The pace of technological change is accelerating rapidly in the energy sector, particularly when it comes to the production and delivery of clean, reliable, secure, and affordable electricity.
Ongoing technological innovations are transforming how the industry generates and distributes power—from new, larger-scale, and cleaner-burning natural gas turbines used by independent generators and traditional utilities to deliver electricity over the nation’s interconnected transmission grid, to highly efficient distributed energy resource (DER) systems that deliver power on demand to business and residential sites.
In communities across the country, renewable energy sources such as wind, solar, and geothermal are poised to play a much bigger role, particularly if the Environmental Protection Agency can overcome the many judicial challenges to its Clean Power Plan, under which states are required to achieve dramatic drops in greenhouse gas emissions by 2030.
But as these and other new opportunities develop, tough new business pressures and regulatory challenges are rapidly emerging. Whether the Clean Power Plan’s ambitious goals are upheld or not, federal and state regulators still will be charged with figuring out how best to deploy and price the new technologies set to enter the marketplace.
As a result, disputes already are happening in a number of states, not just about bread-and-butter service provisions, pricing mechanisms and market structures that currently exist, but about what changes need to be made to accommodate new technologies and market participants.
DEVELOPING NEW MODELS
No matter the outcome, rapid technological change, security concerns, and other considerations will pressure regulators to integrate these new technologies and delivery mechanisms into the grid and to modify or fundamentally change the way in which electricity is priced, delivered and planned.
Many areas of the country will increasingly be forced to focus on issues of market entry—for example, what new providers, products, and services should be permitted; what role traditional utilities and existing power grids will play in production and delivery; and which products and services should be made available to what types of customers.
Furthermore, business deals are being cut, driven by technological innovation, customer demand, and bets placed on the changes that will be made to the power market regulatory regime.
Under current regulatory models, utilities generally charge just enough to build and maintain the infrastructure needed to deliver safe and reliable power to their customers, and they receive a specified rate of return on those investments based on what they are allowed to charge customers.
If an incumbent utility wants to expand services or integrate new technologies, it needs to get regulatory approval for those investments and rate changes. Gaining that approval is usually a lengthy and costly process, as utilities must overcome challenges from consumer advocates fighting for low rates as well as third-party distributed power producers that may see utility expansions as a threat to their ability to enter or grow a new market.
Battles also occur over “stranded costs”—investments made in power-plant capacity that is no longer needed—and who should foot the bill when those assets are taken out of service.
The ultimate responsibility to sort out these complex questions rests primarily with federal and state regulators. Generally, federal regulators focus on matters relating to interstate wholesale power and transmission, while state authorities handle retail sales and local distribution issues.
But, with power markets and transmission and distribution systems becoming more complex, and new products and services being added to, and affecting, these systems, the jurisdictional divide, while increasingly important, is becoming murkier.
NEW YORK REVS UP
In states such as California, New York, and Texas, regulators are working to create new regulatory and business frameworks that would enable higher amounts of distributed energy resources to be integrated onto the grid. New York’s initiative, known as Reforming the Energy Vision (REV), calls for the creation of a new entity that would serve as an interface between the bulk power system, utilities, DER providers, and retail customers. While much remains to be decided, the REV plan envisions this new model as a platform for innovation and market-based deployment that would focus on DERs rather than centralized grid assets.
To make a more distributed grid work, regulators, utilities, and numerous other kinds of suppliers and customers must come up with new pricing models so that those parties that provide both traditional and new grid services are appropriately compensated for the increased value they provide and the parties that use or benefit from these services end up receiving a sufficient bang for the buck.
Current cost-recovery regimes do not always provide an incentive for utilities to take risks and explore new technologies and new products and services, nor always ensure that the parties who benefit from these offerings actually end up paying for them.
Pricing also can be a difficult issue. Estimated levelized cost is one measure for comparing the pros and cons of various energy sources. But because projected utilization rates, existing resource mixes, and capacity values can vary greatly across regions where new generation capacity is needed, the direct comparison of levelized cost across technologies can be misleading.
This is particularly true if the costs being compared do not include externality costs that can be calculated and that would be pertinent to resource selection. A better assessment might be gained through consideration of avoided costs, which would allow regulators to determine the costs that a proposed new resource would save in comparison to the costs (including certain externality costs such as carbon costs) of the existing resource that would be displaced (i.e., avoided) if the new resource were added.
PROTECTING THE GRID
As regulators wrestle with issues relating to this changing competitive environment, awareness and concern about potential vulnerabilities in the electric supply system are continuing to grow. Power outages from Hurricane Sandy in 2012 affected people in 17 states, and 57,000 utility workers from 30 states and Canada came to New York to help return power to the city. Physical and cybersecurity also are growing concerns.
In many regions, the power grid may be the most critical infrastructure asset because it is the backbone upon which the economy—and our nation’s health and safety—relies. The national power grid has become ‘too big to fail,’ so new mechanisms must be developed to make sure it is properly managed and modernized and that critical components are safeguarded against outages and attacks.
To navigate this climate of shifting threats and opportunities, electric power suppliers as well as customers with significant power loads must affirmatively promote—via the regulatory process or through strategic investments—those approaches that would best facilitate their economic, environmental, and security goals. It remains to be seen whether the winners in this process are the proponents of new technologies (or investors and others that will make money from their deployment), or those who try to block, or at least slow down these new developments in order to protect their current market position.
What already is clear, though, is that going forward, both federal and state governments will pick winners and losers by virtue of their policy decisions and incentive programs. They will favor certain technologies and business models and reject or discourage others. Success will require constant engagement at every stage.
Author: Larry Eisenstat is a partner in Crowell & Moring’s Washington, D.C. office and chairman of the firm’s Energy Group. He has considerable experience handling both regulatory and transactional matters, as well as litigation, compliance, and enforcement matters on behalf of both energy and non-energy companies. He also devotes a substantial part of his time to energy policy, strategic planning, investment, and corporate reorganization matters.
Elliot Hinds is a partner in Crowell & Moring’s Los Angeles office and focuses his practice on energy and corporate transactions. He has handled many billions of dollars of energy project finance transactions and advises clients on energy industry innovations.