The FISMA Focus IPD

From: Brookings

By: Charles K. Ebinger and John P. Banks

The Slow Burn

Recently, there has been considerable attention given to the threats posed to the traditional utility business model by distributed generation (DG). Dire headlines abound: “Why the U.S. power grid’s days are numbered,” “Renewables turn utilities into dinosaurs of the energy world,” “Adapt or die? Private utilities and the distributed energy juggernaut,” and “The end of utilities.”[1] This theme is not limited to the U.S.: in a recent strategy paper RWE (Germany’s second largest utility) noted that “the growth of German photovoltaics constitutes a serious problem for RWE which may even threaten the company’s survival.”[2]

But in reality, distributed generation represents the most recent trend in a decades-old evolution of a changing industry. Since the late 1970s, utilities in the U.S. have been undergoing changes that cumulatively have chipped away at the traditional regulated, vertically-integrated industry model. This erosion of monopoly control started with generation after the 1978 passage of Public Utility Regulatory Policies Act (PURPA) spurring the build-out of non-utility independent power generation: In 2011, this represented about 40 percent of total installed capacity in the U.S. The Energy Policy Act of 1992 and several subsequent Federal Energy Regulatory Commission (FERC) orders created open access to the grid and led to the formation of independent system operators (ISOs) and regional transmission organizations (RTOs) governing transmission primarily in the Northeast and the Midwest. Starting in the late 1990s, the restructuring of utilities in 15 states and the District of Columbia further eroded the revenue earning asset base of the industry by unbundling generation.

Now the last bastion of the utility’s monopoly business – distribution – is under attack. Solar photovoltaic PV distributed generation is being deployed at such a fast pace that many stakeholders see a disruptive trend impacting the financial health of the utilities over the long-term.[3] In particular, utilities are increasingly advocating an overhaul of the net metering policy originally established to incentivize distributed generation. When the first net energy metering policy was passed in Minnesota in 1983, renewable energy sources contributed a negligible part of the country’s energy mix. Although the percentage is still quite low, the growth in the past few years has been exponential. According to the Lawrence Berkeley National Laboratory, cumulative PV capacity in the U.S. reached 500 MW in 2007, doubled by 2009, and then doubled again in 2010 and 2011.[4] The popularity of solar reflects several factors, including falling solar prices, state mandates requiring renewable energy and distributed generation, a policy emphasis on de-carbonizing the electricity portfolio, a growing interest in local self-reliance, and a business model that takes advantage of the net metering tariff mechanism.

All of this has taken place amid a decoupling of GDP growth from electricity consumption. During the 1960s, a 1 percent increase in GDP corresponded to about a 2 percent increase in electricity sales. By the 1990s, a 1 percent increase in GDP accounted for less than 1 percent growth in electricity sales.  In a recent report, the Natural Resources Defense Council highlighted that since 2000, “for first time in modern history, the national growth rate for electricity consumption has dropped below that of the population for an extended period.”[5] This decoupling has come as a result of rapid advancements in technology, including the expanded use of highly efficient natural gas combined cycle plants, and the widespread deployment of energy efficiency programs.  In fact, while the number of electronic devices in our homes has grown rapidly over the past 10 years, the overall electricity use associated with them has not grown that much owing to efficiency gains. So, in fact, the same amount of electricity provides far more value today than it did a decade ago. Improvements in efficiency have allowed the financial health of utilities in many jurisdictions to be decoupled from the quantity of electricity sold, edging some utilities away from a commodity-based business model. As the demand curve plateaus (described below), it will be increasingly important to reward utilities for generating more electricity with less. Thus far electricity providers have not been systematically rewarded for investments in efficiency in the same way as they have been for increasing generation capacity.

Turning up the heat

Now, however, several major trends are converging to accelerate potentially far more existential changes with wide-ranging implications.

First, over the next several decades the real price of electricity will rise in stark contrast to the past 50 years where the real price of electricity has been flat. Meanwhile replacing or retiring virtually every power plant by 2050 (except hydro facilities) including 70 percent of the nation’s existing carbon-free generating capacity, modernizing the grid, meeting stricter environmental regulations and renewable mandates, and upgrading the transmission and distribution infrastructure are all converging to exert upward pressure on utility expenditures. For example, the annual capital expenditures of U.S., investor-owned utilities in 2012 and 2013 have been around $95 billion, the most of any sector, and the Brattle Group has estimated that $1.5 to $2 trillion in investment is required by 2030 in the U.S. electric utility industry, mostly in generation.[6]

Second, rising costs are occurring against a flat to declining demand for electricity. The U.S. Energy Information Administration forecasts that electricity demand will increase just 0.9% per year by 2040, representing a marked difference from growth rates in most of the 20th century. Slower economic growth and the accelerated deployment of energy efficiency programs, codes and standards, and demand response are flattening demand. At the same time, the structure of demand is changing with the enormous increase in information and communications technologies. As one analyst has noted the “always-on” digital economy is driving the need for more resilient and reliable power supply for microprocessors, data centers, and an array of home and office devices.[7]

Third, we’re witnessing the increasing threat of cyber attacks – a recent congressional survey of the industry revealed that many utilities report being “subject to daily, frequent or constant cyber attacks.”[8] Perhaps not receiving as much attention is the threat of physical attacks on infrastructure, some of which have already caused smaller scale outages around the country.

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