Opinion: Creative disruption in the electric utility industry


This title is a combination of “creative destruction,” that which occurs when innovation destroys an economic system, and the thesis of “Disruptive Challenges,” a paper that discusses the impact of distributed renewable energy on the utility business model. This study was prepared for the Edison Electric Institute, an association of U.S. investor-owned electric companies, and is on their website.
In recent years, utility regulators, public interest groups, and even utility companies themselves have asked whether the changes that are coming will disrupt their business and regulatory models in the way that that mini-mills changed the steel industry, or the internet and cell phones changed the Ma Bell telephone companies. If that happens, history may be repeated, with current players being replaced by newer, more nimble competitors and the whole economic structure reconfigured.
On the supply side, photovoltaic cells, wind turbines, gas-powered micro-turbines and fuel cells like Bloom boxes, battery storage, etc. are rapidly becoming cheaper and more efficient. So it’s not too hard to imagine that in the not-too-distant future, local energy generation, storage, and sharing will be the norm, not the exception. On the demand side, efficiency — “nega-watts” in Amory Lovins’ terminology — is by far the cheapest source of energy. To implement efficiency at the highest level requires integrating finance, installation and regulation so improvements can be made efficiently and cost-effectively. Smart and flexible grid designs are becoming much more sophisticated, and more capable of dealing with energy users’ different equipment, priorities and financial situations. We are learning how to integrate the sharing of solar, wind, storage, and demand-side resources to smooth out variability and match demand with supply. Electric vehicles, which charge at night when wind is strongest, add another opportunity and complexity,
All of the above points toward a future different from the traditional utility role as sole supplier of energy as a commodity. But historically, utilities have built and financed power plants, transmission lines, etc. with multi-decade lifetimes on the assumption that their passive customer base and its demands would grow, and that high and stable returns on investment were pretty much guaranteed; however reality may not support these assumptions. Customers will make their own investments in mega-watts and nega-watts, with large-scale storage, localized demand management and resource integration not far behind.
The simplistic rate structures that have supported high returns to stockholders may not last either. Under the old model, utilities just divided costs by consumption, or demand, to get the basic rates, and then added on the extras. But these rate structures don’t work when customers are their own power sources. For example, customers with net-zero on-site generation are essentially using the grid as storage, but only pay small fixed administrative fees. Customers who invest in solar farms need time-of-use rates to gain the full benefit when their solar output peaks at the same time as their loads. Fluctuating renewable generation and the ability to manage demand on a large scale create yet another set of economic variables to be figured into the rates.
So the most important asset for the utility of the future may be brains. Wires and the internet may provide the basic infrastructure that allows integration, but the brains support continuous improvement to all the systems so that the utility stays up with its customers.
The old-fashioned centralized utility model also has financial problems. Traditional rate structures fail to accurately separate fixed and variable costs. So when customers generate their own power, utilities’ revenues fall faster than their costs. Utilities then need to raise rates, increasing the incentive for investing in efficiency and local or contract generation, ultimately creating a “death spiral” — rates increase, demand decreases, rates rise further, etc. Also customers will refuse to pay for old fossil fuel power plants that don’t work with wind and solar, creating even more financial chaos. Once investors start paying attention to this increased risk, they will want higher returns on bonds and equity in compensation, further accelerating the death-spiral.
What is the likely outcome? The utility of the future will be a service company, not a commodity provider. It will focus on coordinating the needs and resources of individual customers, so they can gain maximum advantage from their investments, and will structure rates accordingly. So, the question is — are the current players nimble enough to stay in the game, or will they end up being replaced?


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