The Policy Conundrum of Distributed Generation
While distributed generation (DG) offers clear environmental benefits and the potential to improve grid resiliency, it doesn't fit neatly into the current utility business model. Its costs and who will pay them are still up for debate and being studied extensively. In this interview, Director of Policy and Communications Mike Bull proposes a balanced approach to align utility interests with customer interest and reduce carbon emissions.
Jenny: How would you characterize the current relationship between DG and electric utilities?
Currently, and for the last 100 years, the electric utility industry has been designed around central stations, big wires, and a single deliverer of energy to end-use customers. This has been a very efficient way to generate and deliver electricity, and we’ve all benefited from that. At the same time, the way utilities recover their capital investment and operation costs designed to support that centralized system, collecting a utility’s costs through each kWh they sell. Yet, since we are in a very significant transition to a more decentralized system, this commodity-based utility business model is under a lot of pressure.
There is a tremendous amount of innovation and change that is occurring at the “distribution edge” between a utility system and customers, where the meter is located. Distributed energy resources (DER) like distributed generation, energy efficiency, demand response, and microgrids are blossoming here, for a variety of reasons – public policy, consumer demand, technology innovations. And that’s great, distributed resources offer a lot of benefits. But they all share a common impact – they tend to reduce electricity sales, the commodity upon which the utility business model is based.
Jenny: So describe why you say DG poses a policy conundrum.
In order to decarbonize the energy system as quickly and as cost-effectively as possible, we need our utilities to continue to make significant investments in demand-side management, high voltage transmission, utility-scale renewables, power plant replacements, and smart grid infrastructure. DG in and of itself won't scale up quickly enough to decarbonize our electricity supply at the rate we know we need to. So, to the extent that DG and other distributed resources reduce sales and impact the current utility business model, they introduce greater uncertainty about how utilities will recover those bigger, long-term investments needed to address climate change. Utility executives, unsure how they’ll recover those costs over twenty or thirty years since the world they know is changing, will likely increase their resistance to making those investments.
The Edison Electric Institute released a report last January called “Disruptive Challenges.” EEI reflected on a what they termed to be a “death spiral” for electric utilities. Under this scenario, as DER undermines utility sales (and therefore, revenues), the fixed costs utilities have invested in power plants and other infrastructure don’t disappear. They get loaded onto the remaining kilowatt-hours that utilities do sell. This cost-shifting increases the costs of those kilowatt-hours, which increases the utility’s rates and makes DER options even more attractive to customers. As more and more distributed resources are implemented, the utility business model ultimately will collapses. While this scenario is intentionally extreme, it helps illustrate why utilities are so resistant to DG and other distributed resources.
I don’t think we’ll get to that point. But if you’re a utility executive reading that, you’ll pause the next time you’re asked to sign onto a 25-year power purchase arrangement for a 100 megawatt wind project or to commit to construction of a new natural gas combined cycle plant to replace an older, less efficient coal plan, asking yourself, “what will our business look like over 25 years? How do I know that these new assets won’t be stranded?”
Jenny: What, then, is the right approach to DG?
While we want to encourage distributed resources, utility-scale renewable and DSM investments will have bigger and more cost-effective impacts on carbon reduction. We need a balanced approach that continues the progress we have made to reduce the environmental impacts of electricity production and use, and allows utilities to adapt to a changing environment.
As we encourage greater penetrations of distributed resources, we need to recognize the impacts that distributed resources like DG can have on the current utility business model and develop and implement transition tools to mitigate those impacts. Mechanisms like revenue decoupling and the “buy all/sell all”/Value of Solar approach in lieu of net metering that the Minnesota Legislature adopted as part of the solar legislation this past year are terrific examples. These tools allow us all to promote distributed technologies without undermining utility revenues, and without causing uncertainty with regard to the significant investments in cost-effective carbon-reducing actions we need our utilities to make.
So we have to implement those transition tools. And we have to aggressively start the discussion about what the new utility business models should be? It’s likely that the new models will be “service-based” rather than the old commodity-based approach. But we need to have a detailed discussion about what we want our utilities to be doing, and how should those services be paid for? I don’t think we know yet, but we need to figure out… the utility world is changing quickly.
Jenny: Is DG then a distraction?
It’s not a distraction; it’s an option customers are asking for and it’s driving us to questions we should answer.
Customers are demanding more options, including DG. The utilities won’t be able to ignore that demand. We had a retail deregulation revolution in the late ‘90s and early 2000’s that was largely focused on customers seeking lower costs from potential new market entrants. DG is driving the same kinds of conversations, but this discussion is primarily technology-based. As the technology becomes more cost-effective and the systems grow smarter, innovations at the distribution edge are inexorable. They’re going to be implemented. Customers want them, communities want them, our regulatory systems have to get ready for them. But it’s not a utility problem. It’s a shared problem. If we want to meet our CO2 reduction goals in time, we have to solve this utility business structure problem.
Jenny: Why now? Where is the pressure for this discussion coming from?
Technology costs are coming down and are becoming viable at a much broader scale. The cost of solar panels has dropped remarkably over the past several years. Customers and communities also want more control over what kind of energy supplies them.
The other dynamic that we should all be paying attention to is that utility rates are increasing. In the past we’ve always talked about distributed resources and their cost relative to wholesale alternatives like running a coal or gas plant. Now it’s clear that the analysis is the cost of distributed resources relative to what customers pay – “rate parity” as opposed to “grid parity.”
Rates are going up across the country because utilities are refreshing their infrastructure and responding to a number of environmental regulations. They are replacing old distribution systems and building new transmission lines. And as those rates go up, the costs of distributed resources are going down. The relative cost difference is growing smaller all the time.
Jenny: What are the major pieces pushing us towards the decision of where to put our resources? Where is the hard policy debate going to happen?
These kinds of conversations are going to take place at the Legislature and the (Public Utilities) Commission, there will be a continual push to unbundle utility services, to allow distributed resources to provide a greater share of these services to customers. We tend to have these policy discussions on a piecemeal basis: whether this particular policy is the right thing to do now, then on to the next thing. But we need to make sure we take a step back, to keep our eyes on the bigger perspective, which is to reduce carbon from our energy supply as quickly and as cost-effectively as possible.
Jenny: So, the value of solar is one idea, decoupling is another. But these seem like incremental stepping stones, and the hard policy conversation about what we want from our utilities and how to pay for them isn’t happening...
No, it’s not. We’re having good conversations about some of these transition mechanisms, but we haven’t started to ask the bigger questions: what do we want our utilities to do? How will we pay them? That’s a big hard set of questions that we need people to engage in.
They’re going on elsewhere in the country. Rocky Mountain Institute has been engaging on this question through their eLab. Ron Binz, who has just been appointed to FERC, has been leading on the issue through his Utilities 2020 effort over the past few years. A coalition commissioned by Governor O’Malley of Maryland recently issued its Utility 2.0 report. Some conversations are national, some are regional, but none are in the Midwest. We have been working with local organizations, utilities, policy-makers, and other stakeholders to get a Midwest conversation off the ground, and are hopeful we’ll be able to do so in the near future.
Jenny: Very interesting. Thanks for taking the time.
You bet, thank you.
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