I am writing to announce my indefinite hiatus from blogging about topics related to the electricity industry. In the introduction of this blog, I described that blog will include topics related to energy and the environment, specifically due to their relevance in the context of climate change. While I have focused most posts on the electricity industry thus far, there have been a couple exceptions, such as a post on biofuels and one on ocean acidification. Going forward, I will explore new topics related to climate change. I have been wanting to write about issues surrounding water, agriculture, land use, weather insurance, and biochar. I will miss commenting on developments in renewable power, but I am excited about this new chapter in the development of Green Jouleus.
Sunday, December 22, 2013
Wednesday, December 18, 2013
Utility Investments in Solar
I saw this slide, available here, from the 2013 U.S. Solar Market Insight Conference produced by GTM Research and the Solar Energy Industries Association. The slide categorizes various utility investments in solar projects. Previously, I have recommended approaches utilities should take to succeed in an era of distributed solar power, and these utilities are likely to be those at the forefront of new solar business models.
I apologize for the poor image resolution of some of the logos.
I apologize for the poor image resolution of some of the logos.
Saturday, December 14, 2013
Microgrids Have Arrived
First, a definition of microgrids from Wikipedia:
A microgrid is a localized grouping of electricity generation, energy storage, and loads that normally operates connected to a traditional centralized grid. This single point of common coupling with the macrogrid can be disconnected. The microgrid can then function autonomously. Generation and loads in a microgrid are usually interconnected at low voltage. From the point of view of the grid operator, a connected microgrid can be controlled as if it were one entity.
A microgrid is a localized grouping of electricity generation, energy storage, and loads that normally operates connected to a traditional centralized grid. This single point of common coupling with the macrogrid can be disconnected. The microgrid can then function autonomously. Generation and loads in a microgrid are usually interconnected at low voltage. From the point of view of the grid operator, a connected microgrid can be controlled as if it were one entity.
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| Power lines damaged by Hurricane Sandy in 2012 Source: Wikimedia Commons |
While microgrids still are typically more expensive than traditional grid service, they offer the additional benefit of added reliability compared to grid power. The big news in this area is that this past September, a microgrid in Borrego Springs, California enabled a community to quickly restore power after a thunderstorm-induced transmission outage in the area. The quote from UT San Diego:
1,060 customers had their power restored automatically within hours by the Microgrid, using the on-site power. This included the essential downtown business area that contains several gas stations, stores and the local library, which is the designated “cool zone” for the community. The Microgrid continued to use on-site generation to power these customers while repairs were made to the damaged poles, allowing them to keep air conditioners and other vital appliances running during the intense heat. This is one of the first times in the nation that a Microgrid has been used to power a large portion of a community during an emergency situation.
My hat goes off to all the people behind the Borrego Springs microgrid. Microgrids are starting to live up to their potential, and hopefully we look back on September, 2013 as a major landmark in their development.
Thursday, December 5, 2013
CCA Remains a Bad Deal
Community Choice Aggregation, or CCA, has had a number of wins over the past year. I have written about CCA before, including a description of how it works. Recently, Sonoma Clean Power in Northern California announced that it has signed contracts with Constellation Energy for a primary energy supply and with Calpine for a 10-year contract for local carbon-free geothermal power. CCA advocates celebrate that with the Calpine deal, Sonoma is the first CCA to focus on local energy, a long-term goal for CCA supporters.
I believe that in most cases, CCA is a bad deal for consumers, just like municipal power. CCA is similar to municipal power in that local government, rather than a private utility, controls energy purchasing decisions. This is a generally bad deal for consumers because the fallout from bad decisions is much more significant. Utilities have a challenging job which involves making big investments and signing long-term contracts for power under uncertainty of fuel prices and technology risks. With a well regulated investor owned utility, when the utility screws up, the investors pay. For example, in 1988 PG&E made big mistakes with its investment in Diablo Canyon nuclear plant. Diablo Canyon had seismic and design problems which led to some parts of the plant having to be rebuilt three times. PG&E's regulator ruled that $2 billion in cost overruns for Diablo Canyon were imprudently incurred, and thus had to be borne by PG&E equity holders rather than consumer ratepayers. These costs wiped out PG&E's entire 1988 earnings.
In contrast, with municipal power or CCA, the risks of investments and long-term contracts are borne by the local government, and thus by local taxpayers. For example, when SMUD made an imprudent investment of its own in the Rancho Seco nuclear plant, which was prematurely shut down, the utility nearly went bankrupt. Sacramento taxpayers paid the cost for this mistake.
Municipal power and CCA enable the use of tax-exempt municipal debt to fund energy investments. Such low cost debt should lead to lower power prices. But the lower prices come at a steep cost in terms of risk for the local consumers. Moreover, there is not clear evidence that municipal power or CCA actually do offer consistently lower power prices than investor owned utilities. With more risk and comparable prices, municipal power and CCA are a bad deal for consumers.
CCA does have one clear positive aspect: it is a threat that can provoke a utility to listen to customers. For example, San Francisco's stalled CCA program, CleanPowerSF, planned to offer customers a 100% green power option. In response, PG&E announced a 100% green power option of its own. Ultimately, CleanPowerSF has not been able to deliver on its goals of clean, cost-competitive, local power. The only benefit it has provided is prodding PG&E into offering better services, like the 100% green power option. It is frustrating that the PG&E monopoly would not offer a service customer wanted until it faced competition from CCA, but now that it does offer the option, it is surely a better deal than what CCA could offer.
A better alternative to both CCA and monopolistic distribution utilities? The answer lies with Texas' deregulated market for retail power marketers. When I tried soliciting options for a hypothetical house in Dallas (zip code 75001), I was presented with 344 competitive offers. 75 of them offered 100% renewable power.
I believe that in most cases, CCA is a bad deal for consumers, just like municipal power. CCA is similar to municipal power in that local government, rather than a private utility, controls energy purchasing decisions. This is a generally bad deal for consumers because the fallout from bad decisions is much more significant. Utilities have a challenging job which involves making big investments and signing long-term contracts for power under uncertainty of fuel prices and technology risks. With a well regulated investor owned utility, when the utility screws up, the investors pay. For example, in 1988 PG&E made big mistakes with its investment in Diablo Canyon nuclear plant. Diablo Canyon had seismic and design problems which led to some parts of the plant having to be rebuilt three times. PG&E's regulator ruled that $2 billion in cost overruns for Diablo Canyon were imprudently incurred, and thus had to be borne by PG&E equity holders rather than consumer ratepayers. These costs wiped out PG&E's entire 1988 earnings.
In contrast, with municipal power or CCA, the risks of investments and long-term contracts are borne by the local government, and thus by local taxpayers. For example, when SMUD made an imprudent investment of its own in the Rancho Seco nuclear plant, which was prematurely shut down, the utility nearly went bankrupt. Sacramento taxpayers paid the cost for this mistake.
Municipal power and CCA enable the use of tax-exempt municipal debt to fund energy investments. Such low cost debt should lead to lower power prices. But the lower prices come at a steep cost in terms of risk for the local consumers. Moreover, there is not clear evidence that municipal power or CCA actually do offer consistently lower power prices than investor owned utilities. With more risk and comparable prices, municipal power and CCA are a bad deal for consumers.
CCA does have one clear positive aspect: it is a threat that can provoke a utility to listen to customers. For example, San Francisco's stalled CCA program, CleanPowerSF, planned to offer customers a 100% green power option. In response, PG&E announced a 100% green power option of its own. Ultimately, CleanPowerSF has not been able to deliver on its goals of clean, cost-competitive, local power. The only benefit it has provided is prodding PG&E into offering better services, like the 100% green power option. It is frustrating that the PG&E monopoly would not offer a service customer wanted until it faced competition from CCA, but now that it does offer the option, it is surely a better deal than what CCA could offer.
A better alternative to both CCA and monopolistic distribution utilities? The answer lies with Texas' deregulated market for retail power marketers. When I tried soliciting options for a hypothetical house in Dallas (zip code 75001), I was presented with 344 competitive offers. 75 of them offered 100% renewable power.
Wednesday, December 4, 2013
A Survival Strategy for Utilities
This is part 7 of a series on disruption of electric utilities.
Disruption of Electric Utilities
7. A Survival Strategy for Utilities
-------------------------------------
To recap, the situation facing utilities is that the price of distributed solar power on customer rooftops has dropped significantly. Many customers now save money by leasing solar panels and reducing their electricity bills, and this would be true even without government subsidies for solar (the investment tax credit). Utilities do not like this because their traditional business model is to be the energy asset owner, and this role is being usurped by third party solar investors. Solar is taking away utility market share.
Furthermore, utilities really dislike net metering, where customers sell excess solar back to the grid. Utilities justifiably argue that under net metering, utilities are obligated to purchase solar at a higher prices than what it is worth to other grid customers, thereby raising average rates.
Unfortunately, the utility response thus far has been no more effective than the music industry’s early response to file sharing:
The current utility response is effective in delaying the adoption of solar power, but shows no coherent long-term strategy. By fighting solar adoption, utilities lose a significant opportunity to integrate distributed solar into their own business model. Moreover, utilities foot-dragging will eventually lead frustrated solar advocates to pay for expensive battery backup systems in order to remove themselves from the grid. While batteries are not close to being cheap enough for residential homeowners, we are could see larger commercial and industrial customers turning to battery backups or microgrid systems featuring solar and other distributed fossil fuel generation in order to reduce electricity bill and increase reliability. In the long-term, solar-enabled customer flight is a real threat to utility survival.
That said, the percentage of utility customers with solar remains tiny in the United States. It is not too late for utility companies to formulate a reasonable solar strategy. Here is my recommended approach for utilities:
Unfortunately, the utility response thus far has been no more effective than the music industry’s early response to file sharing:
The Current Utilities Response to Solar
- Fight net metering
- Utilities have lobbied for limits to net metering and to reduce the payouts for net metering.
- Fight community solar
- Community solar, also known as virtual net metering, enables a customer to buy a stake of a nearby solar installation to reduce their electricity bill rather than place panels on their own roof. Therefore, larger, cheaper solar can be built in more advantageous locations, and customers without sunny roofs can benefit from solar. Utilities dislike community solar because the solar panels are not behind a customer meter, and so power flows across utility distribution wires, but the utility does not get paid. Utilities do need to get paid for the use of their wires, but rather than naming a price, they have thus far refused to support such programs.
- Limit investment in distributed solar
The current utility response is effective in delaying the adoption of solar power, but shows no coherent long-term strategy. By fighting solar adoption, utilities lose a significant opportunity to integrate distributed solar into their own business model. Moreover, utilities foot-dragging will eventually lead frustrated solar advocates to pay for expensive battery backup systems in order to remove themselves from the grid. While batteries are not close to being cheap enough for residential homeowners, we are could see larger commercial and industrial customers turning to battery backups or microgrid systems featuring solar and other distributed fossil fuel generation in order to reduce electricity bill and increase reliability. In the long-term, solar-enabled customer flight is a real threat to utility survival.
That said, the percentage of utility customers with solar remains tiny in the United States. It is not too late for utility companies to formulate a reasonable solar strategy. Here is my recommended approach for utilities:
Utility “Survival Strategy” Response to Solar
- Pioneer community solar
- Realistically, utilities cannot suddenly go after the current residential distributed solar market. They have lost too much ground to distributed solar companies SolarCity, SunRun, SunPower, CPF, etc. However, utilities are uniquely positioned to lead in community solar because utilities can site and interconnect community projects better than anyone, plus utilities alone can come up with fair distribution wheeling charges. The community solar model would allow utilities to invest in solar while favorably competing with the leaders in distributed solar. Also, the potential customer set is much bigger, and includes housing renters.
- Create a distribution-level energy auction with the utility as the market maker
- While ownership of community solar is an easier short-term advance for utilities, a customer-to-customer market for solar power has much great long-term potential. The analogy is that at the transmission level, independent system operators serve as non-profit market markers between generators and utilities. At the distribution level, however, utilities have the opportunity to play the role of market maker between solar customers. They would profit from distribution wheeling charges, increased utilization of utility assets, and a bid-ask spread between solar buyers and seller. As the price of solar is reduced, more and more people would want to participate, as sellers if they have a big sunny roof, or as buyers if they do not. When all customers can participate in solar, the utility has more ability to charge all customers for distribution system investments necessary to upgrade the distribution grid for more solar generation.
Tuesday, November 19, 2013
Distributed Solar is the Real Threat - The Difficult Position of Utilities
This is part 6 of a series on disruption of electric utilities.
Disruption of Electric Utilities
1. Background on Utilities
2. Why Utilities have Avoided Disruption Thus Far – Reliability
3. Why Utilities have Avoided Disruption Thus Far – Financial Metrics
4. Community Choice Aggregation is a Red Herring Disruptor
5. Distributed Solar is the Real Threat - Trends
6. Distributed Solar is the Real Threat - The Difficult Position of Utilities
7. A Survival Strategy for Utilities
-------------------------------------
Solar represents a dangerous disruption for electric utilities, particularly because as more consumers install solar, the price of power for utility customers will increase. When consumers use less utility power in favor of distributed solar power, utilities have to distribute their fixed costs over fewer customers. Utility electricity prices then increase, and more customers are driven to install solar. Jim Rogers, CEO of Duke Energy, a utility serving Ohio, Kentucky, Indiana, Florida and the Carolinas, described solar as a threat to utility survival in the long term. Moreover, the risk of distributed generation including solar is noted in nearly all utility annual reports.
Disruption of Electric Utilities
1. Background on Utilities
2. Why Utilities have Avoided Disruption Thus Far – Reliability
3. Why Utilities have Avoided Disruption Thus Far – Financial Metrics
4. Community Choice Aggregation is a Red Herring Disruptor
5. Distributed Solar is the Real Threat - Trends
6. Distributed Solar is the Real Threat - The Difficult Position of Utilities
7. A Survival Strategy for Utilities
Solar represents a dangerous disruption for electric utilities, particularly because as more consumers install solar, the price of power for utility customers will increase. When consumers use less utility power in favor of distributed solar power, utilities have to distribute their fixed costs over fewer customers. Utility electricity prices then increase, and more customers are driven to install solar. Jim Rogers, CEO of Duke Energy, a utility serving Ohio, Kentucky, Indiana, Florida and the Carolinas, described solar as a threat to utility survival in the long term. Moreover, the risk of distributed generation including solar is noted in nearly all utility annual reports.
A logical next question, however,
is why utilities cannot enter the residential solar business themselves. After all, solar leasing companies are
financing the installation of energy assets, a business model very similar to that
of utilities. The good money, bad money
theory explains why this endeavor is challenging to a utility. In early 2010, PG&E saw the opportunity
of residential solar ownership and invested $160 million in funds raised by
SunRun and SolarCity, the two leading solar leasing companies. Unfortunately, in late 2010, PG&E faced a
crisis when a gas line it owned exploded in San Bruno, CA, killing 8 people and destroying 38 homes. The disaster forced PG&E to pay large
expenses not recoverable from rate payers and to devote significant resources
to ensure the safety of its existing infrastructure. As a direct result, in 2011 PG&E shutdown its residential solar investing group to focus on its core business. PG&E offered bad money for solar
investment, and leasing companies have found more patient capital from
financial institutions.
As descried earlier, utilities should have the correct financial incentives to defend against the solar threat. In fact, though solar only represents about 1% of California electricity generation currently, utilities have been aggressive in lobbying for changes in rate design of marginal costs that would reduce the incentives to install residential solar. However, the solar industry and political supporters now have the ability to lobby back. In addition, as solar continues to decrease in price, it will undercut even the average cost of power provided by utilities, making it more challenging for utilities to stymie solar via rate design reform. In the short-run, utilities will likely be able to stay in business so long solar customers still need the grid for backup service. In the long run, though, fully modularized solar power may kill the utility industry. NRG, a large S&P 500 power generation company, has announced plans to sell micro gas generators as a backup to distributed solar. Micro generation allows customers to completely disconnect from the electricity grid while staying on the gas grid. While micro generation or other backup power sources like batteries are unlikely to be cheaper than wholesale utility power, the combination of cheap distributed solar plus backup power may be able to provide reliable electricity at a cost below retail rates offered by utilities. As customers start to leave utilities, the remaining customers will see higher rates due to utility stranded assets, accelerating the transition to distributed generation. Even though the utility industry is set up with factors that have encouraged it to fight new entrants, distributed solar power has the potential to be the long-term threat that finally disrupts the electric utility industry.
As descried earlier, utilities should have the correct financial incentives to defend against the solar threat. In fact, though solar only represents about 1% of California electricity generation currently, utilities have been aggressive in lobbying for changes in rate design of marginal costs that would reduce the incentives to install residential solar. However, the solar industry and political supporters now have the ability to lobby back. In addition, as solar continues to decrease in price, it will undercut even the average cost of power provided by utilities, making it more challenging for utilities to stymie solar via rate design reform. In the short-run, utilities will likely be able to stay in business so long solar customers still need the grid for backup service. In the long run, though, fully modularized solar power may kill the utility industry. NRG, a large S&P 500 power generation company, has announced plans to sell micro gas generators as a backup to distributed solar. Micro generation allows customers to completely disconnect from the electricity grid while staying on the gas grid. While micro generation or other backup power sources like batteries are unlikely to be cheaper than wholesale utility power, the combination of cheap distributed solar plus backup power may be able to provide reliable electricity at a cost below retail rates offered by utilities. As customers start to leave utilities, the remaining customers will see higher rates due to utility stranded assets, accelerating the transition to distributed generation. Even though the utility industry is set up with factors that have encouraged it to fight new entrants, distributed solar power has the potential to be the long-term threat that finally disrupts the electric utility industry.
Distributed Solar is the Real Threat - Trends
This is part 5 of a series on disruption of electric utilities.
Disruption of Electric Utilities
1. Background on Utilities
2. Why Utilities have Avoided Disruption Thus Far – Reliability
3. Why Utilities have Avoided Disruption Thus Far – Financial Metrics
4. Community Choice Aggregation is a Red Herring Disruptor
5. Distributed Solar is the Real Threat - Trends
6. Distributed Solar is the Real Threat - The Difficult Position of Utilities
7. A Survival Strategy for Utilities
-------------------------------------
While CCA is not a true disruptive threat to utilities, I will argue that distributed solar is. Solar industry skeptics may argue that solar is propped up by government subsidies and therefore not a sustainable threat to utilities in the long-term. In reality, however, unsubsidized distributed solar is already cost effective for many consumers looking to reduce their utility bills. While utility rate structures can change, regulators are unlikely to give utilities carte blanche to eliminate solar. For example, one can imagine a utility promoting a new structure in which consumers pay a large fixed charge for utility interconnection, while the price of electricity consumption is near zero. Such a rate would negate the benefits of solar, but would infuriate consumers who have already invested in solar as well as energy efficiency advocates. State utility commissions, which must approve utility rates, will not allow this to happen. Utilities are in a tough spot, and it is useful to see how we have gotten to this place.
Disruption of Electric Utilities
1. Background on Utilities
2. Why Utilities have Avoided Disruption Thus Far – Reliability
3. Why Utilities have Avoided Disruption Thus Far – Financial Metrics
4. Community Choice Aggregation is a Red Herring Disruptor
5. Distributed Solar is the Real Threat - Trends
6. Distributed Solar is the Real Threat - The Difficult Position of Utilities
7. A Survival Strategy for Utilities
While CCA is not a true disruptive threat to utilities, I will argue that distributed solar is. Solar industry skeptics may argue that solar is propped up by government subsidies and therefore not a sustainable threat to utilities in the long-term. In reality, however, unsubsidized distributed solar is already cost effective for many consumers looking to reduce their utility bills. While utility rate structures can change, regulators are unlikely to give utilities carte blanche to eliminate solar. For example, one can imagine a utility promoting a new structure in which consumers pay a large fixed charge for utility interconnection, while the price of electricity consumption is near zero. Such a rate would negate the benefits of solar, but would infuriate consumers who have already invested in solar as well as energy efficiency advocates. State utility commissions, which must approve utility rates, will not allow this to happen. Utilities are in a tough spot, and it is useful to see how we have gotten to this place.
--------------------------
As the cost of PV solar power has
decreased, solar power from solar leasing companies has become a low end disruption
relative to electric utilities. Solar
leasing companies are firms that do not manufacture solar panels, but rather
purchase panels and install and lease the panels to consumers. In the past 5 years, the price of photovoltaic
solar panels has plummeted due to competition of Chinese solar panel
manufacturers, and leasing companies are now able to offer solar panels to
consumers at rates below the marginal cost of retail electricity.
The chart "Solar vs. Utility Costs in California" shows how consumer costs for solar have changed over time. The unsubsidized installation cost of solar is measured in dollars per watt on the left axis. However, when customers lease solar, they do not pay this value upfront but rather pay a monthly bill for the electricity they receive. This equivalent $/kWh paid for monthly electricity is shown on the right axis. Years 2007-2013 of solar cost data are based on historical data from the state of California. As solar prices have declined, more and more consumers are able to lease solar panels and pay for solar electricity at a lower rate than the marginal rate for electricity.
Solar vs. Utility Costs in California
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Sources and Assumptions:
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While solar in 2013 remains above the average price paid for residential electricity in California, the marginal price is the relevant metric consumers use to calculate the savings from solar. Marginal costs vary based on a consumer’s local utility, the consumer’s specific tariff, the consumer’s monthly usage, and the time of day. For example, many tariffs charge for electricity based on time-of-use rates, where the rate of electricity is higher during the day and lower at night, in order to encourage a reduction in peak time usage. In addition, many tariffs are inclining block rates in which the marginal rate increases based on higher monthly usage. Inclining block rates encourage conservation and keep rates low for low income consumers using minimal electricity. When a residential customer on a time of use rate installs solar power, the avoided cost of electricity is the higher daytime marginal rate.
The "Solar vs. Utility Costs" chart shows that the highest marginal electricity rate faced by consumers is $0.531/kWh by high consuming customers on PG&Es E-7 time of use rate. In reality, few customers regularly face the $0.531/kWh marginal rate, but many customers regularly pay marginal rates in the $0.25-0.35/kWh range. Therefore, there are many parallel horizontal lines on the chart which represent the various marginal rates of electricity that different consumers pay. Even as solar subsidies expire, the unsubsidized cost of solar will continue to remain below marginal electricity rates for numerous consumers.
As customer bills increase and
solar panel installation costs decrease, the market size increases for
residential customers that can save money by leasing solar panels. The "Residential Solar..." chart below shows the increase in residential solar panel installations that has
occurred in the past decade as more and more consumers find solar power to be
cheaper than their marginal electricity rate.
In 2012, approximately 75% of the solar power installed in California was
done by third-party companies that leased solar panels as opposed to consumers
who bought the panels outright. Residential solar in growing quickly, and is unlikely to stop anytime soon.
Residential Solar Installed Market Size in the United States
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| Source: Greentech Media |
Thursday, October 3, 2013
Community Choice Aggregation is a Red Herring Disruptor
This is part 4 of a series on disruption of electric utilities.
Disruption of Electric Utilities
4. Community Choice Aggregation is a Red Herring Disruptor
-------------------------------------
Community Choice Aggregation (CCA) is program which allows cities and counties to purchase electricity on behalf of community members. The benefit of CCA is that it enables communities to pool their citizens’ purchasing power to buy electricity. A distribution utility continues to own the wires and deliver the electricity, but the CCA is responsible for procuring the wholesale electricity. CCA also lets communities make decisions about how much wholesale renewable power to purchase, and what energy efficiency programs to subsidize. Starting in 1997, CCA programs have been instituted in Cape Cod, Northeastern Ohio and Marin County, California. Now the movement is moving to larger cities, most notably San Francisco and Chicago. CCA is an innovation in the electric utility market that supporters may see as disruptive to electric utilities. However, I would argue that by applying the theory of disruptive innovation, CCA is a sustaining innovation relative to conventional utility service. CCA proponents may think of CCA as a low end or new market disruption relative to utilities, but in reality it is neither.
CCA is not low end disruption
In November 2012, Chicago became the largest city to adopt community choice aggregation. In choosing CCA, Chicago described the primary benefit of CCA to be lower wholesale electricity prices due to group purchasing of wholesale electricity. If CCA provided a benefit from group purchasing, it might be considered a low end disruption relative to utilities, but unfortunately it does not truly offer this benefit. The Chicago CCA is competing against an incumbent utility, Commonwealth Edison (ComEd). ComEd is the fourth largest utility in the country, providing electricity service to 3.6 million customers, and therefore has much more buying power than the Chicago CCA. Group buying will not enable CCA to have a lower cost structure relative to a utility. Moreover, the investor owned utility framework shields the municipal government sponsoring CCA from cost overruns. While municipalities are able to issue tax free debt that an investor owned utilities cannot, the benefit of this cheaper debt comes at the cost of increased risk and a reduction in scale economies. If a power investment made by a CCA turns sour, the local taxpayers rather than private investors are on the hook for absorbing losses.
It appears consumers in Chicago viewed the successes of other CCAs and learned the wrong lesson. While retail rates in these CCAs have often been lower than those of the incumbent utility, the group buying business model is not the cause of lower prices. Instead, the reason that CCAs have looked attractive recently is that many utilities sign long-term power purchase contracts to reduce price volatility to consumers. In the past 5 years shale gas commercialization and an economic recession have led to decreases in electricity prices. Therefore, long-term utility contracts cause utilities to pay above market rates for electricity, making new CCA contracts relatively attractive. In contrast, during an era of rising prices, a CCA would not be an attractive option because any long-term contracts of the incumbent utility would be below market cost. Indeed, it appears that in the case of Chicago, the effects of long-term contracts will be over shortly. ComEd had a number of long-term contracts that expired in June of 2013, and the electricity prices of ComEd decreased. In the long-term, it is likely that the Chicago CCA will be unable to maintain prices lower than those of ComEd, and many other Illinois CCAs are already projected to have prices above the ComEd prices. CCAs in the past have had relatively lower rates, but long-term pricing advantage is an illusion.
CCA is not new market disruption
Some supporters of CCAs may argue that CCA is a new market disruption because it fulfills a different customer need than a traditional utility, but in reality CCA only fulfills distinct experiences of the same need. By offering more local, renewable power, CCA could target the following hypothetical consumer demand: “I want all my power to come from renewable resources.” However, CCA proponents need to realize that the primary customer need is still reliable power. Consumers only interact with their CCA when they get a monthly utility bill. Otherwise, they will expect the same reliable electricity service in their homes. Clean energy is an experience of using and living with electricity service. The experiences provided by clean energy include a lack of guilt from environmental damage, or health improvements when a dirty power plant is shut down. Likewise, local power is an experience of electricity consumption rather than a job itself. Local power provides customers with pride in the product being offered, and satisfaction that the reliable power is leading to local jobs and investment. The problem with targeting experiences rather than an actual customer need is that experiences can and will be replicated by utilities.
For example, the CCA in Marin California has a policy to procure energy from projects that are as close as possible to Northern California. PG&E, the incumbent utility with whom Marin is competing, saw that local is an experience desired by Northern California electricity customers. PG&E proceeded to use the local experience to fight the creation of a bigger CCA in San Francisco. In September 2012, local chapter of the International Brotherhood of Electrical Workers, which represents PG&E workers, began a campaign to publicize the negative local impacts of CCA, including increased prices that would damage the local economy. The union campaign included robo-calls, mailers, and advertising, all aimed at convincing customers to opt out of the city program. By mobilizing local union workers in its marketing campaign, the anti-CCA campaign sought to reclaim a local experience for the incumbent utility electricity. Other utilities faced with CCA encroachment will likely pursue similar local campaigns.
 |
| CleanPowerSF might be low-carbon, but it is not disruptive; Source: sfwater.org |
The other benefit offered by the San Francisco CCA is the choice of energy plans that offer a higher percentage of green power. In response, PG&E introduced its own green plan option, allowing customers to pay more for more renewable energy content. PG&E’s 100% green energy price to consumers is expected to be at a lower rate than that of the 100% option offered by the San Francisco CCA. Questions about cost and administration led the mayor of San Francisco to delay program implementation last month. CCAs face a challenge in that customers are not able to distinguish the difference between clean and dirty electrons as they use electricity. Green is an experience of the electricity job, but it is an experience that can be matched by incumbent electric utilities whenever consumers demonstrate that they value it.
Ultimately, CCAs are targeting the same customer need as an electric utility, and are thus a sustaining innovation. While they may look more attractive in an era of falling electricity prices, they will eventually lose the ability to compete on price. Moreover, any valued experiences of CCA such as local or clean energy content will be matched by incumbent utilities. CCAs may benefit consumers by encouraging utilities to better deliver the experiences that accompany reliable electric power, but they will not themselves disrupt the electric utility industry.
Wednesday, July 31, 2013
Why Utilities have Avoided Disruption Thus Far – Financial Metrics
This is part 3 of a series on disruption of electric utilities.
Disruption of Electric Utilities
1. Background on Utilities
2. Why Utilities have Avoided Disruption Thus Far – Reliability
3. Why Utilities have Avoided Disruption Thus Far – Financial Metrics
4. Community Choice Aggregation is a Red Herring Disruptor
5. Distributed Solar is the Real Threat - Trends
6. Distributed Solar is the Real Threat - The Difficult Position of Utilities
7. A Survival Strategy for Utilities
-------------------------------------
Across industries, low-end disruptions are among the most common forms of disruptive innovation. A low-end disruption occurs when a new entrant targets the lowest margin customers of an incumbent company. Examples include steel minimills, which first produced low-margin rebar rather than high margin sheet steel, or Toyota USA, which started with the low-margin Toyopet and Corona models before moving up market to make Lexus vehicles. Low-end disruptions occur because incumbent companies do not mind losing their lowest margin customers, and thus do not waste their resources fighting new entrants. Unfortunately for incumbents, a rational pursuit of short-term profit maximization, can lead to a longer term disruption as new market entrants are able to gain a foothold in the market and move to higher margin products over time.
Utilities have been resistant to low-end disruption because they are unique among industries in the way they measure profitability. Since the utility regulatory structure was established, utilities have been able to collect revenue according to a revenue requirement formula. The revenue requirement is the total amount that the utility is allowed to collect from customers and, with demand forecasts, is used by regulators to set retail rates for consumers:
Disruption of Electric Utilities
1. Background on Utilities
2. Why Utilities have Avoided Disruption Thus Far – Reliability
3. Why Utilities have Avoided Disruption Thus Far – Financial Metrics
4. Community Choice Aggregation is a Red Herring Disruptor
5. Distributed Solar is the Real Threat - Trends
6. Distributed Solar is the Real Threat - The Difficult Position of Utilities
7. A Survival Strategy for Utilities
Across industries, low-end disruptions are among the most common forms of disruptive innovation. A low-end disruption occurs when a new entrant targets the lowest margin customers of an incumbent company. Examples include steel minimills, which first produced low-margin rebar rather than high margin sheet steel, or Toyota USA, which started with the low-margin Toyopet and Corona models before moving up market to make Lexus vehicles. Low-end disruptions occur because incumbent companies do not mind losing their lowest margin customers, and thus do not waste their resources fighting new entrants. Unfortunately for incumbents, a rational pursuit of short-term profit maximization, can lead to a longer term disruption as new market entrants are able to gain a foothold in the market and move to higher margin products over time.
Utilities have been resistant to low-end disruption because they are unique among industries in the way they measure profitability. Since the utility regulatory structure was established, utilities have been able to collect revenue according to a revenue requirement formula. The revenue requirement is the total amount that the utility is allowed to collect from customers and, with demand forecasts, is used by regulators to set retail rates for consumers:
Utility revenue requirement = opex + (rate base * rate of return)
Opex is equal any operations
and maintenance costs the utility faces as well as fuel costs if the utility
owns generation assets. A utility’s rate
base is equal to its capital expenditures minus depreciation. The utility’s rate of return is an agreed
upon figure which is negotiated with state public utilities commissions for
distribution assets, and the federal government for transmission assets.
The unique part about the
utility profit formula is that there are no low-margin customers. It is more expensive to build utility assets
to serve customers in rural areas compared to those in dense urban areas, but
all utility assets contribute to the rate base.
The costs associated with the more expensive customers are simply
redistributed and collected in the rates of all customers. Under this unique profit formula, a utility
will respond aggressively when a new entrant targets any utility customer.
Friday, July 26, 2013
Why Utilities have Avoided Disruption Thus Far – Reliability
This is part 2 of a series on disruption of electric utilities.
Disruption of Electric Utilities
2. Why Utilities have Avoided Disruption Thus Far – Reliability
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In the United States, the typical utility consumer experiences loss of power for only 2 hours each year.[1] That means utilities are reliable 99.98% of the time. Not bad.
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| Source: Wikimedia Commons |
Despite the impressive reliability metrics of US utilities, utilities
continue to prize reliability above all other measures of performance. In a 2012 survey of hundreds of utility
executives, the top ranked issue facing the industry was reliability.[2] Furthermore, reliability has been the number
1 or 2 issue in every such annual survey since the surveys began in 2006.[3] Utilities are not perfect at delivering
reliable service, but their employees are oriented to respond to customer
outages and have been working against the metric of reliability for over 100
years. Any new market entrant has a difficult task in better addressing this customer
need.
[1] The 2 hour per year figure takes some rough estimation because EIA does not publish
this information. I come up with 2 hours
by looking at data from a table on page 19 of LaCommare & Eto. Including LaCommare & Eto’s own survey
data, we get a median SAIDI figure of 107 and a median MAIFI of 5.5. If we assume an average momentary
interruption of 2.5 minutes for the numbers in the MAIFI index, we get an
average outage time per year per customer of 121 minutes, or 2 hours. Having
said that, the utility surveys listed above are self-reported, and therefore
they may not include all events that a utility is unaware of or neglects to
count. In addition, widespread outages
from natural disasters are sometimes not included in the data because SAIDI and
MAIFI are meant to measure routine events.
[2] Black
& Veatch, “2012 Strategic Directions in the U.S. Electric Utility Industry”, p. 9.
[3] Black
& Veatch, “2011 Strategic Directions in the U.S. Electric Utility Industry”, p. 9.
Sunday, July 21, 2013
Background on Utilities
This is part 1 of a series on disruption of electric utilities.
Disruption of Electric Utilities
1. Background on Utilities
-------------------------------------
The electric utility industry has long appeared immune from disruption. Investor owned electric utilities follow the same business model today that they used in 1907. In that year, Samuel Insull released a policy paper on the electric power industry.[1] Insull, a protégé of Thomas Edison, conceived the idea of private electric monopolies that would be regulated by the states. The policy paper caught on as the dominant approach to establish electric utilities. State regulation created a stable legal and economic framework for utilities as natural monopolies, which enabled the rapid growth of electricity service in America. Insull went on to become President of Commonwealth Edison, the utility serving Chicago.
A natural question becomes,
why have electric utilities been able to resist change? A common argument is that electric utilities are
monopolies protected by the government and therefore highly defensible businesses. The industry is also highly capital intensive. However, powerful monopolies in other capital
intensive industries, such as Standard Oil, AT&T, and U.S. Steel, have all
been disrupted by some combination of competition and anti-trust legislation. I will argue instead that electric utilities
have been more resistant to disruption for two reasons:
- Utilities do an excellent job solving real customer needs.
- Utilities as regulated businesses are evaluated on unusual financial metrics which coincidentally encourage utilities to fight new entrants to a greater extent relative to other business.
In my next post I will examine
further the reasons why utilities have successfully avoided disruption.
[1] Ed Smeloff and Peter Asmus, Reinventing Electric Utilities
(Washington, DC: Island Press, 1997), pp. 10-11.
Tuesday, July 16, 2013
Disruption of Electric Utilities: Introduction
I will be writing a new multi-part series about the
disruption of electric utilities. This
topic has received significant attention recently, particularly after the
Edison Electric Institute (EEI) published this policy paper on disruption in the
electric utility industry. EEI is the
association of United States shareholder-owned electric power companies and
lobbies government on behalf of electric utilities.
I’ll start with some background on the industry, discuss
some potential disruptive innovations, and finally give my recommendations to
the utility industry for how they can successfully innovate on their own and
avoid being disrupted.
These posts are written entirely by me, but they derive from a policy paper written for Professor Clayton Christensen's class, Building and Sustaining Successful Enterprises, at Harvard Business School. Professor Christensen provided meaningful guidance in the writing of this paper.
Friday, June 7, 2013
San Onofre Nuclear Power Plant Shut Down
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San Onofre Nuclear Generating Station
Source: NRC
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- San Onofre; Pendleton, CA (San Diego County); closed 2012
- Rancho Seco; Herald, CA (Sacramento County); closed 1989
- Humboldt Bay; Eureka, CA (Humboldt County); closed 1983
- Santa Susana Sodium Reactor Experiment; Simi Valley, CA (Ventura County); closed 1964
- Vallecitos Nuclear Station; Pleasanton, CA (Alameda County); closed 1963
The only remaining nuclear power plant in California is PG&E's Diablo Canyon, located in Avila Beach, CA (San Luis Obispo County).
The downside of the closure of San Onofre is that Southern Californians will consume higher cost, higher carbon electricity in the immediate future. Nuclear does not count as renewable under California's Renewable Portfolio Standard (RPS). Therefore, with California's 2020 RPS target of 33% renewable power, the utility owners of San Onofre will replace the output of San Onofre with 67% fossil fuel generation.
My own position is that despite the benefits nuclear power has provided to California, it was never a good idea in the first place to install expensive power plants without a viable long-term fuel storage or re-processing plan. In addition, California lost valuable natural coast to the enormous plants, and as Japan has shown, nuclear power in seismically active regions is a risky proposition.
The closure of San Onofre will undoubtedly lead to more pressure from activists regarding the license renewal of Diablo Canyon. The licenses for Diablo Canyon's two nuclear reactors are currently set to expire in 2024 and 2025, but PG&E has filed an application to extend the licenses for an additional 20 years. The Nuclear Regulatory Commission has set up a website specifically for members of the public to learn how they can get involved with the license renewal decision.
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