Much has been written and discussed over the last few years regarding the conventional utility’s “death spiral.” America’s power generation utilities have become increasingly fearful that a significant majority of their customers will generate their own electricity through innovative distributed energy technologies like rooftop solar. In other words, their customers become their competitors. As these customers migrate off the power grid, the utility’s revenues drop due to reduced load and the traditional monopoly model folds.

Utilities have been aware of this emerging threat for some time. Now, as the price of renewables plunges and traditional coal-fired power plants are decommissioned under the Environmental Protection Agency’s Clean Power Plan, utilities have to respond to this changing environment with a new set of tools. In this post, we discuss a few trends developing across the country toward a cleaner, more affordable and more reliable grid.

Performance Based Rate Making

In Minnesota, the state’s leading utility, Xcel Energy, is pushing legislation (HF 1315) to create a performance based rate (PBR) regime that adjusts the utility’s revenue model to align with the state’s energy policy objectives while still protecting the utility’s business interests. Standard ratemaking in most states is based on the cost-of-service versus the rate-of-return. Instead of minimizing costs to achieve higher rates and greater revenues, the PBR de-couples the rate-of-return from the amount of kilowatt-hours sold, and focuses utility returns on its ability to meet a series of performance metrics that, for example, enhance the grid-system, energy efficiency, or customer value. PBR relies on setting a threshold performance level; thus, rewarding utilities for meeting targets and penalizing them for under-performance. An added benefit for utilities and ratepayers is that the PBR method may decrease the number of rate cases, which can be costly and time consuming. Thus, PBR can incentivize utilities to adapt to technological changes and promote distributed generation while continuing to recoup cost of investment and creating returns for shareholders.

Performance-based regulations will inevitably change the relationship between customers, utilities, and regulators. By tweaking their business model to meet state performance goals and create a distributed energy project-friendly market, traditional utilities in Minnesota will not only survive, they may thrive.

Platforms for Distributed Technologies

The New York Public Service Commission (“NYPSC”) is proactively exploring revamping incumbent utilities as “platforms for distributed technologies.” NYPSC’s Reforming the Energy Vision (“REV”) docket envisions these platforms as a transmission line “gatekeeper,” and the conventional utility will fulfill this role. The gatekeeper’s purview would include grid demand response, energy efficiency, and distributed generation. The NYSPC envisions utilities as Distributed System Platforms (DSP) constructing a multi-sided platform market with the utility functioning as the platform provider, similar to the interfaces found in the financial markets, credit card services, video game systems, and many internet businesses. In these markets, transactions take place in a triangular rather than linear exchange, in which buyers, sellers, and the platform provider each interact with two or more other parties rather than one counterparty exclusively. The platform provides the technology, protocols or structure through which users can interact. The NYPSC’s Staff has released its second White Paper that analyzes how to transition utilities towards the DSP market, and a feature of this transition seems to be a version of PBR that incentivizes distributed generation, low cost electricity and grid resiliency. Therefore, instead of spiraling to their deaths, New York utilities will have the opportunity to adapt as this market interface, connecting energy customers to energy producers– a redefined role in a new energy industry as distributed generation clearing houses.

California has taken note of the REV trend and the California Public Utility Commission is in the process of creating distribution resource plans (DRPs) that incorporate distributed energy resources into utility grid-planning and investment regimes. Further, California’s model would place utilities in the role of brokering wholesale and retail grid energy, and perhaps empower the utility as a grid-edge operator similar to an independent system operator of a transmission grid. Again, such strategy may call for incentivized performance-based rate structures.

Net Metering Pushback

Utilities are not all for adapting to new and innovative business models, and in many states are continuing to push back against distributed generation. Net metering, which has incentivized hundreds of distributed energy projects, is a legislative policy that allows generators to sell back unused electricity into the utility grid. Once supported by utilities, these policies are becoming more contentious across the country since in cost-of-service versus the rate-of-return regulatory jurisdictions, there is the argument that net metering prevents utilities from recouping their full return on grid investment. Utilities have raised concerns that net metering policies create an inequitable cost sharing paradigm, whereby customers are paid for over-generation, but do not bear the responsibility or cost for updating and maintaining transmission lines.

For example, contention over net metering in Hawaii brought a regulatory proceeding to halt as the island’s utility maintains that costs are shifted to non-net metering customers. The utility recommends a model for distributed energy resource where owners would be compensated for net-metered electricity at $0.18 per kWh, which lengthens the payback period for solar infrastructure investments. Similarly, the Arizona Public Service Company (APS) established a charge for new rooftop solar panel installations connected to the electric grid through net metering, amounting to $0.70/kW—approximately a monthly charge of $4.90 for most customers. The policy was effective starting January 2014, and will be in effect until the next APS rate case.

Considering that utilities maintain ownership of the transmission lines, and in many jurisdictions that their energy generation role is still a necessity for grid stability and reliability, these companies retain a considerable amount of power over the destiny of our power markets. However, customers that have installed distributed energy projects like solar, expect to receive the net metering rates they were promised. As more utilities stop supporting net metering policies, distributed generation continues to proliferate. Thus, there needs to be a compromise between the utility, customers, and regulators that fairly accounts for all costs. Only then can a win-win solution be developed.

Thoughts for the Solar Customer, Developer, Investor

The unprecedented amount of distributed energy coming online will have to be accounted for in the future power generation industry model. Ultimately, the states will serve as arbiters that will guide the evolution of the electric industry. Many states are closely watching the developments in New York, Minnesota, California, Hawaii, and Arizona as each regulatory body considers its own solutions to balance renewable energy developments with grid maintenance, safety, and reliability. The attractiveness of distributed energy to the customer, developer, and investor will certainly depend on the solution chosen.