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Book it: Optimizing the smart grid for consumers

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  • Dec 10, 2015

We chat with Paul Alvarez, president of the Wired Group and author of “Smart Grid Hype & Reality: A Systems Approach to Maximizing Customer Return on Utility Investment” about data, benefits, issues, ratemaking and regs.

Why did you write Smart Grid Hype & Reality?

Alvarez: I wanted to compare the costs of smart grid capabilities to the benefits actually delivered to customers in a rigorous way. I wanted to help readers reach their own conclusions about the prudence of smart grid investments, and to understand the drivers of variation in customer value from utility to utility. 

Where did you find the data on smart grid capabilities, benefits, and costs?

Alvarez: Much of the data is derived from primary research that my teams completed on the outcomes of large smart grid deployments such as Xcel Energy’s in Boulder, Colorado, and Duke Energy’s in Ohio; this research is in the public domain and available at I also use Smart Grid Investment Grant program data, available from the U.S. Department of Energy’s Office of Electric Delivery and Energy Reliability. Also useful is primary and secondary research conducted by those with expertise in specific smart grid capabilities, such as Ahmad Faruqui, Steve George, and Craig Williamson on time-varying rates; Bernie Neenan, Michael Ozog, and Chris Villarreal on prepayment; and Joseph Eto and John Kelly on reliability, to name just a few. 

What does the available data tell us about the way smart grid capabilities are actually deployed in the field?

Alvarez: I think one compelling message is that smart grid benefits can be made available at no incremental cost to customers; that is, it’s possible for the direct economic benefits recognized on customers’ bills to exceed smart grid bill riders in ideal conditions. 

Unfortunately, the data also make clear that “ideal conditions” have been extremely difficult to achieve, and in fact are not being achieved in the vast majority of deployments. While these missed opportunities are discouraging, the good news is that the benefits could still be captured on behalf of customers and our environment.

What are the impediments to achieving the full benefits in most smart grid deployments? 

Alvarez: There are many reasons, including the fact that change – organizational, operational, and consumer – is often so difficult to achieve. However, I suggest the single biggest inhibitor to smart grid optimization lies in utilities’ economic incentives. 

For example, our research indicates that over half the economic benefit available in an “ideal” smart grid deployment stems from electric demand reduction and efficiency available from capabilities such as time-varying rates, prepayment, and conservation voltage reduction. Unfortunately, all for-profit utilities in the U.S. secure economic benefits by investing capital to accommodate increases in demand; as you might imagine, reduction of electric demand is not high on these utilities’ business agendas. 

Further, almost all distribution utilities of any kind the world over are economically penalized when sales volumes drop via the so-called “throughput incentive”. So utilities are not rushing to optimize smart grids’ efficiency capabilities, either. And that’s doubly unfortunate, as electric efficiency reduces greenhouse gas emissions in addition to providing economic benefits. 

You seem to be criticizing the utilities’ economic incentives and ratemaking policies that worked well for decades. Why change them now?

Alvarez: Well, we all need to recognize that smart grid investments are fundamentally different from traditional utility investments. In the good old days, the relationship between capital investment and consumer benefit was both positive and consistent. When a community’s economic development required electric capability expansion, investments in new generation plants, substations, and wires delivered immediate benefit. There was no question that these investments would deliver value once commissioned, because the lack of investment would result in outages. Accordingly, state regulators rightfully considered capital investment a critical activity, and they rewarded that investment in the ratemaking process.

However, smart grid investment outcomes are not as black and white as traditional investment outcomes. The difference is that customer benefits don’t always follow once “smart” assets are commissioned; the benefits delivered by most smart assets are dependent on what a utility does to optimize smart capabilities after investments have been made. The variability of benefits based on a utility’s post-deployment activities is an entirely new state of affairs with which state regulators are not familiar. 

Capital investment is still critical, but today’s grids and utilities can no longer be regulated or governed with the simple ratemaking assumptions of the past that blindly reward capital investment. The assumption that customer value is positively, reliably, and ratably correlated with capital investment does not apply to smart grid investments, because the value delivered by smart grid capabilities varies so widely from utility to utility. 

What do you suggest to those charged with utility regulation and governance?

Alvarez: I believe state regulators should pursue reforms that better align and calibrate utility compensation with customer interests and value delivery. Rather than rewarding utilities solely for a process input like investment, I suggest that a significant proportion of a utility’s compensation should be based on performance outcomes measures. By focusing on utility performance, a state regulator can better ensure customer and community grid modernization goals are achieved for the least possible cost. State regulators who lack such authority should pursue it in their legislatures with the support of their state attorneys general and energy offices, to help with EPA Clean Power Plan achievement if nothing else. 

Further, I think state regulators and nonprofit utility governing boards should pursue ratemaking and other options that eliminate the throughput incentive or its impacts. Several policy options, from decoupled ratemaking to energy-efficiency program rewards, are available that have already been implemented by a number of state regulators and nonprofit utilities. 

But even these efforts may prove insufficient. When looking at the big picture, these options are short-term solutions to the broader challenges presented by cost-based regulation. Regulators in the European Union favor revenue regulation, which has its own pros and cons but probably warrants greater consideration by U.S. regulators.

But aren’t these reforms risky?

Alvarez: As I said earlier, change is difficult to implement, and regulatory changes are particularly difficult to implement. But I feel electric utility regulatory and governance reforms likely represent some of the least expensive options available to advance economic and environmental sustainability goals in U.S. communities. Only then will utilities be rewarded for more effective delivery, more efficient capital deployment, and better-directed preparations for the future, or penalized for the opposites of these. At some point, the status quo becomes the riskier alternative.


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