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Rethinking the Grid

Producing electricity with decentralized sources offers advantages for consumers and the environment, but this approach will require some serious structural changes

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No longer business as usual: The growth of electric utilities has made electricity cheap and accessible. But the existing business model, Karl Rábago argues, is both "stodgy and resistant to change." The rapid growth of small solar and wind generating capacity offers a new approach with longterm benefits to consumers.
Image Credit: Wikimedia Commons
No longer business as usual: The growth of electric utilities has made electricity cheap and accessible. But the existing business model, Karl Rábago argues, is both "stodgy and resistant to change." The rapid growth of small solar and wind generating capacity offers a new approach with longterm benefits to consumers.
Image Credit: Wikimedia Commons

Karl R. Rábago is the executive director of the Pace Energy and Climate Center at the Pace University School of Law in White Plains, New York. This blog was originally posted at the website of the Northeast Sustainable Energy Association’s Building Energy conference and is republished here with permission. Rábago is a keynote speaker for the opening of the conference in Boston on March 4, 2015.

For more than 100 years, taxpayers, ratepayers, investors, and policymakers have supported the growth and operations of the electric utility industry. The rate-making formula, under which capital investment is recovered and healthy profits are guaranteed, has helped make electric service in the United States nearly universal and relatively cheap. For much of the last century, the model leveraged increasing economies of scale to enable the provision of electricity as well as profits and dividends.

Along with those benefits come significant costs. The electric utility industry is a major consumer of fossil fuels and a large emitter of greenhouse gases, mercury, and other pollutants. The implicit preference for large plants creates a business culture that is stodgy and resistant to change.

Where the vertically integrated monopoly remains, so do the problems. In states where “deregulation,” more accurately termed restructuring, was undertaken, the problems are almost as bad. While restructuring has produced some benefits by encouraging competition among generators and open access to the wholesale grid, retail service competition has not delivered on the promises with which the concept was originally pitched.

In particular, robust markets for energy efficiency and other clean and distributed energy resource technologies and services have not emerged. These services are still overwhelmingly implemented through public purpose funds and programs, as mandates imposed on distribution utilities. Bringing innovation in distributed energy services to customers, especially residential and small commercial customers, is overdue and will require another round of structural change.

A revolution in scale

Utilities are more insulated from market forces than many other businesses, but they are not immune. Low natural gas prices, for example, have increasingly rendered coal-fired and nuclear generation economically unviable, while public concern over environmental and human health consequences has made these plants hard to site and difficult to permit.

High natural gas prices induce conservation and shifting toward alternative sources of fuel. Nuclear power plants, with their chronic cost overruns and delays, strain the patience of investors and require ever-stronger incentives as well as questionable cost-effectiveness evaluations and contorted resource planning processes. Meanwhile, customers and the buildings they occupy are becoming increasingly energy-efficient. All this weakens growth in revenues at the utility level. Remarkably, the electricity industry is driven overwhelmingly by three key factors, all of which are completely beyond the control of either regulators or utility executives: weather, commodity fuel prices, and general economic conditions.

A new and growing component of market pressure on utilities over the past few decades has been the shift toward smaller, more distributed energy resources and services. As chronicled in Small Is Profitable, published by the Rocky Mountain Institute, right-sized resources offer numerous economic, financial, operational, and engineering benefits for meeting the demand for energy services.

These distributed energy approaches offer modularity, risk-reduction, resiliency, and other benefits now increasingly recognized and monetized by customers and entrepreneurial service providers alike. Growth in clean, distributed energy has not come easy, but many concede that the forces of change in the utility industry are now inevitable.

Challenges to growth

Regulators, policymakers, and industry leaders now speak of the need for another restructuring of the energy industry, with the aim of transforming the sector toward “Utility 2.0,” or the “Utility of the Future.” But several obstacles stand in the way of realizing the full potential of distributed energy services.

Pressure on public benefit funds. Public benefit fund programs always face funding pressure. Electric service providers and suppliers make money from sales or have revenues indexed to throughput, so they are often less than enthusiastic about supporting distributed energy. Policy makers and regulators, especially in restructured states, have few other mechanisms for reducing charges to customers, and face continued pressure to reduce or restrain growth of public benefit funds.

Increasing fixed customer charges. A number of distribution utilities are seeking to change the ratio of fixed and variable charges for their services. Traditionally, customers are charged relatively small “customer charges” designed to recover metering and administrative costs. Other costs are recovered through volumetric charges based on kilowatt-hour usage. Now a number of utilities are seeking to increase fixed charges and thus their revenues. Because fixed costs cannot be avoided by lowering consumption, increases in these costs also increase payback terms for distributed resources, making installation less attractive.

Generation capacity costs. Electric generating capacity reserve margins are extremely high in New York and New England, due largely to a massive growth in natural gas capacity over the past decade or so. This new gas generation creates opportunity for demand-side resources, such as demand-response programs in the winter, when gas supply constraints pose potential problems. But overall, excess capacity and relatively low natural gas prices create strong economic challenges for distributed energy market growth.

Transmission and distribution infrastructure investments. Investments in the transmission and distribution grid comprise a two-edged sword for distributed energy resources. On the one hand, investment at the “Smart Grid 1.0” level, involving advanced metering infrastructure, distribution automation, and other system improvements, is critical to enable value optimization for many distributed energy options, especially demand response and load management.

However, major transmission and distribution investments, especially hardening and some resiliency improvements, compete for scarce capital and create large, unamortized, rate base balances. Some utilities see increased deployment and operation of distributed energy as a threat to timely recovery of these investments.

Attacks on net metering. Most notorious in utility regulatory policy arenas over the past few years are utility industry efforts to abolish or severely undercut net metering for distributed generation, particularly rooftop photovoltaic systems. Championed by the Edison Electric Institute, American Legislative Exchange Council, Americans for Prosperity, and other advocacy groups, the effort to end net metering is taking place in both legislative and regulatory forums. The standard argument is that net metering, which allows self-generation to offset consumption charges at the retail consumption rate, constitutes a subsidy, because the credit is greater than the cost of wholesale power.

The argument continues that because the bill of a net metering customer is lower, the difference constitutes a shortfall in projected revenues for the utility that must be made up on the backs of non-solar customers. These non-solar customers, it is argued, are poor people who the utility can never imagine enjoying solar energy systems.

Cynicism aside, the argument suffers most from the faulty premise that one can assume electricity produced at the point of consumption can never have more value than the wholesale price of electricity. And though a bedrock principle of utility ratemaking is that rates must be founded on cost-of-service studies and objective cost allocation exercises, not one cost-of-service study has yet supported the subsidy argument.

Dozens of valuation studies have been conducted in recent years, most of which support the argument that distributed solar generation is worth more than the retail prices of electricity, and that solar customers who only receive retail rate credit are, in fact, subsidizing other utility customers.

The real issue with distributed resources is that they reduce revenues for utilities and conventional generators in the commodity electricity business model. Distributed generation reduces the need for generation and transmission infrastructure, both today and in the long run. With rapid growth in distributed energy resources due to falling prices and increasing popularity, this emerging trend has been characterized as an existential threat to utilities.

One for one for one: One for all

The gap between where we are and where we must go is daunting. As difficult and expensive as it has been to install open-access wholesale markets, the realization of healthy markets for distributed energy will be exponentially more difficult. In an environment where the scale of solutions required is huge and the political risk associated with even proposing them is formidable, proposals for regulatory reform often lead to only incremental changes.

Pilot programs have demonstrated all that they can. It is time to complete the process of bringing sustainability to the electric utility sector. Three major agenda items pave the way for the transition.

Valuation analysis. The process of transformation should be primed with value-based pricing of distributed energy solutions. Assumptions about subsidies and cross-subsidies in net metering, energy efficiency, and other distributed systems should be flatly rejected in favor of actual analysis of full, long-term benefit and cost analysis. The analysis of the value of solar that began with Small Is Profitable should expand to all the major distributed energy resource categories — solar, savings (efficiency and demand response), storage, security, and smarts.

Rates, charges, and incentives associated with these resources should be based on actual analysis of value to service providers, customers, and society. Once the value of distributed energy resources is understood, regulators can move to create competitive market opportunities for third-party providers of these services from within the current model through local integrated resource planning.

Third-party participation. The utility sector must be aggressively opened to third-party service and technology provider participation, especially in distributed energy service markets. With advances in intelligence and information systems, there is no reason for electric service to remain so dumb and data-poor. The culture of utility management needs an injection of innovative thinking that third-party entrepreneurs can bring. Elements of retail electric service amenable to competitive service should be unbundled and offered up to competitive providers on open-access terms, just as has been done in competitive wholesale markets. This will lead to loss of market share among current big suppliers, but can provide far more value for ratepayers and society. With proper oversight, providing utilities an opportunity to compete fairly for some of that market share can mitigate such adverse impacts.

Performance-based regulation. The utility sector elements that serve customers must move from cost-plus regulation to performance-based regulation. The old system was perfectly designed to encourage over-building of infrastructure and over-consumption of electricity. While the benefits of widespread electrification and economies of both generation and grid infrastructure justified that model for more than half of the last century, it has outlived its usefulness.

The commodity model must be replaced with a service model. Instead of compensating utility service providers based on commodity production and delivery in a model focused on rates, a shift to performance regulation would reward service providers for maintaining grid reliability while helping customers manage their bills. It would also derive maximum energy service value from the most cost-effective blend of supply-and demand-side resources. This shift could align utility and customer interests while securing improved environmental, economic, and equitable performance in the near and long term.

The entire transition process should be structured around a defined system of metrics. The utility sector today is not competitive, and markets are significantly distorted by the lack of meaningful competition among retail electricity service providers. In vertically integrated monopoly systems, fuel prices are still passed directly through to customers. In the restructured markets, the pervasive model is rate competition only, with little focus on service. An intentional path of market structure conversion is essential.

Policy makers should adopt a “one for one for one” transition model: For every new megawatt worth of conventional generation or transmission capacity added to the system, regulators should secure the permanent retirement of one megawatt of existing conventional generation, and the permanent addition of one megawatt of distributed energy resources.

The deal is easy to understand and offers a clear path toward the desired end state of robust distributed energy markets. Regulatory mandates can be relaxed as the market grows. Distributed energy acts as a hedge and price-check on additional investments in conventional resources. The retirement of existing conventional generation prevents significant excess capacity from frustrating transition efforts. The goal is the emergence of a new utility model remarkably reminiscent of the original light company model, but with the benefit of modern technology and competition — the load management utility.

The load management utility

Yogi Berra tells us, “If you don’t know where you are going, you’ll end up someplace else.”

Even with the uncertainty that accompanies a major undertaking like utility restructuring, some effort to visualize a desired end state is an essential first step in the journey. The utility of the future must embrace, not oppose, distributed energy resources. It must thrive on and encourage innovation, internalize environmental responsibility and customer empowerment, and provide a platform for innovation in product and service development. In short, the utility of the future must be the current system turned upside down.

Today’s utility model can be summarized quite briefly: forecast and assume demand, build or acquire supply to fit, and implement demand-side options only to the extent forced to do so. The inverse of this model, or “the utility of the future,” is the load management utility (called the “distribution system platform provider” by the New York Reforming the Energy Vision publication).

The load management utility is an entity operating under performance-based regulation and compensated not on throughput, but on service. Its mission is to manage electricity loads using every distributed resource and technology at its disposal, through third-party partners, using wholesale resources only when all distributed resource options are exhausted.

The load management utility shifts market surplus downstream to customers, as happens with all mature markets. It utilizes a robust, locally integrated resource planning process, and provides transparent price information determining short, medium, and long term planning cost values for marginal distribution capacity and energy.

The performance standards reward optimization of several factors, including short and long-term prices, environmental responsibility, customer satisfaction, grid reliability and service quality standards (especially for service to low-income customers), and minimization of revenue requirement.

The load management utility uses its platform provider role to encourage third-party participation in provision of services rather than to exercise market power, operating essentially as an “independent distribution system operator.” The load management utility operates at the retail level, fully under the oversight of markets and state regulators. Its functions are therefore not wholesale transactions until it buys or sells energy or other services to the wholesale system operator, thus reducing problems associated with bifurcated jurisdictional authority over electricity rates and services.

The load management utility is a vision of what today’s utility distribution service providers can become, for the benefit of the utilities, customers, and society alike. Its incentives align with the best interests of all three, eschewing the sub-optimization inherent in traditional approaches that seek to “balance” economic and environmental concerns, or economic and equity concerns.


The time has come to complete the transformation of the electric utility sector. A deliberate and sustained effort to establish robust markets for distributed energy services is the major remaining step in that process. Policy makers, regulators, and utility leaders must focus first on understanding the value of distributed energy resources of all kinds, creating meaningful opportunities for third-party technology and service providers to participate in competition for marginal energy service dollars, and shifting utility regulation to a performance based model of regulation. In the end, the process can lead to the emergence of the new central feature of electric service — the retail level load management utility.


  1. kevin_in_denver | | #1

    Not Holding My Breath and Heading Off Grid
    "The time has come to complete the transformation of the electric utility sector. "

    In my 38 years of following the Colorado electric utility sector, I haven't seen them make any sensible changes on their own. For example, Xcel was forced into net metering by a popular vote, and now they want out of it. So I don't expect this sector to get intelligent any time soon.

    It's a perverse market after all, a monopoly provider "regulated" by a PUC with an unclear agenda and no real leadership.

    To me, as an infill new home builder, it's pretty obvious which direction I will take as soon as retail net metering goes away.

    1. Install a large, steeply tilted PV array with battery storage. Cheap, longer lasting batteries are becoming more available.

    2. Install a 3kw automatic natural gas generator for electric backup. (I'm betting that natural gas will remain cheap.)

    3. Install a minisplit downstairs ($2k-$3k) and a 26" through-the-wall (TTW) air conditioner($400) in the upstairs hallway.

    4. Install a small direct vent natural gas fireplace for backup heat or ambiance. ($1200)

    With this recipe, I can stop following the electric utility sector and grinding my teeth like Mr. Rabago here.

  2. Expert Member
    Dana Dorsett | | #2

    co-generate with that generator!
    If gas is going to be cheap forever in your neighborhood, a 3-5kw micro co-generator will be more valuable than just a 3kw backup generator for when your batteries crap out, or you go through a dark cold winter week with snow on your panels. Running a 3kw generator to keep your mini-split running is silly- it runs at ~20% thermal efficiency as a generator, but a co-generator could be running ~70-80% efficiency just as a space heater (while throwing the electricity away), and 90%+ if you're using both the power and the heat.

    But Xcel won't stay in business very long if it becomes economic to execute on your plan. It doesn't take a more than a trickle of true grid-defection to drive their revenues even further into the dirt, forcing them to raise rates to cover their fixed cost, and start what has become known in the biz & related blogs as the "utility death spiral". Most utilities understand those implications, and their regulators SURELY will by the time it gains any traction. In both Hawaii and Australia there are businesses already selling grid-defection kits to a small but growing group. In HI the HECO utility basically went bankrupt on their lack of foresight on managing distributed generation, and have been bought out by another investor owned utility (at fire-sale price, well below the $6-7B price offered by a group of investment bankers with a distributed energy plan less than five years ago.) The western Australian grid operators are on the brink too, unless they can get the state to subsidize retirement their no longer need excess coal plant capacity. Utilities in Germany that learned too late have also succumbed.

    Don't believe for an instant that the board at Xcel isn't aware of just how quickly that can happen. No matter how incestuous the relationship between the regulated & regulators are at the state level, when it becomes cost-effective to defect from the grid, they're all screwed. They know it, and they see it coming- the best they can do by tinkering around the edges would be to forestall the inevitable. The massive top to bottom regulatory reform currently under way in NY is a big experiment, but the outcome there will likely guide reforms in other states.

  3. Expert Member
    Dana Dorsett | | #3

    Oh yeah- and...
    ...the solar industry isn't going to just roll over and cry themselves to sleep when the utilities demand too much either:

    Demand charges are one thing, demand charges well in excess of actual infrastructure cost, or demand charges only applied to PV customers are another.

    Nobody ever said the transition was going to be easy or a bump-free ride, even if the transition IS inevitable.

  4. kevin_in_denver | | #4

    Leaving Xcel's Electricity in the Dust
    "Running a 3kw generator to keep your mini-split running is silly"
    I agree. Hence:
    "4. Install a small direct vent natural gas fireplace for backup heat or ambiance. ($1200) "

    That's way cheaper than a co-gen and the hydronic heat distribution associated with it.

  5. kevin_in_denver | | #5

    Don't underestimate how stupid Xcel is
    "Don't believe for an instant that the board at Xcel isn't aware of just how quickly that can happen"

    Remember, these are the same people that self-sabotaged Boulder's Smart Grid City. Definitely NOT the smartest guys in the room. But as I said above, they have never had incentives to be smart.

    The City of Boulder was so pissed that they fired Xcel and are running them out of town. They even believe they can CONDEMN Xcel's assets and take them. I love it!

  6. user-3549882 | | #6

    Rethinking the Grid, a familiar topic
    Mr. Rabago is a man of many words. I also. His point of view is clear. His idea includes "complete transformation". I've come to be cautious when I hear these words.

    PV is pretty simple to me. I like the idea of sunlight producing electricity. It's clean, widely available, and a successful, established technology. It just works and the economics are trending favorably. You don't have to call anyone and ask for permission. Well, after you get all of the necessary approvals for the installation.

    As long as the PV owner is actually using the electricity being generated, there are no issues (at least none I can bring to mind). It's when the PV owner wants to sell surplus electricity to me that I get suspicious and dubious of lengthy arguments. I also reach to cover my wallet when I hear things like: "desired end point", "Utilities are the problem", "public benefits", "valuation", "third-party service", and "one for one transition model", as examples.

    No one has asked me how I think the grid should work but I'd start with an appreciation of all they do on a daily basis and all they've done to get us this far. I'd also say the grid should continue to evolve as better models and technologies emerge. After that, I'd say take the surplus electricity from PV or wind or green whatever and create a market for possible sale back to the grid. The market could be managed by the Utility or anyone else, as long as it's a free market. The price offered for third-party generation would vary, sort of like the BID and ASKED price mechanism for OTC stocks. If a PV supplier doesn't like the price, no electricity flows. This way, there's no need for "valuation calculations". The best way I know to test a proper valuation is to subject it to the decision making of a willing buyer and seller. In addition, a customer might be able to specify whether they want plain vanilla electricity or green only. If it's green only, the Utility would have a demand input and this would cause them to bid higher for third-party generated green electricity and/or operate their own PV (green) to satisfy the demand. Of course, if there is a subset market for green power, then those who supply it would have responsibilities similar to those currently carried by the Utility. Failure to perform would have a penalty because someone has to supply the green electricity or suffer the consequences. Also, presumably a green supplier who occasionally draws from the grid during cold, cloudy days might be subjected to a tailored rate structure for these circumstances because at that point they are no longer a supplier but an unpredictable consumer.

    Something like the market model would make the buying and selling decisions of green electricity also DISTRIBUTED. The Utility should be able to adapt to this new game as the grid already has provisions for market-like interactions from multiple and geographically diverse producers. The reaction of PV owners would probably be negative in the short run but mildly positive longer term. Those seeing it more negatively might check to see if they aren't relying on some sort of political issue and supporting argument.

    Whatever we decide to do, I expect a reasonable price and reliable supply for electric power wherever the grid goes. I'd like for the power produced and to be environmentally responsible and, as an example, I have no doubt that green energy will continue to grow in market share, even if we continue for a while to stumble along with the archaic grid rules of the past. Meanwhile, energy efficiency improvement projects complement the gains from green generation.

  7. exeric | | #7

    If it sounds too good to be true then it probably is
    For those who think a completely deregulated, market operation will work then I suggest watching the movie "The smartest guys in the room, The Enron story". There are ALWAYS people who can game the system and the less regulated it is the more that will happen. This idea of split second market pricing and valuation smells suspiciously like what Enron gamed California with. The people controlling the big pipes, i.e. the utilities, will be under tremendous temptation to manipulate "need" and "surplus". I always think that people who completely trust market forces to come to proper valuations just don't understand human nature. Or else they do understand it and are the ones inflicting the manipulation.

  8. Expert Member
    Dana Dorsett | | #8

    As if...
    Eric: As if the NY reformers aren't painfully aware of Enron shenanigans & Wall Street system gamer types... !?!

    Their reformed model is very much like an "internet of power trading", with willing buyers & sellers, but it's still a regulated market. The grid operator (NY-ISO isn't in the power generation biz, and even at the local grid level grid operations will become further disentangled with independent power management companies and independent of power generation companies. The grid management companies are compensated for their ability to keep it running smoothly at the lowest cost, which will sometimes mean subsidizing distributed power generation installation on capacity limited feeders & substations when it's cheaper than upgrading the capacity of those assets (something disallowed under prior regulations, where any subsidies to rate payers had to be subsidized equally, independent of their location on the grid.)

    MANY states currently have decoupled utility profits from kwh sales, and allow a variety of different types of power purchase agreements between suppliers and users. Sun Edison developed an entire business model around power purchase agreements for homeowners who allowed them to put company owned & operated PV on their roofs (and has recently become the largest PV installer in the world, mostly outside of the US.)

    Utilities will still be regulated, but vertically integrated monopolies managed by regulators (who of course can never be gamed, conned, or influenced by the monopoly) has proven to be too crude a model.

    Kevin: Past & current behaviors and decisions notwithstanding, Xcel is further along the distributed renewables learning curve than most US utilities, amazing as that may seem. It's definitely going to be a rough ride, but the transition has passed a tipping point- it's now unstoppable. I'm giving Xcel better than 50% odds of survival, which is more than I'm giving most investor owned utilities. Georgia Power (a vertically integrated state-wide monopoly) has maybe 25% odds of making it to 2030, unless they can somehow write-down their stake in the Vogtle nuclear plant construction without sticking their ratepayers with the bill. (Oh yeah, it's already ON their bill, years in advance of even loading the fuel rods for the initial testing.) The new Vogtle nuke makes even less sense than the Moorsburg combined cycle coal plant in Hamburg ( ). GP's grip on their regulators is weakening- everybody from the Tea Party to the Green Party is pushing back, but the end game is anything but clear. They seem even more ostrich-like than HECO was before they hit the wall- overconfident in their own view, bolstered (perhaps too much) by the assent of their regulators.

  9. krrabago | | #9

    Thanks - Keep 'em coming!
    There is no great praise to a blogger than to have introduced a topic that engenders robust discussion. Thanks!

  10. exeric | | #10

    Dana, I was reacting to WD's comment
    Dana, I was reacting to WD's statement, "Those seeing it [market pricing for PV owners] more negatively might check to see if they aren't relying on some sort of political issue and supporting argument. "

    I'm saying, yes, I checked and it doesn't come from a political issue but from a real experience that happened to all of us in my state only 15 years ago. It caused real hardship for a great many people here and those with short memories are doomed to repeat it. Those who are saying it's different this time because it's localized PV rather than natural gas pipelines to electricity generating power plants seem to me to be seeing things through rose colored glasses. People tend to see what they want to see and if they do not experience it themselves then they just don't believe the experiences of others like me. Instead they say "this time its different".

  11. Expert Member
    Dana Dorsett | | #11

    Almost on cue...
    This bit o' bloggery comes up discussion how the issues surrounding New Yorks proposed regulatory changes are shaping up:

    Yes, it really is different this time, in so many ways it's hard to articulate. That's why there is an ongoing and seriously debated discussion period, with many stake holders weighing in.

  12. exeric | | #12

    I hope it succeeds
    Often when these paradigm change moments occur what happens is that the baby gets thrown out with the bath water. In California's case we really bought into the fact that market pricing will create unimaginable efficiencies and that the market is always right. There are still backward types who actually believe that despite Enron and the 2008 financial debacle. Some people cannot be taught that regulation is required to set up bounds within which markets operate. Otherwise the Gordon Gecko types take over.

    I really hope that the New York example is different. However, I've seen so much ignorance in believing this unfettered market philosophy in my lifetime that it's hard to believe they actually have "got" it. If they have finally got it then I applaud them. If they haven't, and it's really hard to know ahead of time, then woe to New York.

  13. exeric | | #13

    Let someone else be the guiney pig
    I should add that whatever the outcome I'm glad some other state is letting it all hang out this time, and not us. Whew!!!

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