Reimagining electric utilities for the 21st century

In my last post, I explained the core problem facing US electric utilities: They are still structured as monopolies that bundle together disparate energy services, despite new technology making it possible, and desirable, to “unbundle” those services.

That core problem explains why so many utilities are fighting rooftop solar, hostile to energy efficiency, and/or working to secure bailouts for big old coal and nuclear plants. In all cases, their financial returns depend on excluding emerging competitors from electricity markets, maintaining monopoly access to customers.

It’s an unsustainable situation. Utilities are overdue for some deep restructuring, to open up competitive markets for electricity services and spur innovation.

That is, to understate the matter considerably, easier said than done. What might these new utilities look like? And how can they be brought to life?

Here’s my premise, as explained in the previous post: The only “natural monopoly” left in electricity is the grid itself. The utility has two core functions that properly remain the purview of a single entity, responsible to the public:

Beyond that, however, everything ought to up for rethinking.

What would it mean for distribution utilities to open up to competition?

There are lots of ideas floating around about this — I’ve put some links to further reading at the bottom of the post — but for now I’ll just draw on the taxonomy offered in the Lynne Kiesling paper I mentioned in the last post. It’s a decent introduction.

(Note: This is a completely blue-sky, blank-sheet-of-paper exercise. I’ll leave the ugly political-economy side of it for later.)

The idea is to open up competitive markets for various energy services, using the distribution grid as a neutral, open-access platform, like the internet. Energy services can mean power generation, storage, capacity, “balancing services,” management, and efficiency. It could also mean financial services that enable participation in energy markets, through aggregation or arbitrage.

Ideally, the prices set for those services on those markets would reflect their true value to the grid, including their value in meeting regulatory mandates.

Given all this, the question is what role the distribution utility should play in those markets. Should it own its own backup generation reserves? Should it sell solar panels to its customers? What is its role in compliance with and enforcement of regulatory mandates for clean energy and efficiency?

Kiesling breaks the question down like so: “Should distribution utilities own assets and transact directly on their own behalf, manage transactions on behalf of others, or coordinate the transactions of independent economic agents?” Different answers to these questions yield three basic business models.

In this, a variation on the traditional model, “the distribution company directly engages in energy-related transactions themselves, as market participants.” This means utilities own generation and participate in distribution-edge markets by selling solar panels, leasing storage technologies like batteries, and the like. These assets would be added to the “rate base,” meaning utility investors would continue to receive their state-guaranteed returns on investment.

There would be markets, but utilities would participate in them.

This is a step back, in which the distribution utility “uses the automation and communication capabilities of smart grid technologies to manage transactions on behalf of agents in electricity markets; this management function can include some ownership of assets for reliability purposes.” So the distribution utility might own some reserves for reliability purposes, but for the most part it would serve as a broker of transactions between energy services providers and customers.

This is a step further back, in which the utility is not a market participant at all but is instead a “facilitator of the transactions of independent, distributed agents in the electric network.” In this model, the distribution utility divests itself of all assets that aren’t the grid itself and moves into a primarily service role: providing market structure, price signals, real-time supply and demand data, and enforcement of rules and regulations. (Another possible role: serving as a single point of contact for customers, who could receive one bill that tallies up a range of third-party energy services.) Those services would become the utility’s new revenue streams.

The overriding idea is to, over time, replace central planning with markets. Rather than a utility deciding years in advance how much demand there will be, how much supply is needed, and how much it all costs, those decisions will be made on an ongoing, real-time basis by the dynamics of competitive markets.

The utility’s role in option No. 3 is to manage, but not participate in, those markets.

It would set up a kind of clearinghouse, where those who have power or services to offer register and those who need power or services come to shop. For instance, at times of high sun when solar power is flooding the grid, the value of solar electricity will fall, but the value of energy storage (to hold some of that surplus for later) will rise. So solar providers will be able to connect with storage providers, which will offer competitive bids.

The value of electrons (and other services like demand shifting, voltage regulation, or capacity reserves) will vary throughout the day, and from location to location, depending on grid conditions. So a key role for the utility will be to make that real-time price information easily available, so that market participants can make sensible choices.

For instance, a customer’s automated home energy management system has a certain amount of energy stored in its battery appliance. Should it sell some of that power on the grid, or buy more power and increase the stored reserve? That will depend on how much power is worth at the moment.

Or say the utility determines that backup reserves are running low, threatening reliability. It would then automatically boost the price of reserve power, allowing power providers to bid in more capacity.

And so on. The hope and expectation is that — as the 20th century seemed to demonstrate — markets will do a better job of determining value than central planners, which means a cheaper, more efficient power system with less waste and redundancy.

Despite my reputation as a wild-eyed leftie, I’m actually a big fan of well-regulated markets, especially as instruments of innovation, which is what’s most needed in the world of electricity right now. For that reason, I favor option No. 3. The danger of the first two, Kiesling argues, lies in “vertical foreclosure,” whereby a monopoly “[fails] to sacrifice market share or to exit when innovation and dynamism become relevant competitors, and regulatory institutions likewise fail to facilitate the diminution of the monopoly.” This kind of “failure to exit” has anticompetitive effects on markets largely through “incumbency and consumer inertia.”

Another way of putting that is that utilities have every incentive to begrudge competitors, cling to sunk costs, and use access to regulators to keep the game rigged in their favor. As long as a company with a captive set of customers and state-guaranteed returns is participating in energy-service markets, it will distort those markets.

In fact, this is the great danger of the transition that lies ahead for utilities: that they will fight it every step of the way, clinging to the regulated assets that provide them their most predictable returns. You can see this happening in crude form in utilities like FirstEnergy seeking customer bailouts for their big baseload coal and nuclear plants. You can see it happening with the battles over rooftop solar all over the country. But as utilities are pushed toward the service model, unbundling even the products and services they provided on the retail side, that type of fight will become more common.

If they use their pull with regulators to protect themselves, it will only slow down (and raise the cost of) the clean energy transition. Technology has evolved to the point where there are uncounted innovations waiting to happen all along the outer edges of the grid, just as the internet unleashed a wave of distributed innovation.

Part of the reason utilities are still using technologies older than, uh, me is that the technologies are huge and the regulatory model is built for caution. It takes a long time to innovate on technologies that only come in multibillion-dollar increments, and when your returns are guaranteed by law and reliability is your only obligation, you’re likely to stick with the tried and true.

By contrast, grid-edge innovations are based on new ICT services, new financing models, and small-scale technologies that are plunging in price. That makes for low barriers to entry, if regulators don’t keep those barriers artificially high. One way or another, those distributed innovations are going to swarm over the utility dinosaurs like mammals. Utilities have a choice: evolve or, like US coal companies, go under in maximally undignified and ungracious fashion.

Most of what I discuss above is idle dreaming, akin to sketching unicorns. The actual political economy of the utility sector is an unholy nightmare, with odds forever stacked against reformers and innovators. Nonetheless, here are three things that might help the process along.

The trickiest part of all this will be the transition. Utilities fear that they’ll get stuck with billions of dollars in stranded assets. Ratepayers fear that they’ll get ripped off or end up paying more for power. Social justice advocates fear that a shift toward a more market-friendly system is “privatization” that will end up screwing the poor and offering the wealthy a higher tier of what is supposed to be a public service. Regulators fear that they’re being asked to rebuild a very large, complex airplane that’s already in flight, and nobody really knows what the hell they’re doing.

All those fears are reasonable. The best way to address them is to start talking about it. Pull stakeholders together, see what’s possible, and get planning.

Work is underway to rethink utilities in several states, including New York, Hawaii, and Massachusetts. These reform efforts differ in ambition — Massachusetts is mostly experimenting with new rate structures that vary by location and time of use (a valuable first step), whereas New York is engaged in a root-and-branch rethinking of the entire utility model:

All these efforts are steps in the right direction, though. It would be extremely helpful if some of them demonstrated success so that other states would feel more confident following along. Each successful experiment builds a little momentum. This is an area where the “laboratories of democracy” are really needed.

I know, there’s no such thing anymore. But insofar as it is possible, it would be helpful to expand the group of people who a) understand the root causes of utility dysfunction, and b) organize and advocate for reform. Due to the patchwork nature of US grid regulation, it will be a state-by-state battle, but each one of those battles is more likely to be won if there is something like a national consensus about the need for utility reform.

Battles over rooftop solar panels are important in the near term, but ultimately, they are symptoms of a larger problem, which won’t be solved with a few rate tweaks. Right now, the interests of utilities — protect existing investments, sell as much power as possible, and keep competitors out — are fundamentally at odds with the interests of ratepayers and the social imperative to decarbonize the power system. Only deep reform can realign utilities’ interests with the public’s.

Utility reform is an incredibly complex subject — everything in my last two posts has been extremely stripped-down and simplified, to the horror of the half-dozen people in the world who actually understand the subject in depth — so if you wanted, you could spend basically the rest of your life reading about it. But don’t do that. Instead, here are a few good places to start: