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Paradigm Buster: Why Distributed Power Will Rewrite Open-Access Rules

Fortnightly Magazine - October 15 1999

distributed generation, however, appear to promise a long-term, unpleasant margin squeeze quite at odds with the traditional equation. The math is simple. Today, the average cost of production from the generation plant is on the order of 4 cents per kilowatt-hour. The average cost of T&D is around 3 cents per kilowatt-hour. In the old, cost-plus world, the retail price was determined by the sum of production, transmission and distribution, yielding average retail prices of around 7 cents per kilowatt-hour.

However, the cost of power from distributed resources is expected to approach, say, 6 cents per kilowatt-hour in many applications and locations. Sometimes this 6 cents may be the cost remaining after charging some costs to products other than commodity power (e.g., power quality or thermal energy). When costs such as these are achieved, the fundamental equation for the next decade is that production, transmission and distribution cannot materially exceed the otherwise available retail price. To put the matter a bit simplistically, 4 cents plus 3 cents must find some way to equal less than 6 cents.

This equation identifies the battle lines. Owners of central station plants will redouble their efforts to lower their own costs and begin to participate in the regulatory process to constrain regulated T&D costs. Owners of the T&D facilities similarly will seek to reduce costs. At the same time, they will assert, quite rightly, that there are costs associated with interconnecting to the existing grid, providing backup or standby service, etc. The economic attractiveness of the distributed option will be affected significantly by how these costs (together with offsetting T&D benefits) are recognized in new distribution rates.

It won't take vast numbers of distributed units to have a vast impact. What matters most is whether the marginal cost of distributed power (net of non-commodity benefits and charges) falls below the marginal cost of power delivered from the grid. As this occurs - as it is seen to occur - industry participants will respond far more quickly than regulators might imagine to adjust prices, costs and services. A few hundred megawatts will have an impact on the market far in excess of their actual generation capacity.

Regulatory Questions: Uncharted Territory

Distributed generation challenges the conventional regulatory paradigm in part because of the difficulty in classifying it either as a competitive or regulated monopoly function. In fact, it may be both. Specifically, the new technology forces to the fore threshold questions regarding what entities will play which roles in the new industry. These questions concern the management of facilities and assets.

Who Owns the Plant? The battle here pits the regulated local utility against a competitive generator. Presumably, the construction of new power facilities on the customer's property would be a competitive function. At the same time, however, other applications of distributed power will be located at distribution substations (or elsewhere on the T&D system) and presumably would be owned by the utility.

Perhaps the real question is whether ownership of the new assets at either utility or customer sites will be determined by regulators to be an