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Friday, August 5, 2011

Hey Grid, What Makes You Think You're So Smart?

On July 1, 2011, Pacific Gas and Electric (PG&E), Southern California Edison (SCE) and San Diego Gas and Electric (SDG&E) submitted their Smart Grid Deployment Plans as required by the California Public Utilities Commission.  At 290, 178 and 391 pages respectively, the plans are definitely weighty.  They also contain lots of attractive graphics, informative statistics, and interesting projections.  They estimate an implementation cost in excess of $6 billion (on top of the more than $1 billion each for PG&E’s and SCE’s Smart Meter deployment) to achieve a set of vaguely defined benefits that they estimate to be only slightly greater than the cost.  The smart grid benefits include:
·      Safe and reliable integration of renewable energy resources.
·      Integrating electric vehicle charging into grid operations.
·      Enhanced demand response.
·      Customer empowerment.
·      Improved grid reliability – reduced outages.
·      Automated and improved grid management.
·      Foundational and cross-cutting utility systems, facilities and programs necessary to continuously improve application of new smart grid technologies.  (Whatever that means.)

Behind the plans is the implication that there are massive future benefits that have not yet been identified – Smart Grid killer apps if you will – that will do for the electricity industry what advances in cell phone technology have done for the telecommunications industry.  That promise of future market transformation and a wonderful new world brought about by the new and improved Smart Grid is the underlying driver behind this process.  Otherwise, it is just boring utility infrastructure stuff.  The problem is that the platform for developing this exciting future is being crafted by utilities and their regulators, a combination not known for innovation.  Google and Microsoft, entities with a somewhat better reputation for high-tech innovation have recently terminated their nascent Smart Grid programs.  What’s the deal?

The problem is simply that the utility industry does not and cannot undertake the kind of risk-taking and innovating needed to make the Smart Grid anything more than an incremental improvement in utility operations.  It has nothing to do with the quality, intelligence, and forward thinking of utility management and everything to do with the regulatory compact under which utilities and their regulators operate.  In other words, it’s all Samuel Insull’s[1] fault.  It was Insull who promulgated the idea of natural monopolies to avoid the costly waste of duplicate electric systems and the use of regulated rates to protect consumers.  Under this simulated market model, utility companies have their regulators determine whether investments proposed and expenses incurred are just and reasonable and issue Certificates of Public Convenience and Necessity to approve proposed investments.  Utilities are then allowed to recover their costs and a return on equity for their capital investments.  Thus, utility focus is not on offering consumers the most value or developing competitive advantage through innovative products, but on building ratebase and demonstrating to their regulators that their investments and expenses are reasonable and thus worthy of recovery through rates.  In other words, utility earnings are a function of how much stuff they can convince regulators it is reasonable for them to own.  This is not a recipe for the innovation and risk-taking required to develop new and better products or services or for finding new needs or wants that The Smart Grid can fulfill.  It is, however, a great way to build ratebase in new ways and to pass the cost to consumers based on potentially illusory – but reasonable – anticipated benefits.  Up side may be limited to an authorized rate of return on equity, but even failed investments or massive cost overruns can be charged to consumers provided they are found to be just and reasonable.  Utilities have no incentive to think outside the box, but plenty incentive to make sure the box is very well built using the finest, most reasonable, materials.  Is it any wonder that Google and Microsoft decided to take a pass?

What can we expect from utility Smart Grid activities?  The most likely thing is capital investments that reduce operating expenses.  This is consistent with the initial Smart Grid investment – the Advanced Metering Infrastructure, aka smart meters.  While utilities wax poetic about empowering customers and facilitating demand response, the primary benefits of the new metering infrastructure are eliminating the need for meter readers and the getting the ability to turn electric service on and off remotely.  Both replace pass through expense items (employees) with rate based investments in meters.  On top of that, California utilities will be able to continue to get a rate base return on the old – not smart – meters that are being replaced.  They were, after all, a reasonable investment when purchased.  Other Smart Grid investments in distribution and transmission automation will be justified based on things like reduced outage rates and durations - soft benefits, but reasonable. 

The bottom line is that as long as The Smart Grid is in the realm of utility companies and regulatory agencies its impacts will be limited and the transformative “killer apps” will remain nowhere to be found.  Remember, when cell phone licenses were issued in the early 1980s, at least two licensees were allowed in each area and only one could be a regulated telecommunications company.  It was this competition, not the reasonableness of cell phone services that produced the innovation and amazing success of the industry.  We have a long way to go before that kind of competition comes to the electric utility industry.  But at least now I can find out how much electricity my house uses each hour, information I never realized I needed before, but may soon be able to access from my Smart phone.

[1] Insull started as Thomas Edison’s private secretary in 1881, developed the regulated utility industry model into a thirty state empire, was indicted and tried for fraud in the 1930s only to be acquitted by a jury that needed only two hours of deliberation to reach their verdict. 

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