The utility industry has entered a period of disequilibrium in recent years, contemplating how best to leverage emerging technologies and evolve their business models (we will return to this point below).  Initial response to E.On’s decision: its share price rose about 5% today.  E.On said it will present a plan in 2016 to spin off most of the unit that currently holds the conventional generation.

Tomorrow is quietly arriving, not just in Europe.

As Adam’s recent post pointed out, solar electricity will reach grid parity in 36 states in the United States, even if the tax incentives for solar systems drop to 10% of its current level.   The figure below, from a Deutsche Bank report “2014 Outlook: Let the Second Gold Rush Begin,” shows the forecast savings in 2016 from solar energy for every kWh of electricity, assuming a 20-year lifespan of solar panels (average electricity price minus the levelized cost of solar energy).  Leading the country are Hawaii, California, New York, Connecticut and Vermont.
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Solar has already reached grid parity in the 10 states that produce 90% of solar electricity in the US.  Even though solar still accounts for only 0.23% of the total electricity generation in the US in 2013, the rapidly declining costs bode well for solar in the long term.   The chart below from a Bernstein Research report “Equal and Opposite … If Solar Wins, Who Loses,” shows the prices of energy sources in the past 60 years.

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While the prices of fossil fuels fluctuate in the short term due to supply-demand volatility, the cost of solar will continue to fall as technologies advance and volume grows.

Indeed, 1.3B people (18% of world population) still have no access to electricity, according to an International Energy Agency (IEA) report in 2014. Most of them are in developing countries and rural areas where there is little infrastructure. They just might leapfrog billion-dollar bulk generation plants and transmission lines to focus more on renewable and distributed generations. This is exactly what happened in communications where mobile-cellular subscription in developing countries has been growing at more than twice the rate in developed countries for most of 2005-2013 to approach the world population, as the two charts below from ITU illustrate.

MobileGrowthRateMobiileGrowth

Projections by the consulting firm Navigant Research paint a rosy picture. One of its 2014 reports says that the global residential generation and storage revenue in 2013 is already $54.7B, and will grow to $71.6B by 2023 at a CAGR (compound annual growth rate) of 2.7%.  A Navigant whitepaper (Smart utilities: 10 trends to watch in 2014 and beyond, 2013) estimates that the total load curtailment from DR (demand response) programs globally in 2013 was 58GW, and will reach 140GW by 2020 at a CAGR of 13.5%.  North America contributed roughly 71% in 2013, for a total 41GW of power, with a strong participation from residential households.  To put this in perspective, a nuclear plant in the US has an average capacity of 1GW, a coal plant 257MW, and a gas plant 85MW, so a load curtailment of 41GW is worth 40 nuclear plants, 160 coal plants, or 480 gas plants!   This sounds a bit too early to be true — if you know of data that confirm or disprove these numbers, I’d really appreciate hearing from you.  Here is the full list of 2012 generation capacity in the US by energy source from EIA:

2012USGenerationCapacity

Navigant also estimates the global smart grid technology revenue at $45B in 2014, covering transmission upgrades, substation automation, distribution automation, IT/OT (information tech/operation tech) software and services, and AMI, with the IT/OT software and services at about $10B.

Evolving role of utility

If we imagine a future where renewable and distributed sources generate the bulk of our electricity and where the grid has a lot more active and intelligent loads, microgrids, and other DER, what will be the role of the utility?  Contrary to what some people think, I believe the role of utility in such a dynamic future is much more important and profitable.

Take rooftop PV as a recent example.  The proliferation of rooftop PV in the last few years is due as much to innovations in business model as to falling technology and financing costs.  The most popular model now involves a partnership of three parties: (i) an operations company to install, operate and maintain a rooftop PV system for free, (ii) a homeowner who provides the rooftop and signs a long-term (e.g. 10-20 years) power purchase agreement to buy electricity from the PV system, typically at a price that is lower than their current price from the utility, and (iii) an investment company that assumes the risk and finances the deal.  This partnership mines a natural, and renewable, resource and splits the benefit, an ingenious model!

Where is the utility in this picture … or, what can its role be?

A very important one.   Imagine that, instead of the third-party system operator and the financial company, the local utility finances, builds and operates the rooftop PV systems for its customers.  This has two important advantages compared with the current model (let’s put aside potential regulatory and economic hurdles for now).

First, on the business side, the utility already has a strong relationship with its customers, has the trust of their customers, knows their consumption profile and hence can identify customers who can most benefit from a PV installation.  The customers will have the peace of mind that a large stable utility company will see the contract through.  In fact, this contract can be completely transparent – before the PV installation, the customers typically do not know, nor care, where and how their electricity is produced but just pay as they consume; after the PV installation, nothing needs to change except a lower price.  This model can incur much lower cost of customer acquisition, accounting, and support, to the benefit of all.  It also opens up a new approach to net metering that can be un-controversial.

More importantly, having all PV systems on a distribution circuit managed by a local utility offers a distinct engineering advantage over having them managed in isolation by (possibly multiple) third-party solar installers.  One of the greatest challenges to integrating renewable sources at scale is their volatility and randomness that make it hard to maintain supply-demand balance and voltage/frequency stability.   As an infrastructure provider, the utility has unparalleled visibility and access to the grid and its state.  It has the unique capability to jointly optimize in real time the operation of these PV systems as well as the operation of its own grid assets (such as capacitor banks, tap changers, phase shifting transformers and other controllable devices) in order to stabilize voltage and balance power. In other words, there is a potential loss in social optimality by not having the utility manage these DER.

This is but one example where the distribution utility can play an active, profitable and irreplaceable role in a future grid dominated by DER.    As I explain in earlier posts on network architecture (part 1 and part 2), the fundamental difficulty with layering in power networks means that the coupling between the infrastructure and the end-use services is much stronger than in communication networks.  Unlike infrastructure providers in telecommunications, the distribution utilities are in a much better position than third parties in providing many services if they engage more closely and actively with their users.  Indeed, there are startups today whose business model relies on getting access to some of the customer or state information of the grid that only the distribution utility has.  It is a clear indication that utility often holds the key to value creation in this period of disequilibrium.  It can and should use it profitably to facilitate the historic transformation of our energy system to a more sustainable form.

Far from a death spiral, DER is creating an emerging platform on which distribution utilities can innovate and thrive through new products and services.

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