“Innovation isn’t about technology. It’s about your business model.”
– Maryrose Sylvester, CEO of GE’s Current.
Grid modernization plans are all the rage. The North Carolina Clean Energy Technology Center (CETC) recently reported that 37 states plus Washington, D.C. engaged in some form of activity in the first quarter of 2017 to transition the power system to the future.
Such activities include investment in new technologies, changes in regulated utility functions, definitions of new business models and modification of regulatory frameworks. Although each state is progressing at their own pace and with their own approach, the overwhelming portion of states pursuing grid modernization activities illustrate how prevalent the movement is and the different flavors these plans can have.
Technological advances that permeate the power sector and the rest of the economy underlay most grid modernization plans. Policies are pushing investment in distributed energy resources such as renewables and storage. Energy efficiency and demand response are experiencing widespread implementation due to federal and state programs.
A much broader trend in technology is tied to the information age, including smart meters, greater access to big data, faster processing speeds to create analytical insights and self-learning programs that benefit reliability, resiliency and customer service objectives. At the same time, regulators are grappling with whether to implement new technologies under regulated rates or via support for competitive markets. This tension between competitive versus regulated activities is inherent in most grid modernization plans.
As part of grid modernization activities, utilities increasingly are adopting new roles subject to regulatory oversight. A 2016 report issued by MIT’s Energy Initiative focused on the Utility of the Future describes the role of the utility in addressing three megatrends: decentralization, digitalization and decarbonization. Two-way energy flows on the distribution system, increased use of information to optimize the low voltage system and growing installation and integration of distributed energy resources requires some form of a “distribution system operator” or “DSO” to oversee and manage the network.
Regulated utilities also may play a direct role in implementation, although the scope of that role is being defined on a state-by-state basis. For example, while New York has confirmed that utilities cannot own renewable generation, other states such as Iowa have enabled its utilities to invest more than $6.7 billion in wind farms which will serve 63 percent of retail load by 2017. California utilities, in contrast, are tasked with enabling competitive entities to enter into the market via long-term power purchase agreements. Massachusetts is considering a number of demonstration projects proposed by its utility grid modernization plans.
New Business Models
The combination of flat load growth in the face of growing regulatory demands requires both utilities and regulators to consider new business models. This trend started in 1982 when California adopted decoupled rates to prevent a utility’s revenues from declining when customers buy less energy.
By 2016, more than 15 states had adopted decoupled ratemaking concepts, reversing the perverse incentive that encourages utilities to sell more electricity even when it is more cost-effective to invest in demand reduction measures. Reforming rates, however, is just one part of the move towards new business models. Redefining regulated services, customer categories, compensation schemes and the role of the 21st century utility is a critical part of getting grid modernization plans right.
New Regulatory Framework
A new regulatory framework may be required to implement most state grid modernization efforts. Legislation is granting regulators expanded authority to oversee new areas of energy investment. Regulators are tasking utilities with development of comprehensive plans that usually have a scope extending well beyond traditional services.
As fundamental functions and core value propositions offered by distribution utilities change, new compensation mechanisms will need to be proposed, reviewed and adopted to properly align incentives. Cost-of-service ratemaking may eventually be replaced with something similar to performance-based rates as regulators increasingly require utilities to meet performance metrics or face the consequences.
As states begin penalizing for performance, rewards for over-achievers will need to be addressed. The role of regulators themselves in overseeing the market may need to be redefined.
Incentives are aligned for utilities to engage in grid modernization efforts as traditional business models face a challenging environment. Whether such efforts are driven by state government, regulators, utilities or competitive forces, they will be critical to bringing a century-old industry into the future.
If you are engaged in developing a grid modernization plan, think through how you intend to address technology, regulated versus competitive functions, business models and regulators. The future will thank you.
About the author: Tanya Bodell is the Executive Director of Energyzt, a global collaboration of energy experts who create value for investors in energy through actionable insights. Visit www.energyzt.com. She can be reached at: [email protected] or 617-416-0651.