The Future Business Model for Energy Utilities in the U.S.: Quo Vadis?
- Aug 17, 2017 11:00 am GMT
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The energy transition, distributed generation and digitalization force incumbent utilities to change their business strategies. With today’s post we give a first overview of the future business models that are discussed in the US in response to these developments.
The US-debate about the future business model for utilities
In his book “Smart Power” (2010), Fox-Penner provides a nice summary of the potential future business models for the US. Though this book is already seven years old, the models presented still help to structure the more recent studies in this context. Fox-Penner introduces two general business models for utilities in the US: the Energy Service Utility and the Smart Integrator.
Energy Service Utility
Fox-Penner builds on the work of Sant (1980) when he defines the main task of the Energy Service Utility as
“to provide lowest-cost energy services to its customers […]. It is responsible for supplying all retail generation customers’ demand within high reliability. It can own the generations that provide supply […].” (Fox-Penner, 2010, 189).
The Energy Service Utility builds on the traditional integrated business model: generate, transport and sell electricity to the consumer. However, the Energy Service Utility extends its product line by providing end use services like heating, cooling, lighting etc. to the consumer. Basically, the Energy Service Utility manages the grid: It secures network operation and provides most services to the customers with little competition (Ralff-Douglas & Zafar 2015).
Utilities in different US states, e.g. the Wright-Hennepin Cooperative Electric Association in Minnesota, have already applied the Energy Service Utility business model. In the case of Wright-Hennepin Cooperative Electric Association this means that the utility provides a broad range of services to their customers, e.g. access to community solar, off-peak services for space heating, air conditioning and water heating based on off-peak rates, direct load control of water heaters etc. (for further details see Corneli & Kihm 2015). As a result of this early strategy shift towards an Energy Service Utility, the Wright-Hennepin Cooperative Electric Association remained an important player in its service area.
Currently, many utilities in the US are developing their business model into a similar direction as Wright-Hennepin Cooperative Electric Association. For example, different demand-response or demand side mechanisms are provided to the customers by the utilities (especially in New York and California). These products focus on the end consumers’ consumption or production of electricity, rather than on the pure selling of kWh. The shift from selling kWh to selling services to the customer is a challenging task, but it can be done. Especially with digitization (digitalization) and the development of smart grids, the potential for “behind-the-meter” services increase, e.g. with respect to energy efficiency or demand-response mechanisms. The market for (digital) energy services is increasing and so is the competition. Currently, companies like Nest, OhmConnect, Tesla or the German-based Sonnen GmbH have started to provide energy services to end consumers, e.g. based on battery storage systems. Utilities transforming into energy service utilities will have to face this competition and provide services that can compete with those of the non-incumbent companies.
From a regulatory perspective, the Energy Service Utility model raises several questions. Most prominently, to which extent the utilities can remain integrated companies. Already today, the electricity supply chain in New York where utilities own networks and retail, but no generation businesses is more separated than in California where utilities own some generation, networks and retail businesses. In a future with energy service utilities, these supply chains in the different US states might become more separated to secure competition in the energy service market.
The Smart Integrator
Fox-Penner (2010) defined the Smart Integrator as
“a utility that operates the power grid and its information and control system but does not actually own or sell the power delivered by the grid.” (Fox-Penner, 2010, 175)
The Smart Integrator represents platform business model for the utility that is based on strong separation (i.e. unbundling) mechanisms. While the Smart Integrator is not responsible for the generation of electricity, it does take responsibility for balancing the system and to send price signals to the end-customer. The Smart Integrator can be understood as having evolved from an unbundled DSO that owns and operates the network and provides the digital platform to the energy market to develop new services and products. Thereby, the Smart Integrator severs as an intermediate between the different market parties (generators, aggregators, consumers, retailers) without being active in the market itself. In contrast to the Energy Service Utility that acts as the manager of the electricity system, the Smart Integrator focuses on the facilitation of competition on the grid, i.e. the Smart Integrator functions as a market facilitator (Ralff-Douglas & Zafar 2015).
The evolution towards the Smart Integrator model is triggered by the increasing need to integrate small distributed generation facilities into the grid, which differs from the traditional task of DSOs to secure one-directional power flows. In addition, the Smart Integrator should establish an open platform for information which needs to be capable to transmit and store huge amounts of data from different sources and allow all eligible parties to access this information. The latter task is increasingly discussed in the US, especially in New York where the Distribution System Platform Provider (DSPP) is currently developed in the course of the REV process (for more information on the DSPP see this post). The basic idea is that the DSPP manages and operates the distribution grids in NY and coordinates the transactions between market parties and customer. The DSPP can be compared to the Smart Integrator concept, though the degree of separation of the networks from market activities has not yet been finally designed for the DSPP.
In California, the California Public Utilities Commission (CPUC) discusses the Smart Integrator as one of three models for the future of Public Owned Utilities (POU) (Ralff-Douglas & Zafar 2015). Ralff-Douglas and Zafar point to a very important challenge for the Smart Integrator model: Where is the efficient line between regulated tasks performed by the Smart Integrator and the market activities that are outside the scope of the Smart Integrator? The definition of this line between regulated and market activities will be crucial for the development of new business models in the energy service area.
From Energy Service Utility towards the Smart Integrator?
We can observe in New York that the shift from the traditional kWh business of utilities towards a more service- or even platform-oriented business model starts with the Energy Service Utility model. At least, this is the case if there is (reasonable?) doubt that markets for energy services might not flourish without the utilities actively involved. However, even if we need the Energy Service Utility to kick-start energy service markets (from our perspective, this is not necessarily the case and needs further investigation), we can expect that the markets will soon reach a maturity level where a more separated structure as proposed in the Smart Integrator model, seems favourable to increase competition and thereby efficiency. The coming years will show how to proceed in the development of the utility business case. For now, it is obvious that the traditional business case is not future-proof, but a final solution has not been defined yet. Even the REV process in NY still faces many open questions, especially how utilities gain their revenues in the Smart Integrator models and how we incentivize utilities to change their business model to a Smart Integrator. We will discuss these issues in the oncoming post here on www.enerquire.com.