Changing the utilities' business model

As the greening of the grid continues, power suppliers will have to adapt to new electricity tariffs that focus on service, not kilowatts.


Electricity suppliers should be paid according to the services they provide, including reliable and environmentally friendly heat, light and power, rather than the quantity of electricity they supply, according to green groups and retailers themselves.

"The retail electricity distribution business should not be viewed or regulated as if it were a commodity business," the Edison Electric Institute and Natural Resources Defense Council said in a joint statement yesterday.

"Instead utility businesses should focus on meeting customers' energy service needs."

Edison is an association that lobbies on behalf of investor-owned power companies in the United States, while NRDC is one of the country's most prominent green groups campaigning for action to reduce global warming.

In their joint statement, EEI and NRDC called on regulators to break the link between utility revenues and the amount of electricity sold so suppliers have an incentive to provide heat, light and power in the most efficient and environmentally friendly way - even if that means selling less electricity.

New business model

There is a broad consensus that the power industry needs to update its century-old business model. But achieving that shift is proving unexpectedly difficult, as it runs into obstacles from regulators and some of the power companies themselves.

In many instances, regulated tariffs still reward companies for the amount of power they supply, and penalise them financially if their customers take less power from the grid.

In others, utilities appear unenthusiastic about customers generating their own power from micro wind turbines and rooftop solar panels, or cutting consumption by investing in energy efficiency measures.

Lack of enthusiasm among electricity suppliers prompted Britain's energy minister to write to the country's utility regulator on Feb 10 complaining that "energy suppliers still see their role as selling gas and electricity rather than having a different business model where the value proposition is to save households energy."

Sam Insull's insights

The modern electricity business owes its form to Samuel Insull, chief of Commonwealth Edison, who built the first large-scale power distribution company in the U.S. Midwest more than a century ago ("Smart power: climate change, the smart grid and the future of electric utilities," Peter Fox-Penner, 2010).

Insull's crucial insight was that it was cheaper to provide electric service by combining power plants and customers over a grid rather than trying to supply different groups of users from separate power stations.

He also recognised there were enormous economies of scale in both power generation and distribution that made them natural monopolies. The more power supplied the lower the unit costs.

And in an industry with some characteristics of a natural monopoly and requirements for heavy capital investment, Insull realised suppliers could benefit from accepting regulation in exchange for restrictions on competition and guarantees they would be able to recover their capital and operating costs from customers.

For the last century, employing Insull's model, electric utilities have generally offered multi-part tariffs and bulk discounts to encourage their customers to use more power. The more kilowatts a customer uses, the cheaper they are on average.

Regulators, too, have generally based rate rises on the amount of electricity generated and transmitted over the network. Utilities have been rewarded for investing in more generation and transmission capacity to supply more power to their customers.

In the traditional model, there is no incentive to help customers take less power from the grid. Customers who cut their consumption or generate their own power depress revenues, undermine the economies of scale inherent in central generation and distribution, and leave utilities with under-used power plants and transmission lines.

Greening electricity

To cut greenhouse emissions, policymakers in most U.S. states and other countries have required utilities to purchase a certain quantity of their power from clean sources like wind, solar, nuclear and hydro.

In addition, utilities have often been required or encouraged to help their customers make homes and offices more energy efficient by installing more insulation and weatherising.

Finally, many utilities have been required to allow customers to generate their own power from rooftop turbines and solar panels, and even sell surplus power back to the grid.

Instead of power flowing one way across the grid, from central generating stations to homes and offices, it increasingly flows in two directions, with customers sometimes taking, and sometimes supplying, electricity to the network.

Bi-directional net meters record the time, direction and amount of electricity flowing between the customer and the network. Customers are charged only for the power they take, and credited for power they supply, according to the time of day and time of year.

"Micro-generation" or "distributed generation", as the system is known, is popular among green groups, customers, politicians and some utility regulators. Power retailers are understandably less enthusiastic since it threatens every aspect of their traditional business model.

Recovering grid costs

Net metering is not a panacea. Even with micro-generation, most customers still want a connection to the grid to even out their electricity demand and production.

On a sunny or windy day, a home-generator may want to sell excess power back to the grid. On a cold, overcast and still day, a home generator may still need to take some power from the network.

The problem is how much to charge micro-generators for the network services that they continue to rely on.

"Although (distributed) generation can reduce a grid's needs for central station generation and other infrastructure, it typically does not eliminate its owners' needs for grid services," EEI and NRDC explained in their statement.

Grid services include everything from basic transmission to voltage and frequency control and providing back up power when the sun does not sunshine and the wind does not blow.

The question is how much to charge micro-generators for all these services they continue to use even as they cut the number of kilowatts they take from the network.

In many cases, early net metering programmes have been very generous. If net metering was extended to a much larger group of customers, as policymakers hope, on the same terms, utilities would be left with lots of under-used power plants and transmission lines and a "revenue adequacy" problem.

While some power plants and transmission lines could be permanently closed, others would still be needed to provide back-up and other grid services.

Redesigning power tariffs

There is a risk that customers who continue to rely on the grid will end up subsidising micro-generators who produce most of their own but still expect the grid to be available as back-up.

The same problem occurs with energy efficiency. Reducing consumption cuts some but not all of the costs of supplying customers. As less power is supplied, average unit costs tend to rise because some costs are basically fixed.

In their declaration, EEI and NRDC agree there is a "vital need for regulatory policies that will support fair and adequate cost recovery for maintaining the evolving grid."

From the moment Thomas Edison opened the first power plant at Pearl Street on Manhattan in 1882, cost recovery and tariff design has been central to the development of the electricity industry.

It is a technical subject which receives far less media and public attention than smart metering and renewables. But no issue is more important.

Updating cost recovery and tariff systems will be essential to integrating more home-generation over the next 20 years while ensuring electricity remains reliable and affordable for all customers.

Originally published by Reuters. Reproduced with permission.

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