Two utilities embrace technology and innovation
For more than a year electric utilities have heard warnings of an impending and rapid increase in rates, driven by a loss of retail electric sales without a commensurate change in tariffs and revenue requirements. The premise of this alarming tale starts with utility customers, who have begun with increasing momentum to switch to distributed generation and energy efficiency, (with storage not far behind), causing electric sales to plunge and eroding utility earnings to the point of failure. Many believe the handwriting is on the wall - that this "death spiral" is inevitable. That's a clever narrative, to be sure.
Yet the premise fails to account for regional differences, policy changes, technological advancements, and economic realities. Most importantly, the narrative ignores the history of electric utilities - how they have managed time and again to to adjust successfully over the years to the ups and downs of markets and regulatory policy.
A Story of Change
The story begins in the mid-1990s, when the vast majority of investor-owned electric utilities (IOUs) in the United States were vertically integrated. These vertically integrated electric utilities were - and still are - fully regulated, with coverage across generation assets, transmission and distribution networks, and with captive customer segments.
Up to this time, vertical integration had proven its case as the most reliable way to provide inexpensive power to the public. However, in the late 1990s, IOUs across the United States faced a new challenge - the prospect of losing their regulated generation and customer franchises, as policymakers introduced retail electric choice and competitive wholesale energy markets. Nevertheless, despite dire warnings, IOUs adapted and re-shaped their businesses. From this trauma came two new utility business models: (1) the distribution utility and (2) the hybrid electric utility. Distribution utilities - which operate primarily in the Northeast, Mid-Atlantic, Illinois, and Texas - provide transmission and distribution services in markets that feature competitive generation.
Hybrid electric utilities span both vertically integrated and competitive business models and largely include California utilities and vertically integrated or distribution utilities with competitive generation or retail businesses. In short, when faced with major regulatory changes that threatened traditional business models, electric utilities were able to adapt and shape successful futures. Numerous other examples also come to mind. For instance, consider the rise of commodity prices and the introduction of clean energy policies in the 2000s.
As natural gas and oil prices rose from $3 per MMBtu and $25 per barrel in the early 2000s to $9 per MMBtu and $100 per barrel in 2008, new clean energy policies emerged at the federal and state level to promote utility-scale renewable generation and further curb emissions. These clean energy policies created a new set of challenges for U.S. electricity regions and utilities, which varied by geography. Major challenges included the integration of intermittent renewable resources and potential loss of fuel diversity. Electric utilities invested in smart infrastructure and renewable and non-renewable generation to confront changing clean energy policies.
Today, natural gas and oil prices stand at roughly one-third and one-half of what they were in 2008. This economic reality has allowed fossil generation to remain competitive. It also expands the definition of clean energy in the United States from utility-scale wind and solar generation to encompass also the idea of customer-centric technology and innovation.
Today the rise of customer-centric technology and innovation has created a whole new set of challenges. Advances have occurred in energy efficiency, demand response, distributed solar, energy storage, and electric vehicles, as well as smart grid infrastructure and analytics. Industry observers tout these developments as solutions to their own special interests, whether political, environmental, or commercial. Just as with deregulation and past forms of clean energy policies, electric utilities have two basic choices: react to the agendas of the special interests or chart a path forward to create the most value for stakeholders and customers.
Customer-centric technology and innovation changes the way regulators think about electric markets. The prime example is the New York Public Service Commission's initiative known as Reforming the Energy Vision. REV seeks to embrace change - to transform how New York's electricity is procured, distributed, and regulated. That means making the electric system more resilient. That means customer participation in distributed energy resources (DERs). That means progress toward accomplishing the state's clean energy objectives - downstream at the customer end as well as upstream at the utility.
The current phase of REV seeks to accelerate the deployment of DERs and microgrids by redesigning rates, creating principles and frameworks for cost-benefit analysis, and setting up mechanisms for distributed-level pricing (think ISOs at the distributed level). In other words, REV is giving New York's distribution utilities an opportunity to adapt their current business models and re-expand their regulated operating spheres. Similar efforts include Massachusetts and its Grid Modernization Plan, Maryland's Utility 2.0, and California's Assembly Bill (A.B.) 327.
The Massachusetts plan seeks to expand grid investment, distributed renewable energy, and energy efficiency through smart meters and the implementation of real-time pricing information at the customer level. Maryland's Utility 2.0 includes a pilot program to design a new business and regulatory model for the integration of customer-centric technologies. California's A.B. 327 requires IOUs within the state to submit distributed energy resource plans to the California Public Utilities Commission by mid-2015. Utilities recognize that change is coming. They are working actively to adapt by shaping new regulations and business models.
These utilities are designing customer-centric frameworks to align their own best interests with those of their customers, their financial stakeholders, and market forces. And when we examine our own client portfolio at PA Consulting, we see utilities applying a range of these strategies.
Here are two prime examples of such forward-thinking electric utilities:
Utility A - A Trusted Advisor
This utility is pursuing a strategy aligned with the best interests of its own unique customer base and the policy and market forces likely to affect the business. Utility A anticipates a shift toward customer empowerment, DERs, and greater use of data in the operation and maintenance of the transmission network. Its recent strategic customer initiative aims to create a host of seamless bundled services aligned to customer needs. A goal is to become a trusted adviser for customers on energy needs, particularly in the development and management of cost-effective and resilient energy systems. Through this initiative, the Utility A looks to provide its customers with solutions such as: Cost reduction.
Energy efficiency measures or demand management activities whereby customers consciously choose to use energy during off-peak times. Resiliency. A range of solutions including energy storage, on-site customer generation or micro-grid projects. Power quality . Technologies or energy management methods that improve power quality and eliminate the risk of even minor fluctuations. Environmental improvement . Clean, renewable energy systems, plus the analytical tools that will help improve resource efficiency. Utility A believes that by developing valued relationships with customers and private-sector partners, it can offer a full range of energy products and services and tailor these solutions to ensure that they achieve customer goals.
The first steps on this journey include 1) more detailed research into the future needs of its customer base, 2) development of a revised catalogue of services and products, and 3) demonstration and testing of these new service and products. Examples of such new products and services include combined heat and power, micro-grid pilots, electric vehicle charging stations at public sites, and solar installations for public schools.
Utility B - A Smart Grid Vision
Another example of customer-centric innovation comes from Utility B, which is building a roadmap for its own modest share of the smart grid. For Utility B, this vision runs from smart appliances, to a mobile app to monitor energy usage, and to optimization of distributed generation and demand response. For example, by combining three pieces - 1) customer education for its dynamic pricing program, 2) a credit for peak energy savings, and 3) an energy efficiency program - Utility B is enabling customer choice in load-control devices to allow for multiple levels of curtailment cycling, plus web-based programmability for thermostats to improve customer convenience and satisfaction.
Utility B over the past five years has enrolled more than 360,000 customers into its energy efficiency and rebates program, which has created more than 300 megawatts of capacity for peak demand reduction capacity in its service areas. In addition, Utility B has released a mobile app for customers of its operating subsidiaries to provide such customer functions as 1) the ability to view and pay bills, 2) enroll in paperless billing, 3) access energy usage information, and 4) report streetlight issues. Utility B also was one of the first in the nation to partner up with the White House and the U.S. Department of Energy on the Green Button program (a secure way for customers to get their energy usage information electronically).
This last point allows its customers to leverage the Green Button standard to allow third-party service providers to access to their energy data directly, which allows vendors to create a range of apps for customers, such as to target electric vehicle owners or customers interested in solar energy. Utility B also is creating a customer-centric proposition across the entire energy value chain by focusing on renewable integration. The utility has gained experience from completing the interconnection of thousands of renewable energy systems for retail customers. It is working also on an advanced modeling program to rapidly provide the studies needed to safely connect these distributed systems to the grid, and advancing sectionalizing equipment that increases options for microgrids.
We are seeing real shifts among our electric utility clients in terms of business model design - moving away from the traditional model of asset installation, recovery of investment through regulated return, and the maximization of savings through improved internal operational efficiencies, and over to a new business model that relies on a robust cost-benefit analysis both for recovery of investment cost and accounting for savings that often flow directly to the customer. We anticipate that numerous other electric utilities will develop holistic and targeted customer-centric strategies for technology and innovation, particularly in regions that are relatively deregulated and which claim high aspirations in the area of clean energy.
For some electric utilities, that provides not only more ways to engage their customer base, but also to enhance stakeholder value and adapt to changes in policy and markets. Most electric utilities recognize that monetizing investments in customer-centric technology means introducing services to customers within a market that allows pricing flexibility. And so the path forward looks very different for distribution electric utilities in the Northeast, Mid-Atlantic, and Texas, which can lay claim to regional competitive wholesale energy markets, from what vertically integrated electric utilities are facing in the Southeast, Midwest, and Western United States.
For those distribution utilities that operate in regions with competitive markets, we advise embracing customer-centric technology and innovation for what it is - a major opportunity to re-establish and expand their regulatory sphere, while providing the public with a clearer path to achieve clean policy objectives. That offers a win-win opportunity for distribution utilities and for the public they serve. For the vertically integrated electric utilities, we recommend at a minimum that they should anticipate an increasing dialogue on the subject. Without a strategy founded on such pressures and opportunities, a static electric utility risks considerable loss or unrealized gain.
Matt Mooren and David Cherney are energy experts at PA Consulting Group
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