Energy Efficiency is
Changing the Utility Business Model
By Michele Negley, CLEAResult
Energy efficiency is more than just LED light bulbs and remembering to turn the lights off when you leave a room. Energy efficiency stretches across multiple industries, from building and construction, to automotive, to retail appliances and beyond. It’s become a staple in homes with devices like voice-activated personal assistants to help manage and control electricity usage, battery storage to charge electric vehicles (EVs) or save energy generated from solar panels, and automatic sensors to reduce unnecessary energy usage.
What began in the early 1970’s as a way to circumvent the energy supply disruptions stemming from the Arab oil embargo, energy efficiency has since evolved with the help of policies and regulations, new technology and increasing customer empowerment to leverage that technology for comfort, convenience and control. These market transformations have caused seismic shifts in the utility business model, forcing the industry to take a fresh look at the way people use energy, devise innovative and integrated solutions to meet the needs of more engaged, tech-savvy customers, and address profitability challenges within the current business model.
Today’s Energy Market Dynamics
At a utility conference in Austin, Texas, last fall, Chuck Caisley, vice president of marketing and public affairs at Kansas City Power & Light, set the tone for the day’s discussions with one colloquial statement by comedian, Chris Rock, “You don’t get a cookie for a s’posed to.” In the opening remarks of his keynote speech at CLEAResult’s 2017 Energy Forum, Caisley neatly summed up a nascent point with which many utility executives were just beginning to grapple: Customers today expect their utility to be safe, reliable and affordable, but now they want their utility to also provide comfort, convenience and control.
According to Caisley, in an industry with an average disruption rate of around 0.0002 percent, the industry is potentially spending billions of dollars on something that’s already impossible to improve. The challenge for utilities, then, is to figure out how to make comfort, convenience and control for consumers profitable, when less energy usage means less revenue. Under the traditional model, utilities have little, if any, incentive to encourage widespread deployment of energy efficiency solutions due to the cost of efficiency programs, lack of return on investment for energy efficiency expenditures, and inability to recover the short-term, fixed costs of providing service, according to a 2015 ACEEE report titled “Valuing Efficiency: A Review of Lost Revenue Adjustment Mechanisms.”
For some utilities working to address this challenge, regulations may offer one solution. For example, 17 states currently have loss revenue adjustment mechanisms (LRAM) in place, which is a rate adjustment that allows utilities to recover revenues that are reduced specifically as the result of energy efficiency programs. Of those states, 15 shared their quantitative data with ACEEE for their 2015 report, which showed the amount utilities could recover for electricity savings ranged on average from $0.02 per kWh to $0.13 per kWh, and for natural gas, recovery amounts ranged from $0.09 per therm up to $0.33 per therm.
Another option that many utilities are exploring to recover lost revenue is decoupling, which breaks the link between the amount of electricity or natural gas utilities sell and the revenue they can recover, ensuring that a utility can meet its revenue requirement even if other factors dampen sales. Decoupling isn’t widely favored by states, however, because revenue is based on a regulatory formula rather than by how much energy a utility sells. This means that regardless of how much energy it actually sells, the utility will still receive only a specific amount.
While LRAMs and decoupling both remove disincentives to energy efficiency, neither solution incentivizes it.
A third option that some states are beginning to explore is called performance incentive mechanisms (PIMs), or shared savings mechanisms. For investor-owned utilities, appropriately structured and sufficiently compensated performance incentives can align stakeholder interests by increasing return on equity and shareholder value, while decreasing customer spending and encouraging energy efficiency solutions like distributed energy resources (DER), demand response or energy storage. With meaningful incentives in place, PIMs can effectively accelerate energy efficiency adoption while also increasing earnings for utilities, according to a 2016 CLEAResult report titled, “Lower Spending, Higher Returns: Aligning performance incentives to accelerate a 21st century utility model.”
From Centralized to Distributed
Consumer preferences, pressure from environmental groups and the growing digitalization of our world have all converged to drive significant changes across the energy life cycle. Combined with artificial intelligence, devices for the connected home have put more power into the hands of consumers than ever before. This proliferation of personalized, digital devices and the interconnection of them in the form of the Internet of Things (IoT) or Industrial Internet of Things (IIoT) has created innumerable opportunities for companies like Amazon and Google to develop products that serve the needs of the new tech-savvy customer. However, this also creates more competition for utilities. According to data from management consulting firm McKinsey & Co., with IoT devices seeing a 31 percent compound annual growth rate, and 29 million U.S. homes expected to have a connected device at the end of 2017, competition from big tech companies will only increase.
Along with tech companies, utilities may also see more competition with automotive manufacturers like Tesla and BMW, where the growing adoption of EVs not only increases electricity demand and disrupts the traditional model of energy supply and demand, but also allows EV owners to store excess electricity in batteries, shifting customers from energy consumers to energy managers. Major energy companies, like Shell, are also not far off from joining the competition. In October 2017, Shell acquired NewMotion, the largest electric vehicle charging station company in the Netherlands–a signal that oil companies could soon be making a play for market share with respect to servicing EV owners.
Further facilitating the industry’s decentralization are blockchain and DER, which together have the potential to completely upend the traditional power trading model. As the growth of residential solar and battery storage gives consumers more choices and more control over where, how and at what price they purchase power, common billing mechanisms like net metering could be replaced by more complex energy transactions via blockchain, which could encourage the formation of new types of wholesale energy providers to compete with utilities.
Customer preference for convenience, comfort and control is continuing to drive integration across smart devices, new tech platforms, EVs and other forms of DER, which will encourage more competition for utilities as new entrants look to meet these needs. Staying competitive in this new digital environment will require utilities to refocus their business models around the customer and look for ways to collaborate with new partners to maximize customer empowerment.
Customer Centricity is the Key to Navigating the Future Successfully
Despite the growing competition in the energy management space, utilities have a unique advantage to leverage historical customer data and trends on energy usage, renewable generation and market prices to inform customized programs and develop strategic partnerships to improve customer empowerment.
By managing, analyzing and customizing data for stakeholders and new market entrants, utilities have an opportunity to position themselves as platform providers, bringing value to customers and partners alike by acting as a hub for the integration of disparate assets like smart thermostats, voice-controlled products, EVs and more. To successfully accomplish this, strategies must be developed to embed connected home technology and other IoT vehicles in day-to-day operations to better inform utilities of supply and demand trends and adapt programs to suit customer behaviors.
Finally, utilities must be willing to embrace and explore partnerships with non-competitive entities and industries, like Nest and Microsoft, to better learn from each other and improve products and services. Whereas a product manufacturer might think of all the bells and whistles of a particular tool, a utility will know and understand its customers best and can tailor applications of a given tool to maximize customer satisfaction among specific demographics. These partnerships will require utilities to equip workers with adaptive mindsets to respond quickly to fast-advancing technology and capitalize on new market opportunities.
As the utility business model becomes less centralized and more distributed as the result of innovations in energy efficiency, utilities must move beyond the traditional value proposition of safe, reliable and affordable to meet customers where they are and where they’re headed.
As customer expectations for comfort, convenience and control drive technological innovations, device integration, and new competition, utilities must be prepared to experiment with and advance new regulatory models. They must also seek out unique partnership opportunities and reframe business models to be more customer centric to be best positioned for future growth and opportunities. | PGI
Michele Negley is a senior vice president at CLEAResult where she leads a team of 275 consultants across 12 states that implement more than 100 energy efficiency, renewable and demand response programs and strategic marketing/analytics for utilities. She provides guidance to her teams and clients that draws upon her deep experience from electric system operations to helping utilities navigate quickly evolving business models. She serves as the executive point of contact for utility clients, provides regulatory testimony for DSM filings and helps utilities customize and implement strategies.