Modeling the value of various technologies and applications.
Ahmad Faruqui (firstname.lastname@example.org), Peter Fox-Penner and Ryan Hledik are economists with The Brattle Group. The authors acknowledge ComEd Vice President Val Jensen for funding portions of the work on which this article is based, and for his contributions to their thinking on the subject. Also, they acknowledge Clay Davis for contributions to model development and Heidi Bishop for editorial help.
As the momentum to upgrade America’s aging electric grid continues to build, more power companies are announcing initiatives and partnerships that will lay the groundwork for their involvement in the development of the smart grid (SG). In order to stay ahead of the curve and the competition, companies are struggling to define, quantify, and strategize for the deployment of SG technologies in their service areas.
Defining the SG involves not only identifying the component technologies, but also understanding their power to transform the entire electric industry business model. This power to transform is tied to their potential for achieving significant cost reductions, decreased energy consumption, increased reliability, lower carbon emissions, and improved quality of service.
Finding a way to quantify these benefits and compare them across multiple scenarios will be a strategic necessity for any company looking to enter this new arena. Attempting to adopt these technologies without careful, detailed analysis will lead to strategies that do not capture the full range of available benefits. Worse, they can end up costing customers more than they are worth. Decision makers should ask themselves: Have we analyzed the full range of strategies? Are we certain we’ve selected a strategy that maximizes the potential benefits across a range of energy futures? Have we made the right trade-off between the higher risks that come with higher rewards?
Developing winning strategies for the adoption of SG technologies poses a major challenge for decision makers because there are still considerable areas of uncertainty. A valuation model can help quantify the likely benefits of various technologies. From these estimates, large-scale trends emerge that will affect the entire industry.
SG benefits aren’t the complete basis for either business strategies or public policies. Benefits always should be weighed against cost and rate fairness issues in any technology deployment decision. General benefit estimates provide a useful starting point for any company preparing to develop its own specific strategy.
Defining the Smart Grid
The SG encompasses virtually all facets of the electric industry, with benefits ranging from expanded generation resource alternatives to decreased energy consumption. Due to this wide array of applications, the term “SG” has several uses in today’s industry. When applied to the transmission and distribution, or the wires side, of the grid, SG can refer to expanded transmission lines designed to intelligently link new energy sources to the existing grid or the introduction of enhanced control channels for managing the transmission system. SG applications also hold significant promise downstream of the wires, on the customer side of the business.
The first major step toward a downstream SG is installation of advanced metering infrastructure (AMI), which allows for the collection of energy usage information on a sub-hourly basis and the retrieval of that data by both consumers and energy companies.1 Smart meters, a key element of AMI, enable a wide range of end-use products to be offered to customers. The American Reinvestment and Recovery Plan set a national goal of installing 40 million smart meters in homes with its energy investments. The state of California already is moving ahead with full-scale deployment of AMI, and several other states, including Georgia and Texas, likely will follow suit.
Discerning realistic time frames for the deployment of SG technologies is a crucial step in developing a company’s SG strategy.2 It will take time and investment to propagate SG technologies across the approximately 3,000 distribution systems in the United States.3 Already, significant progress has been made with more than 40 different SG pilot programs in place. Some utilities, such as Xcel and Austin Energy, are leading the industry with carefully crafted SG pilots. Many of these pilots are designed to explore not only the direct benefits of AMI and smart transmission and distribution, but also the impacts of new technologies and customer programs that this upgraded infrastructure backbone will enable.
Modeling Smart-Grid Benefits
In assessing the benefits of the SG, an analytical model separates the potential benefits into two major streams: established technologies and benefits; and leading-edge technologies and benefits. SG applications that already are feasible and have benefits that likely will be realized in the short term include AMI, demand response (DR), and SG-enabled energy efficiency (EE). AMI is the backbone of the SG due to its role as an enabling technology and current level of adoption across the grid. With AMI in place, time-based pricing, automated controls, in-home displays, and other information-based technologies will be possible. Time-based pricing, such as dynamic pricing, allows utilities to charge customers prices based on the cost of electricity, which fluctuates greatly by day and even by hour. Armed with detailed information on the cost of electricity, usage can be shifted to times of the day when prices are lower.
The second stream of SG benefits, those dependent on leading-edge technologies, will require technology improvements and supportive policies before they can be brought successfully to market. These technologies include distributed energy resources (DER) and plug-in hybrid electric vehicles (PHEVs). DER can be defined as small, modular, energy generation and storage technologies that provide electric capacity or energy closer to their point of use than centralized sources.4 DER technology has existed for years, and related products already have entered the market to a small extent. Large-scale market penetration, however, will not be possible until technology barriers are overcome and policies are in place to support them. The SG will accelerate greatly the development of DER by improving their functionality and economies via time-differentiated prices, and by allowing customers to store and dispatch excess power.
PHEVs also promise a major source of potential economic benefit. Without SG-enabled technologies, PHEVs will charge using simple charge timing protocols, adding demand to the grid when it is most costly. If properly designed, the SG would provide enough flexibility to handle the increased charging load, and possibly allow PHEVs to send excess power back to the grid. The technological hurdles associated with emerging technologies create great uncertainties in the timing and valuation of their benefits, but are no less important in SG benefit analyses. DER and PHEVs are transformative technologies that hold extraordinary potential for economic and environmental benefits.
These two major categories—established and leading-edge—represent a simplified description of all potential benefit streams. To quantify these value streams, each component of the SG is evaluated for seven types of benefits: avoided metering costs, avoided generation investment, avoided T&D costs, energy cost savings, system reliability benefits, carbon emission reductions, and (for later use with the PHEV module) avoided gasoline costs. Each component of the SG provides a different set of benefits from among these seven metrics. The total value of an SG investment is the sum of benefits from each component of the SG listed above. In abbreviated equation form: Total SG Value = Sum of the Values from AMI, DR, EE, DER, and PHEV.
Big Picture Benefits
Good SG strategies begin with careful assessments of risk levels, opportunities, and the regulatory environment. Utilizing some general assumptions and industry observations, an analytical model generates baseline benefit estimates and reveals big-picture benefit trends. A few of these benefits can be captured with little to no investment, but most require significant capital outlays.
To illustrate this thought experiment, consider a fictional utility called Smart Power, which serves approximately one million customers in an urban area and has experienced growth in peak demand at a slightly faster rate than growth in energy consumption (see Figure 1). Based on current industry trends, Smart Power might deploy AMI to all customers by 2012. To quantify all benefits, the model considers a 40-year time horizon, which is necessary to capture the impacts of emerging technologies.
For AMI, the model considers the direct value from avoided meter reading and operations and maintenance (O&M) costs. These avoided costs represent a major benefit for Smart Power as AMI allows it to reduce labor costs and increase operational efficiency by reading meters remotely. Current annual metering costs for traditional meters are conservatively estimated to be $15 million a year for this utility (or roughly $15 per customer per year). These avoided costs amount to a present value of $250 million. The next step, of course, would be to compare this against the costs of AMI.
The next benefit stream5 includes customer savings from dynamic pricing alone, as well as savings from dynamic pricing offered in conjunction with such enabling technologies as two-way communicating thermostats in residential applications and automatic DR in commercial and industrial (C&I) applications.6 Dynamic pricing significantly can reduce Smart Power’s capacity requirements by decreasing system peak demand. The model reveals that these technologies potentially could decrease the utility’s system peak demand by approximately four percent over the 2010 to 2050 horizon. Dynamic pricing has the potential to generate $347 million in savings by differentiating the price of electricity by its costs, which vary during the day as demand fluctuates. When the incremental effects of enabling technologies are included, dynamic pricing benefits reach a combined present value of $501 million for Smart Power.
The energy efficiency benefit stream includes impacts from both rapidly deploying in-home displays (IHDs) to residential customers, and implementing continuous building commissioning in C&I facilities. The purpose of an IHD is to share directly with customers the detailed current and historical information on electricity usage that smart meters collect, thus allowing customers to make more informed energy usage decisions. Recent pilots have suggested IHD programs can create a significant conservation effect of roughly 6.5-percent energy savings per device owner.7
Further, AMI allows continuous building commissioning, which ensures that a building’s complex set of systems are designed, installed, and constantly tested and calibrated for optimal performance, leading to significant increases in energy efficiency at the commercial and industrial levels.8 A realistic market penetration for continuous building commissioning would be about 20 percent of small to medium C&I buildings and 0.2 percent for large C&I facilities.
The combined energy efficiency benefits from IHDs in the residential sector and continuous commissioning in the C&I sector amounts to a present value of $906 million. This value stream is mostly due to avoided energy and carbon costs, with some additional savings from avoided capacity generation.
Another area of SG benefits involves distributed energy resources (DERs). DER broadly includes all forms of renewable generators located near customers, as well as downstream dispatchable storage (possibly including PHEVs, which will be included in future models). While DERs will deliver carbon savings and other environmental and reliability benefits, the conservative model examines only one DER technology—on-site (fixed) energy storage. The value of this technology is that it can shave peak power use by allowing greater off-peak purchases to be stored for use during peak periods.9
In modeling the impacts of DERs, batteries are assumed to penetrate customer segments roughly in proportion to the value those customers place on avoided outages, which is highest in the commercial sector. In the model, market penetration rates are expressed as the percent of the class peak that can be displaced by discharging the batteries to their full capacity during low-price hours. Benefits of DERs are derived primarily from the ability of these resources to store off-peak energy and use it to meet demand during peak times. This can lead to a reduction in energy costs, and deferral of the construction of new peaking capacity. Energy storage also has the ability to firm up intermittent resources like wind generation, adding to their value and potentially leading to an increase in market penetration. Another major benefit includes increased reliability as batteries function as back-up generators. All together, the potential benefits of expanding and developing the DER market could reach $178 million by 2050 in present value terms.
The model shows that total preliminary estimated NPV benefits for Smart Power exceed $1.8 billion, excluding PHEV benefits yet to come (see Figure 3). This is about 60 percent of gross annual revenues for Smart Power and quite possibly much more than a smart grid system will cost.
Developing A Strategy
With such a great potential for cost savings, the SG might attract many new entrants into related markets. Retail energy providers, energy service companies, curtailment service providers, and equipment manufacturers will find new avenues for opportunity. Current manufacturers of batteries, energy storage technologies, and small-scale renewable generation resources also will benefit as their markets expand significantly. Entrepreneurs in the auto, telecom, and IT industries already have begun developing strategic partnerships with utilities to support expanded SG applications. Finally, the public sector will exercise varying levels of authority in the development of the SG. Government agencies, regulators, and legislators at all levels will significantly influence how the grid develops, impacting siting, protocols, green-technology policies, and other factors.
With these new relationships in mind, there are several important choices to be made when considering an SG strategy. How should a utility manage its relationships with retail energy providers and aggregators, new market entrants, and the public sector? What level of involvement in DER and PHEV technologies will the utility incorporate into its long term strategy? How will it be affected by the pricing of default energy commodity service, the deployment of advanced meter infrastructure, and addressable end-use technologies?
With so many considerations, it can be very easy to get trapped into the wrong strategy. Some companies will be tempted to choose the do-nothing strategy, telling themselves they will minimize risk and let others make the big mistakes first. Unfortunately, this strategy leaves money on the table in the short-term and increases the risk that they will lose customers in the long-term. However, adopting the opposite, do-everything strategy can be equally damaging to the long-term success of a company. Overzealous companies entering these new markets unprepared will get entangled in regulatory and legislative battles well beyond their core competencies. The optimal strategy will require a careful selection of options and a balancing of risks and rewards.
Based on the considerations above, five basic strategies emerge:
1) The Neutral Bystander plays a minimal role in the deployment of SG technologies. The neutral bystander strictly observes regulatory rules that prohibit the company from going beyond the meter and into the customer’s premises.
2) The Infrastructure Manager takes a leadership role in identifying the potential benefits of SG infrastructure. The infrastructure manager will prefer to let others make investments in SG end-use technologies, but sees the value in reducing conflicts and redundancies. Well aware of the potential value of SG opportunities, these leaders will actively advocate the use of open protocols.
3) The Market Catalyst shares a similar appreciation for SG technologies as the infrastructure manager, but seeks a more active role in utilizing the tools. The market catalyst provides multiple default services and conducts SG pilots and tests. Such demonstration projects help to create a space in the retail market for new entrants.
4) Market Enablers make investments into core SG hardware, such as in-home displays and programmable communicating thermostats, as well as covering all the functions of a market catalyst. Market enablers recover their investment costs through their rates and are well prepared to become market leaders.
5) The Active Market Participants expand their investments beyond core hardware and consider additional SG end-use technologies if deemed in the public interest. These additional investments in leading-edge products and services likely will include grid-friendly appliances and buildings, distributed generation infrastructure, and PHEV-related services. In order to incorporate these advanced new grid functions, active market participants should use strategic partnerships and outsource services to telecoms and IT providers when it wouldn’t be cost-effective to produce these services internally.
Each company will have to evaluate these strategies across a range of alternative futures or scenarios. The best strategy will be the approach that remains robust across alternative futures. To properly assess these futures, each scenario should be treated as a different state of the world rather than a different outcome within a given world. Development of these state-of-the-world scenarios requires careful assessment of the factors that drive them.
Future scenarios are driven primarily by regulatory, political, technological, and environmental factors. As the market develops, additional factors such as intensity of retail competition, supply-side costs, and customer culture increasingly will drive these scenarios as well. Within a scenario, each driver can acquire one of many outcomes.
To make this process more manageable, decision makers should isolate a smaller number of scenarios that define the range of future possibilities.
The emerging SG market represents an unprecedented opportunity for the utility industry to streamline costs, reduce energy usage, and improve infrastructure over the coming years. Over the long-term horizon, related technologies have the potential to redefine the industry structure and our energy economy. Substantial benefits can be realized by adopting basic technologies early on, with potentially greater benefits for those who also plan for the long-term implications and opportunities.
Planning for these industry shifts isn’t an easy task, and decision makers should make use of the best resources available to mitigate risk as they select a smart-grid strategy capable of maximizing benefits within a variety of alternative future scenarios.
Finally, recent policy shifts and rapid growth in SG technologies illustrate there’s no way to remain unaffected by this transformational suite of technologies. Failure to devote time and resources to basic planning can cause companies to become stuck in a neutral bystander strategy, fall behind other market participants, and miss opportunities for growth. On the other hand, inadequate planning can lead to unrealistic strategies that waste time and resources, taking companies off track. Modeling detailed scenarios and benefits early on will reduce a company’s chances of becoming stuck in the wrong SG strategy.
1. “EIA Glossary,” U.S. Department of Energy, Energy Information Administration. (Accessed Mar. 24, 2009) http://www.eia.doe.gov/glossary/glossary_a.htm.
2. “No Small Change: The Stimulus Package and Its Impact,” Patton Boggs, LLP, Feb. 12, 2009.
3. “The Smart Grid: An Introduction,” U.S. Department of Energy, Oct. 28, 2008.
4. “Distributed Energy Resources: A How-To Guide,” U.S. Department of Energy, Office of Energy Efficiency and Renewable Energy. (Accessed Mar. 25, 2009)
5. In the case of SG benefits involving DR, the only benefits measured are the savings in the costs of new supply (fixed and variable). Additional analysis is needed to divide this savings into customer vs. shareholder benefits.
6. Automatic DR is a communications infrastructure that provides the owner of the system with electronic signals that communicate with the facility’s energy-management control system to coordinate load reductions at multiple end-uses. For information on Auto-DR, see Wikler et. al., “Enhancing Price Response through Auto-DR: California’s 2007 Implementation Experience,” Proceedings of the ACEEE Summer Study on Energy Efficiency in Buildings, August 2008.
7. Hydro One, “The Impact of Real-Time Feedback on Residential Electricity Consumption: The Hydro One Pilot,” March 2006.
8. EPRI, “The Green Grid,” June 2008.
9. The model utilizes an optimization module to capture the value of selling power back to the grid by dispatching the battery power against two historical price series to maximize profits on a daily basis: a day ahead market and a 10-minute spinning reserve market. By charging when the price is low and selling this power back to the grid when the price is high, energy costs are reduced and flexibility is added to the grid.