A new business model for the electricity sector

The recent ruling by the Supreme Court to suspend Environmental Protection Agency regulations on mercury emissions from coal-fired power plants is being hailed by some EPA critics, but the decision will have little effect on long-term movement away from coal in the industry. For one thing, the vast majority of U.S. coal plants have already complied with the regulations; others are turning to cheaper natural gas and renewables.

Likewise, standards due from the EPA this summer to reduce carbon emissions from existing U.S. power plants have prompted concerns that the rules will raise costs and reduce reliability. These concerns have in fact been put to rest by a number of recent independent studies.

{mosads}More fundamentally, however, critics of the administration’s Clean Power Plan fail to acknowledge a basic reality: The electricity sector is already in the midst of profound change, with new technological and market forces challenging utilities’ business models. These technology developments will help de-carbonize the utility sector at a very low cost, and at the same time increase reliability — but only if utilities rethink their business model, which in turn requires that states’ utility regulations are reformed.

For a century, America’s electric utilities developed as an ever-growing network of wires, fed by ever-larger power plants, meeting ever-increasing electricity demand. But that recipe is being supplanted. Advanced technologies such as LED lights, solid-state motor controls and super-efficient buildings and houses are slashing energy demand. Renewable energy is displacing the old mainstays of coal and gas by becoming the cheapest power source available, with solar prices down 80 percent in five years and wind down nearly 40 percent between 2008 and 2013. Electricity storage is growing, as are electric vehicles, though both industries are still embryonic.

Add to these trends the environmental (and legal) imperative to slash carbon pollution and our reliance on aging power plants, and further change has become inevitable. A third of America’s coal-fired power plants are already scheduled for retirement; the rest average 35 years in age and come with an enormous carbon handicap. 

Declining demand, growing expenses, an obsolete capital stock and paltry R&D: These are the daunting prospects facing many of today’s utility CEOs. Industry leaders recognize it’s time for a new utility business model, and with it, a new approach to utility regulation. More than half of 400 utility executives said they’d prefer a new regulatory model in a recent industry poll.

So what does a utility of the future look like? 

We know America’s electricity supply is rapidly de-carbonizing. Renewables generated 13 percent of national power supply in 2014, but Iowa got a third of its electricity from renewables this past March. California will hit 50 percent by 2030, and another dozen states, including South Dakota, Oregon, Colorado and Minnesota, are surging ahead. Cleaner electricity will feed increasingly
efficient homes and devices, and these will be increasingly controlled by iPhones, sensors and data centers. Add this all up, and it reveals a new role for utilities: system optimization.

What does that mean? Variable supplies, like wind and solar, require new operating regimes. Most people instinctively think renewables require batteries to keep the lights on when the sun is down or the wind doesn’t blow, but batteries are still expensive. Luckily, it turns out that there are a half-dozen other ways to solve the variable supply problem — answering the criticism of Clean Power Plan opponents who say renewables can’t keep the lights on. 

Consider “demand response,” which cleverly and invisibly matches demand to variable supply. For instance, on hot, windless days in Texas (easily predictable 24 hours in advance), a smart utility could pre-cool buildings using excess electricity in the early morning when demand and costs are low, instead of running the air conditioning full-time in the afternoon when demand is high. This demand response resource turns out to be vast, cheap and largely undetectable by customers. 

Efficiently linking together utility systems through regional energy markets is another effective strategy. Seattle and San Diego rarely share peak demand or peak supply. Proper use of the wires between them would save an estimated $208 million annually and allow more renewables.

We have a whole suite of options to manage the transition to a low-carbon future. But today, no single utility has the mandate to take advantage of them all, and therein lies the great opportunity: Electric utilities are ideally positioned to deploy each option in the most cost-effective manner. 

America can de-carbonize its grid and maintain or improve reliability and do so at the same cost or cheaper than the old system, but it needs utilities reengineered as system optimizers, deploying demand, supply and market strategies in the most efficient combination. This new business model in turn requires different utility regulation. 

Instead of simply rewarding utilities for selling as much power as possible, as we do now, we should incentivize utilities to meet core goals nation-wide: affordability, reliability and a clean environment. Utilities should be given a long-term mandate for these goals by their public regulators and should be rewarded when they exceed the mandates and penalized when they fail. This “performance-based regulation” is a marked departure from simply rewarding utilities with returns on invested capital. 

States hold this regulatory authority, and a number of them, including New York and Minnesota, are moving in this direction. As the Clean Power Plan is implemented, dozens of others could avail themselves of the same opportunity.

The old electricity utility business model is on its way out, and quickly; the Clean Power Plan will simply accelerate this process. Smart utility CEOs and regulators can engineer a replacement business model that rewards making our electricity system affordable, reliable and clean. It is time to have a business that reflects today’s options and imperatives. 

Harvey is CEO of Energy Innovation LLC.