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A Low-Carbon Electricity System Roadmap

21 October 2014

This article is adapted from the following, with the author’s permission: Nelson (2014), Roadmap to a Low Carbon Electricity System in the U.S. and Europe.

For more than a century, reliable electricity has underpinned the modern economy. In the 21st century, the electricity system will be even more important as it will deliver more of our energy needs and reduce carbon emissions through low-carbon energy supplies. However, the growth of low-carbon technologies is a long-term trend that threatens the viability of the industry as it is currently structured, by curtailing demand growth, introducing new sources of competition, and increasing the cost and technical difficulty of serving the demand that remains to be met by the large incumbent utilities. An effective and economical transition to a low-carbon electricity system requires change across every electricity industry business segment, from generation to transmission, market operation, distribution, and even customer management.

This evolution will not be easy. Using the U.S. as an example, the industry has evolved mainly through the efforts of publicly-traded investor-owned utilities (IOUs) regulated on a state-by-state basis. IOUs own and operate generation, transmission, and distribution assets, typically in a vertically-integrated manner. The sheer complexity of the industry has created a set of business practices and entrenched interests that encumber the industry with a great deal of inertia. We see transmission systems that cannot be reorganized due to incumbents’ fear of losing competitive advantage, power plants that cannot be shut down due to local employment or tax base concerns, and new technologies that are more expensive simply because they must adapt to the current business structure.

Now the imperative for rapid system evolution is stronger. The momentum of new low-carbon technologies and environmental concerns suggest that none of the historical patterns—slow but steady growth, dispatchability, and dominance of large-scale centralized generation—are certain characteristics of the electric utility industry of the future. While replacing an aging, fossil-fuel generation fleet may seem the most obvious challenge to achieving a new low-carbon electricity supply industry, it will not be enough. Integrating renewable energy at scale into the existing industry structure, built around the operational and financial characteristics of a fossil fuel­­–driven system, will be very expensive and may not work at all: market operations, grid system design, and utility incentives in the long term could easily exceed original investment costs.

To make a successful transition, each of the five major business segments of the integrated utility model faces major challenges and requirements for new investment and restructuring. Work in each of these areas is underway; however, there is a long way to go from ideas to solving individual problems, to a cohesive plan, and to restructuring the industry. This kind of integrated thinking is crucial. Taking some of the most promising solutions under discussion today, we can sketch the outline of a future electricity industry.

Integrated thinking is crucial to a roadmap toward low-carbon electricity (Image: Chris Jones @ Flickr)

 

Generation

Large, utility-scale generation will continue to play a role. However, less of it will be fossil fuel­­­–based. The fossil-fuel generators will be valued more for their flexibility than for their actual energy output. Current business models are based around optimizing fuel choice and availability to maximize output and minimize fuel costs within the constraints of system peaks and troughs. These models are outdated when a large share of generators have no variable fuel costs, while those that do are valued for their flexibility rather than generation.

New business models will need to reflect these changes:

YieldCos: New infrastructure-style companies will become the owners of non-dispatchable, large-scale low-carbon generation such as wind. These assets will be owned by investors seeking steady, predictable, bond-like returns. YieldCo vehicles have already begun to emerge in 2013 with NRG’s YieldCo.

Municipally- (and industrially-) owned and financed generation, where long-term low-carbon energy supplies are purchased directly from developers. For companies, this provides long-term energy price certainty, while for municipalities, it can leverage lower cost financing to provide energy to meet its own needs and supply those of its residents.

Crowd-sourced energy investmentwhere consumers can buy shares of generating units and receive payments as shares of energy. This idea is in early stages as significant legal and regulatory obstacles remain, but the longer-term benefit for consumers to purchase fixed-price, long-term energy supplies could make the system attractive.

Distributed generationparticularly in the form of rooftop solar, is already becoming a very attractive supply option for households and commercial establishments. It leads, however, to operational and investment challenges.

Generation operation and service companies will emerge to operate and maintain power plants as contractors, rather than owners. As ownership of generation becomes more dispersed and new companies emerge to operate and maintain systems for passive owners, this new class of companies could flourish.

Balancing generation companies (Balancing GenCos) will play an increasingly important role in a future dominated by renewable energy. They will focus on providing balancing services using flexible fossil-fuel and hydroelectric generation and storage systems. The majority of their profits will be derived from their flexibility.

Transmission

Separating transmission from generation and operating the transmission assets through a small number of entities covering large geographic extents can improve coordination and efficiency, enable better integration of intermittent renewable energy by gathering a diversity of supply sources, and level the playing field for new generation technologies. This has long been the goal of regulators and policymakers, but has only partially been realized.

Energy markets

The increased emphasis on the bulk purchase of power from renewable energy, along with the increasing value and sources of flexibility, will create new challenges. Expanded networks and resource differences may place additional value in markets with locational pricing. One result may be a separation of bulk power markets from balancing service markets, with a smaller number of system operators overseeing larger and more complex markets. In any scenario, significant market design enhancement and adaptation will be needed.

Distribution

Customer-generated electricity, such as from rooftop solar, is growing rapidly. This creates operational, investment, and pricing challenges for the distribution system. Tiered tariffs and net metering in California are creating incentives for the largest consumers to install distributed generation. In doing so, an increasing share of distribution costs falls on an increasingly smaller segment of consumers. However, altering the pricing model could make new distributed energy less attractive to build and undermine other efforts needed for a low-carbon energy system.

The increase in distributed generation and electric vehicle charging will change the operational characteristics of distribution systems, requiring additional investment, more active management, and increasingly heavy data gathering and complex pricing, all at a time when some consumers are leaving the grid. There may be a time when storage and distributed generation will be cheap enough for homes to leave the distribution grid entirely (RMI 2013).

The end game will probably be a conversion of distribution services from energy supply to infrastructure, load balancing, and backup services, and for distribution services to be priced accordingly. In many cases, it may make sense for distribution systems to be built, managed, and paid for as infrastructure rather than energy. Community ownership may be an attractive model.

Customer management

From the customer’s perspective, the mark of a good supplier has been one that provided reliable electricity on demand. Customers seldom thought of the costs they imposed on the system. While government-sponsored demand-side management and demand response programs have sought to address this issue, the overall impact has not been transformative. From the generator’s perspective, it has just been easier to continue building and operating more flexible generation. From the billing and customer service perspective, tracking customer electricity use in a way that encourages energy efficiency and price responsiveness has been too difficult. From the consumer’s perspective, the potential savings may not have been sufficient to overcome barriers and motivate action.

Several things are changing. From the generator’s perspective, flexible generation is becoming more valuable. But it is in the customer service and consumer side that the most interesting changes are taking place. Advances in smart metering and information technology are providing new avenues to monitor and evaluate customer use and savings. Meanwhile, customers have new end uses (like electric vehicles), greater potential control (due to advances in information technology), their own sources of generation (like solar panels), and in the near future, possibly their own storage. All together, customers will have more control of their energy uses (for instance, by controlling when they charge their vehicles or their energy storage systems).

As the utilities evolve, there should be more room to supply the range of services customers may find attractive and to integrate electricity services into a range of other businesses. For example, new businesses could take advantage of emerging technologies and smart meter data to turn historically passive consumers into active ones. New businesses could offer packages of services such as energy efficiency, distributed generation, and payments for grid services, helping customers benefit from participating as both consumers and service providers in energy markets. These businesses might even sell electric vehicles bundled with distributed generation, sophisticated energy use monitoring and flexibility software, charging stations, and energy storage.

Putting the pieces together

There will no longer be any significant advantage for the same company to generate, distribute, and deliver electricity. Yet some of the scale lost from this de-integration could be gained through geographical aggregation. We might see companies that own only balancing generation or transmission, but over wider geographies. Individuals, municipalities, and investment funds would also own more of the system, but with split ownership, there will be a greater need for service companies to provide the operation, construction, and maintenance services. On the commercial end, there may be more opportunities to wrap energy retail and service delivery with services across a wide range of industries.

Some questions about this roadmap remain. How can these new types of companies thrive? Would they have the financial wherewithal to deliver these services? And how would nations and states transition to this new set of businesses?

Once the viability of the model is certain, additional questions must be asked to refine the industry design. What policies are most cost-effective in encouraging deployment of renewable energy? How do regulators ensure reliable electricity with a portfolio high in renewable energy?  What policies and regulations maximize the flexibility of the system? What risks would specific types of investors take, and what returns might they require?

To answer these questions, we need to estimate the size and market for all of these opportunities and to explore potential business and regulatory structures. Putting this together, we can then begin to evaluate the paths for transition and to identify what governments, regulators, utilities, and investors could do to make these paths more effective.

References

1. International Energy Agency. 2012. “Energy Technology Perspectives 2012: Pathways to a Clean Energy System.”

 

2. Rocky Mountain Institute. 2013. “New Business Models for the Distribution Edge” (April).

Gireesh Shrimali is an Assistant Professor of Energy Economics and Business at the Monterey Institute of International Studies and a Faculty Fellow at Stanford University’s Steyer-Taylor Center for Energy Policy and Finance. Previously, he taught at the Indian School of Business (ISB), where he helped found the CPI-ISB Energy and Environment Program in collaboration with Climate Policy Initiative (CPI). His current research focus is on renewable energy finance and policy.  He holds a PhD from Stanford University and a BTech from the Indian Institute of Technology, New Delhi.

Cover image: Anonymous image licensed under CC0 Public Domain.

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