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Challenges to the Electric Utility Business Model in a Climate-Changing World

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Rudy Shankar's picture
Director Energy Systems Engineering, Lehigh University

Summary Entire career experience has been devoted to technology development and implementation support for public and non-profit companies, mainly the energy/power industry, including change...

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  • Feb 23, 2022
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This item is part of the Special Issue - 2022-02 - Business Side of Running a Utility in 2022, click here for more

One of the best kept secrets is how utilities operate and especially how investor-owned utilities (IOUs) maintain financial sustainability. Although entirely unintentional, the business model for most public utilities—those entrusted to serve large population sectors—is not well understood by the customers. Under an agreement between the service area – represented by a public utility commission (PUC) – and the utility, the latter is guaranteed to be compensated on a rate base plus a reasonable profit that allows investment on infrastructure. In return, the utility is to offer the service at a “reasonable price” and assure “reasonable reliability” [1].  These principles justified for over a century has served the customers and the nation very well. It has no doubt contributed to the U.S. becoming an economic giant and superpower. The availability of cheap, reliable electricity through the decades is the reason. Electricity rates in the US can be as low as $0.08/kWh (Wyoming) to $0.45/kWh (Hawaii), the median price in the US hovers around $0.15/kWh, far lower than 20 developed nations (for example: Germany $0.35, Denmark $0.31)

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This prosperity persisted for decades, from 1940s to today. However, the utilities have seen a steady degradation of profit largely due to the decoupling of  the trend where economic GDP rise went with electricity consumption rise. Consumers reduced their electricity expense mainly due to more efficient lighting—replacement of incandescent lights with LEDs and CFLs; and more efficient appliances. Since the utilities sold only one product, the use of energy or kilo-watt hours, reducing consumption was a sure sign that the business model was going to be challenged. The way we generate and use electricity is changing. Decentralization and decarbonization—how we manage distributed generation and reduce carbon footprint of electricity generation as well of other major industries-- are getting attention The transition in how we generate electricity is being driven in large part by the growing share of increasingly cheap renewable energy. The U.S. generates 66 times more wind energy and 144 times more solar energy[2] when compared over the past two decades.

These changes on the grid are reflected graphically in Figure 1 which is a plot of year-on-year profit of utilities over the years. While the electric power industry was undergoing rapid expansion during and after the post- world war boom, the profits were in double digits but declining in the 1980s on wards and into the new millennium. There has been little or no growth in the past two decades, mainly because the per-capita consumption has decreased mainly because of the aforesaid reasons of increased efficiency. But if profitability were tied to the one product that is decreasing per capita, the utilities have had to strategize and increase electrification. Coincidentally, this was just what the “doctor ordered” for reducing green house gas (GHG) emissions by not only reducing/eliminating fossil fuels for electric power generation but also to convert other industries that consume fossil fuels—transportation and cement and steel industries—with cleaner alternatives.

Figure 1: Utility Year on Year Financial Growth

New technologies as well as access to the internet are also radically changing the way we use power: electric vehicles, energy storage, super-efficient electric heating and cooling systems, and software that can manage energy use in real time. These technologies can not only save us money and make us more comfortable; and address climate change.  However, the grid remains the “last resort” and has a mandate to supply reliable power to its customers. So while these technologies are emerging and have distinct advantages, providing customer choice, they are also sometimes in direct conflict with the utility’s mandate. This paper will highlight some of these areas.

Net Metering 

Figure 2: Net Metering System in the US

The Energy Policy Act of 2005 required state electricity regulators to "consider" (but not necessarily implement) rules that mandate public electric utilities make available upon request net metering to their customers. Net metering was pioneered in the United States as a way to allow solar and wind to provide electricity whenever available and allow use of that electricity whenever it was needed, beginning with utilities in Idaho in 1980, and in Arizona in 1981.  A graphical illustration is in Figure 2.

Net metering policies are determined by states, which have set policies varying on a number of key dimensions. Several legislative bills have been proposed to institute a federal standard limit on net metering.

One of the most dramatic changes in net metering is under consideration in California. Dubbed NEM 3.0, the new proposal has created a monthly “user fee’ for solar customers precisely to compensate utilities for the infrastructure required to support such efforts. The new proposal has some interesting features, allowing greater user participation especially for lower-income demographics, and the support of storage to be able to defer excess solar use to night time. But it has drawn heavy criticism because of the user fee clause that appears as a punitive “solar tax”.

EV Charging Infrastructure

The EV Charging infrastructure market is the most promising for utilities who have seen per capita load-erosion through the years. An electric vehicle at home would be by far the largest appliance and the potential for large-scale adoption of EVs make it doubly attractive. The electrification of vehicles will benefit communities in a variety of ways including improved air quality from reduced emissions of pollutants such as nitrogen oxides and carbon monoxide.  It will also reduce carbon dioxide emissions from the transportation sector and diversify fuel sources for vehicles.  EVs offer an environmentally-beneficial source of load growth and an opportunity to demonstrate environmental stewardship.  Given the economic and environmental benefits of electrification, power utilities across the United States are eager to promote EV adoption.  

Utilities are well ideally positioned to partner with the auto industry, EV owners, municipal and private vehicle fleets, car sharing companies, and communities to offer products and services that encourage EV adoption and provide convenient and grid-friendly vehicle charging options.  Many utilities have found that investments in charging infrastructure, customer education, and designed rates and incentives encourage EV adoption. The investments will depend on continued support for EVs at the federal level.

The federal government, through the adoption of tax and environmental policies, has sought to incent EV development and adoption.  EV owners receive federal income tax credits when they purchase their vehicles.  Manufacturers benefit from corporate average fuel economy (CAFE) standards that can be met by including EVs in the fleet-wide average.  The elimination of tax credits promoting EV adoption or the weakening of CAFE standards could discourage further investments in EVs just as electric utilities are realizing the benefits of transportation electrification to optimize electric grid infrastructure, improve management of electric loads, and integrate renewable resources.

Both the electric and transportation sectors are impacted by regulatory and customer demands to reduce carbon dioxide emissions.  While the challenges for the transportation sector are different, consumers’ support for reducing emissions is growing annually.  The electric sector is responding to consumer demand, making strides in its own carbon dioxide reduction efforts, and poised to assist the transportation sector’s move toward the use of electricity as a more environmentally friendly transportation fuel.  Electrification of vehicles will enable public power utilities to help reduce air pollution and carbon dioxide emissions and support growing customer demand for EVs while increasing electricity sales and moderating rate pressures.

Energy Storage

Figure 3:Storage Technologies for Different Applications

Energy storage technologies have the greatest potential to alter the electricity landscape: they could defer demand for generation for peak-demand times thus lowering the overall cost and price to consumers; they could smooth intermittency of renewable resources thus making these ssources more grid friendly and dispatchable. One of their still unexplored use is for market arbitrage. As the graph is figure 3 shows, energy storage technologies have a spectrum of uses, from large amount of power for long times—sometimes called grid-scale batteries to very short durations of small or large amounts of power. The most durable and usable type of energy storage is pumped hydro which requires large amounts of land. Of the total world capacity, pumped hydro accounts for well over 90% of the installed facilities.  Most of the global pumped-storage hydropower capacity caters for applications such as energy management, frequency control and provision of reserve.

Utilities manage in front of the meter storage, especially to manage their large assets of generation capacity. But the various other uses of storage for voltage management, frequency control especially with increasing penetration of DERs are matters which are still being discussed and debated. More detail in the last section on grid-forming technologies.

Pricing

Electricity prices are dependent on many factors, such as the price of power generation, government taxes or subsidies, CO2 taxes local weather patterns, transmission and distribution infrastructure, and multi-tiered industry regulation. The pricing or tariffs can also differ depending on the customer-base, typically by residential, commercial, and industrial connections.

Electricity prices generally reflect the cost to build, finance, maintain, and operate power plants and the electricity grid. Where pricing forecasting is the method by which a generator, a utility company, or a large industrial consumer can predict the wholesale prices of electricity with reasonable accuracy. Due to the complications of electricity generation, the cost to supply electricity varies minute by minute.

U.S. consumers pay substantially less than their counterparts in developed nations. The service is usually more reliable. A number of emerging societal and technological changes are challenging the infrastructure that is required to provide electricity service to virtually every household in the United States and the utility business models developed in the 20th century to own and operate electricity systems. The declining cost of DERs and climate change mitigation, among other trends, have created challenges for the management of the electric grid. Consumers in the US pay a flat price (retail) to protect them from price shocks, although the utilities may have to pay significantly higher price to meet peak demands during inclement weather or special occasions. Most notably, Texas does not have the protection mechanism and witnessed a disastrous impact last winter.

Many argue that dynamic pricing is fair way to fairly assess the consumer. There have been scholarly debates that automation would remove some of the “mystery” of constantly varying prices; however, the majority of the consumers seem skeptical in the implementation.

Grid-Forming vs Grid Following

Managing the stability of electric power systems is based on vast experience with large, synchronous generators, the industry workhorses for over a century. Today’s electric power systems have increasing numbers of renewable sources, such as wind and solar power, as well as energy storage devices, such as batteries. In addition to the variable nature of some renewable generation, many of these resources are connected to the power system through electronic power inverters.

The operation of future power systems must be based on the physical properties and control responses of traditional large, synchronous turbine generators as well as inverter-based resources.

Most inverter controllers today are grid-following and built on the assumption that system voltage and frequency are regulated by inertial sources. Such control approaches cannot guarantee system stability in low-inertia setting and are unlikely to sustain an inverter-dominated infrastructure. This limitation has inspired an investigation into grid-forming control methods for power electronic inverters, which provide functionalities that are traditionally provided by synchronous machinery.

One of the most exciting area of research is the management of the grid, especially the distribution management systems. As DER resources proliferate behind the meter, there are two schools of thought: grid-following inverters versus grid-forming inverters. Grid-following inverters synchronize to the grid voltage waveform, adjusting their output to track an external voltage reference.  Grid-forming inverters set their own internal voltage waveform reference and can synchronize with the grid or operate independently of other generation. Grid-forming inverters with a firm energy source behind them may be able to replace many of the capabilities historically provided by synchronous generators.

Examining these developments deeper provides a snapshot of the possible financial tug of wars that may ensue. Grid-following control could lead to undesirable outcomes; grid-forming on the other hand would be more desirable but it distances the role of the utility in establishing grid control.

This is no doubt going to be a development that could impact the financial sustainability of utilities.

Acknowledgements

Many thanks for interesting discussions over the years with my colleagues at TVA, EPRI, and various utilities around the world. Special thanks to Andrew Kosnaski, formerly with TVA now with Exelon.; Bob Irvin, formerly with Duke Energy and TVA now with Joules Accelerator; Anda Ray. formerly with TVA and EPRI; Revis James, formerly with NEI and EPRI; Jeremy Platt and Dale Gray, formerly with EPRI, and Deepak Ramasubramanian, EPRI


[1] Bonbright, James, “The Principles of Public Utility Rates”. 1961

[2] US Department of Energy, Energy Information Agency. Electricity in the U.S. - U.S. Energy Information Administration (EIA)

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Matt Chester's picture
Matt Chester on Feb 23, 2022

Agreed on the importance of all these shifts, Rudy. As a customer, I find that I typically want more of these than my utility is providing at this time-- have you seen success in pressuring utilities towards such programs coming from the customer side in the past? 

Rudy Shankar's picture
Rudy Shankar on Feb 24, 2022

Yes, customers are asserting the rights and the power of the internet makes it possible for ordinary citizens to overturn a decision made by a utility. About 10 years ago customers at a major southern utility preferred to substitute a PUC-backed natural gas generation capacity with solar technology. The coming years are going to see intense electrification and utilities must have a path to recover their investment. Innovation is not directly rewarded as much as high grid reliability and low customer complaints under present rules.

Two diverse examples of innovations come to mind. Smart wires was invented based on some early work at EPRI which led to power control applications to improve transmission efficiency. Big money saver to utilities, but not visible to customers. And then you have smart meters that not only do not require meter readers to come periodically to your residence, but is the hub for managing the grid edge enabling and controlling solar on roof tops, your EV charger and managing your energy storage asset. This is more visible to the customer.

Barry Cinnamon's picture
Barry Cinnamon on Mar 1, 2022

Hi Rudy - good overview from a utility's perspective. But customers now have options for self-generation and storage that are much cheaper than utility sources. What flabbergasts me is the rapid increase in homeowner electric rates in California. These rates went up 11% in 2021 and 10% in 2022, with more increases announced. Coupled with inflationary and grid unreliability pressures, I expect rates to continue to rise at a 10% rate through the end of the decade. The utility business model will collapse when consumers see that retail electric rates are 5x more expensive than their own self-generated and stored power.

Rudy Shankar's picture
Rudy Shankar on Mar 1, 2022

Thanks for your comments, Barry. Yes, I agree that customers have many options in self generation and storage. EVs are going to further revolutionize our lives: easier to maitain and fuel cost-- even with CA electricity rates-- less than $1 per equivalent gallon. But we must continue to supporting diverse generation to minimize risks since no one-form of generation is a siver bullet. Perhaps in the distant future nuclear fusion could be that. The grid must be maintained, modernized and made resilient. It is the "last resort" for delivery, even as customer choices expand. The customer price of electricity should be transparent and include the infrastructure costs. 

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