Electric Industry Transformation: Pathway to the “Grid of Grids”
Senior Fellow, ISE
President, Future Energy Advisors
Most observers of the electricity industry agree that the electric utility as we have come to know it is destined for major change, driven by environmental imperatives and technology advancements.
However, while there is some agreement on what the ideal “utility of the future” will look like, there is less consensus on the pace or pathway of the transition from what exists today.
The Evolving Utility Landscape
Decades from now, in an ideal world, electricity will be mostly, if not completely, generated by zero-carbon sources. To ensure resilience and compensate for the intermittency of solar and wind generation, large volumes of energy storage will be added to the electricity system.
The historical reliance on electricity generated remotely at large power plants and transmitted long distances to buildings in cities will be turned on its head. A growing share of electricity will be produced by an expanding variety of distributed energy resources (DER)—including rooftop photovoltaics and other forms of distributed generation, as well as energy storage assets that include grid-connected electric vehicles—located locally on customer premises. The bulk power grid will be utilized mainly for interregional balancing.
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The local distribution utility will cease being a mere delivery conduit for electricity, instead becoming a coordinating platform that enables and supports transactions between customers, some of whom will be selling excess power from their DER devices at certain times. Unlike today, where electricity travels “one way”—from power plant through the wires to customers—electricity flows will be bi-directional and always changing, implying growing needs for local balancing by the operator of the distribution network.
For resilience, many customers will be able to “island” themselves from the grid, becoming self-reliant as necessary. This means that the electricity distribution network will be able to instantly disassociate itself into pieces and recombine as needed to handle disruptions.
To manage this greatly increased degree of operational and transactional complexity, a massive reconfiguration of communications and control systems will be necessary. Augmenting the present collage of legacy closed-network analog approaches, digitization of the grid will occur by overlaying a set of cloud-based optimization and command services—some of which will be based on predictive analytics or enabled by blockchain—that enable instant seamless coordination among and between any and all parties that are connected to the grid.
In sum, this ideal future can be characterized as the “grid of grids” (GoG). Physically, what is now one unified network will become a collection of smaller networks that can operate in concert or independently as needed. The physical infrastructure will be accompanied by a virtual lattice, a cybersecure subset of the Internet of Things, that enables dynamic reconfiguring to both maintain reliability and minimize total costs of electricity service to customers.
The Gap Between Present and Future
“Unless (and until) a host of institutions upon which the electricity industry is currently founded are transformed, the investments necessary to fund the transformation to the ‘Grid of Grids’ will be stymied.”
Obviously, achieving this GoG future vision would entail a massive investment, probably on the order of trillions of dollars in the U.S. alone, to both (1) add the necessary renewable energy and energy storage assets to achieve zero-carbon resilience and (2) update or replace old equipment on existing transmission and distribution networks with modern variants.
Mobilizing staggering amounts of capital and building the GoG is a daunting prospect to accomplish in a relatively short period of time. The good news is that global financial markets are vast, and are hungry for good investment opportunities and can direct such funding relatively quickly—under the one very important proviso that the risk/reward profile is sufficiently attractive.
And therein lies the rub. Attracting the trillions of dollars necessary to fund the transition will require restructuring the playing field within the electricity industry in which revenues are generated and redefining the roles of players in the sector so that their responsibilities and risks are appropriately aligned. In turn, this means overthrowing a status quo between a lengthy list of entrenched and cautious stakeholders—especially utilities and regulators—averse to such major changes.
Unless (and until) a host of institutions upon which the electricity industry is currently founded are transformed, the investments necessary to fund the transformation to the ‘Grid of Grids’ will be stymied.
Economic Pressures Will Drive Change
“Just as telephone service has transitioned over the past three decades from per-minute charges to fixed monthly contracts, it is plausible to expect electricity service to experience a similar evolution in transitioning to the GoG.”
While politics and personalities always impede institutional changes of this type, the impersonal forces of economics are mighty strong. The inequities and opportunities associated with mismatches between prices and costs will create arbitrage opportunities and frustrations for those who pay too much and subsidize those who pay too little. Eventually, these economic mismatches become strong enough to erode resistance to change—especially as they intensify and become glaringly apparent.
Even though the GoG is still many years away, the economic pressures driving the transition towards it are already building.
Note that electricity has historically been priced with a significant per-kWh “energy” charge. In the case of most residential customers, the monthly electricity bill is mostly a straightforward multiplication of the amount of electricity consumed times the price of electricity.
For most of the history of the industry, this retail pricing philosophy was sensible, because the variable cost of electricity generation was significantly more than zero: each incremental kWh sold required another fraction of a pound of coal to be burned. Accordingly, especially for small residential customers, it was most cost-efficient to install inexpensive electricity meters that simply counted the number of kWhs consumed, and then later bill customers based on their indicated quantity of consumption.
Alas, in the GoG based on renewable (mostly solar) electricity and storage, the variable cost of electricity in the GoG will be nearly zero. Consequently, the logical foundation for per-kWh electricity pricing to customers mostly disappears.
Just as telephone service has transitioned over the past three decades from per-minute charges to fixed monthly contracts, it is plausible to expect electricity service to experience a similar evolution in transitioning to the GoG.
Even though retail pricing of electricity to customers hasn’t yet migrated to the new paradigm, those parties that currently own or operate electricity generation assets are already experiencing considerable financial stress.
For many wholesale power markets, in which generation assets are compensated for their services, a sizable influx of renewable energy projects—generally driven by policy prescriptions such as renewable portfolio standards, and more recently corporate elective purchases of power from renewable sources—has substantially depressed market-clearing prices for energy. These price declines have been sufficiently large to make it unprofitable to continue operating many existing power plants, particularly coal and nuclear, driving them out of the market into retirement.
In essence, the wholesale markets are beginning to exhibit the eventual outcome for retail electricity prices: the variable component is falling dramatically: often to near-zero, sometimes to zero, occasionally even below zero. As a result, cost recovery and opportunity for return on investment must increasingly come from fixed charges.
In the case of participants in wholesale power markets, this means greater reliance on capacity markets rather than energy markets for revenue generation. And yet, at least to date, capacity markets have generally produced low prices and consequently only-modest potential revenues.
No Clear Pathway, But A Clear Direction
While the exact pathway to the GoG is unclear, the general route is unambiguous: a set of institutional changes involving new roles and new responsibilities—and, most importantly, new pricing structures probably involving new definitions of products and services in the provision and delivery of electricity.
Because institutions are deeply steeped in history and legacy, they will generally resist the required changes. Alas, the economic misalignments will eventually become sufficiently strong that electricity customers will insist upon required reforms—or else.
The alternative would be for a growing number of customers to “cut the cord” and become self-reliant on ever-more-economic DERs, the so-called “death spiral” that the utility industry has long feared. Not only would this be a bad outcome for electric utilities, but also to society: otherwise valuable electricity grid infrastructure would be prematurely abandoned, and excessive capital investments would be incurred as customers go “off-grid” unnecessarily.
Richard Stuebi, a non-resident senior fellow at the Institute for Sustainable Energy, is founder and President of Future Energy Advisors (FEA), a management consulting practice providing advisory services to corporate clients pursuing innovative growth strategies related to energy. Prior to founding FEA, Richard was Vice President, US Strategy & Group Technology at National Grid.