Why Smart Grid Advocates Should Learn About Utility Regulation

But as we have talked about Smart Grid in the region, it has become apparent that many Smart Grid advocates don't understand the current regulated electric system. They don't understand how we analyze utility investments or how prices are set. They don't understand the incentives provided to utilities or protections required by customers. Put simply, they don't understand the "regulatory compact" between customers and utilities.

The Smart Grid has the potential to change our electricity system in fundamental ways. But to effectively create positive change, it's necessary to understand the present. I, like our current President, worked as an organizer after college and think one of Sal Alinsky's rules for organizing is important to keep in mind anytime we are talking about fundamental change:

As an organizer I start where the world is, as it is, not as I would like it to be. That we accept the world as it is does not in any sense weaken our desire to change it into what we believe it should be -- it is necessary to begin where the world is if we are going to change it to what we think it should be.

In the Pacific Northwest, we rejected the Enron-sponsored deregulation proposals a decade ago. This means that we have integrated monopolistic utilities that are regulated by the states' regulatory agencies or are accountable to locally-elected Boards. Regulators and local Boards have the responsibility to protect customers from monopoly abuses and get power at just, reasonable, and affordable rates. And that regulation is subject to legal requirements and historic policies and principles. Some of the key elements applicable to the Smart Grid:

1. Rate Base as an Incentive for Investment. The current structure of regulation for investor-owned utilities was developed in order to incent long-term capital investment. Building power plants, transmission systems, and distribution networks cost billions of dollars. The current system is designed to encourage capital investment by providing a utility with a return on invested capital-utility profits come from investing in power facilities, not directly from the selling of kilowatt hours.

2. Utilities can generally only charge customers for investments that are "used and useful" for providing utility service. It may take a utility more than a year to build a power plant or construct a transmission line, but it cannot put those costs into rates until the asset is up and running. Likewise, utilities are generally discouraged from keeping assets in rates after those assets stop providing service.

Other important principles in understanding the regulatory system that guides investor-owned utilities include:

1. Cost-based Rates are Required. Rates are based on actual utility costs of providing service, not the marginal cost of power in the marketplace. While some Smart Grid proponents would like customers to be subject to the marginal costs of the marketplace in order to create an incentive for customers to purchase smart appliances and Home Energy Applications of the Smart Grid, Oregon law requires rates based on the utility's actual costs.

2. Regulatory Compact. As utilities make investments on behalf of customers, customers pay the utility the cost of that investment plus a reasonable rate of return. That is all to which the utility is entitled. The asset itself becomes dedicated to customers for its useful life. In many respects, utility customers are buying the actual system from the utility and as we pay off the rate base (mortgage) on each asset that asset belongs to us and is dedicated to us. We are owners of the electrical system, not renters.

There are clearly Smart Grid advocates who disagree with each of these principles. Some argue that investments should not be made by a utility because that will interfere with the competitive market. Others argue that utilities should be allowed to invest in Research and Development that will not necessarily be used and useful. And some believe that rates should be based on the marginal costs of new generation, not the depreciated costs of decades old hydro facilities.

While regulatory principles are important elements in protecting consumers, some identify them as roadblocks to the future development of a Smart Grid. Regardless of whether you agree that these principles are necessary structures that protect customers or see them as roadblocks which prevent new technology integration, they do exist and are integral to the regulation of utilities in this region. And whether you want to build on them or tear them down, stakeholders in the Smart Grid conversation must acknowledge that they are currently there and plan to deal with them.

I think one statement in the article sheds much light on everything related to R&D and commercialization of Smart Grid technologies:

"Others argue that utilities should be allowed to invest in Research and Development that will not necessarily be used and useful."

It's hard to believe any proponent of Smart Grid technology would suggest that R&D invested in implementing their technology would result in it not being used or useful. Such thinking is self defeating because it if you openly admit your new technology is not likely to be used or be useful, you won't be able to sell it very effectively.

In the private sector, business invests in R&D of new technology and new products fully understanding that there is commercial risk involved but at the same time believes that the outcome will be a used and useful technology that is by extension commercially successful. In reality it is gambling that their new stuff will be commercially successful, i.e. that it will sell sufficiently to make a profit over time.

The sobering truth however about private sector R&D is that for every successful outcome, there are multiple commercial failures along the way since there are (usually) multiple R&D efforts competing for the same market application. It is clear from this article here that this sobering reality is unacceptable to the current “regulatory compact” between customers and electric utility companies since every "investment" made by utility companies must by definition result in a used and useful asset that customers pay for and eventually OWN over time through rate base increases.

In essence the current regulatory regime will only allow low- or non-risk investments in anything that will be applicable to all customers as a grid asset. But many Smart Grid technologies are deemed as very risky given much of it has not been proven for its usefulness or economic benefit to customers, and so some are guaranteed to end up as commercial failures.

Our utilities are therefore paralyzed by regulation, because we have the classic chicken-and-egg problem for utilities. They are discouraged, even prevented, from investing in R&D of Smart Grid technologies, and then later recovering its development and deployment costs through rate increases, UNLESS the end result is known beforehand to be a used and useful grid asset for all its customers.

Until regulation changes that will allow utility companies to take more commercial risks in their investments, Smart Grid is destined to evolve and be commercialized at a snail’s pace relative to new technologies in other industries.

Smart Grid might evolve faster if competition for utility companies were to emerge that forced utilities to make riskier investments in Smart Grid for their own survival. The emerging competition is the rolling out of widespread distributed micro-generation from renewable sources, permitting over time an increasing number of customers to unplug from the grid either part-time or completely, and has already started to happen.

There may be scope to develop an enhancement to smart grid whereby potential off-peak customers may use some type of programming to advise their willingness to accept excess off-peak power, according to availability.l

The TOU rates are designed so that on average the total revenue collected keeps all the generators profitable. But the ratio of on-peak to off-peak TOU rates are much less that the ratio of highs to lows of real-time grid wholesale prices experienced by generators over the course of 24hours.

As Harry alludes to above, many types customers simply cannot (easily) load shift their consumption habits to avoid on-peak rates. Using some form of storage is one solution to avoid them. Exposing these types of customers to real-time grid prices instead of TOU rates would save them even more money because the real-time grid prices are typically much lower than TOU billing off-peak rates at night.

Exposing some but and not all customers to real-time grid prices is in theory feasible using the smart meter infrastructure. In practice however it complicates the meter infrastructure and billing software substantially. Utilities prefer to bill everyone uniformly because regulators insist they do so, and because of added costs of tailoring billing to individual customers.

Presently there are some large industrial customers permitted to use real-time grid prices, but these customers communicate with the grid system operator and real-time pricing data using SEPARATE communications from the smart metering infrastructure, with additional hardware set up on the customer’s site to handle it. Sounds dumb I will admit, but utilities won’t upgrade their smart metering systems to handle real-time pricing and individualized billing unless regulators or the government give them some means of recovering their added costs.

A genuine open competitive market for all customers is the only solution in the long term. Regulated monopoly for end-distribution, and a free market for T&D, managed by the smart meter network is the only solution. Anything else is dream-world.

Here's another example of how utility companies view Smart Grid “investing”.

Here in Ontario our local utilities are distribution-only entities (generation and transmission are owned by separate companies). Our local utilities have known about various real-time in-home display products for many years now. Many of the latest designs can communicate directly with various smart meter infrastructures now deployed throughout Ontario. A handful of pilot tests of the newest display products were implemented this year among our larger utility companies, but only when the Ontario government provided funding for pilot testing them (through its agency the Ontario Power Authority). The utilities wouldn't have implemented them without this funding.

Following these pilot test projects, future wide-scale deployment of ANY of these display products to all of a utility's customers will be predicated on massive government handouts to pay for them all. There is no way the utilities are going to pay for them out of their own pockets, and moreover they have no appetite to apply to regulators for rate increases to pay for them.

One point I'd take issue with is the notion that consumers "own" utility assets. Not true for investor-owned utilities, which raise private capital to build these assets. The regulatory compact allows regulators to limit returns on those assets, but claiming consumers own them is stretching a point.

Smart Grid applications that touch customers directly, such as distributed generation, distributed storage and demand response, typically don't make economic sense in a cost-of-service environment. Why? Because their incremental costs can't compete with utility prices based on the depreciated book value of a portfolio of assets, some of which were built at significantly lower historical costs. Commercial building owners won't install thermal storage unless the on/off-peak price differentials are large enough to justify a large capital investment, and in most cases the differentials are far too narrow.

All this means regulators will have to choose between ironclad assurances that consumers will have access to all of the affordable electricity they want, and embarking on a different path that treats electricity as a scarce resource and Smart Grid initiatives as the means for managing that scarcity. In most cases, regulators have, in fact, made the choice by default. The notion of a Smart Grid is likely to be just another passing fancy.

Jack Ellis, Tahoe City, CA

A small point -- I do not agree that "actual cost" is necessarily incompatible with the concept of charging "marginal cost." Actual cost is time variable due to underlying changes in the cost of operating the system at peak and non-peak periods -- the actual cost of fuel, for example, changes as more expensive units come on or off line. To use the example above, the coffee shop that runs its kitchen equipment full out during the morning rush and then shuts down at night would be incurring disproportionately more actual cost than an all-night convenience store with identical energy usage over a given billing cycle (but you knew that). To the extent that rate design cannot capture this time disparity, an intraclass rate subsidy exists.

ROMed systems may be a bad idea.

And so iare buggy C/ asesmbler implementations too, ino.

'embedded controller forth for the 8051 family'

And you may be hit with hacking too?

I must agree with Jack. Sad but true.

Consider what might happen if electricity did become a scarcer resource, with threats of brown outs or rotating black outs. The backlash from the public would force political leaders to act, and their historically easier solution would be to simply build out the grid with more capacity.

Things may not be so easy however if electric vehicles become widely used to replace some of our oil consumption. The extra demand on the grid from millions of vehicle batteries recharging at random times throughout the day would require potentially huge increases in peak generation capacities, and in local distribution capacities. The cost of increasing these or alternatively the cost of implementing Smart Grid to manage the demand will be tough pills to swallow for the politicians, and we the taxpayers.

Nobody wants to deal with more technology and more information if it is not for entertainment purposes, since we live in a world of information overload already. So I must also agree with Kenneth above.

The public may not have a choice however for the reasons I mention above regarding electric vehicles and the potential for Smart Grid as a means to manage them.