Beyond-the-meter technologies challenge the utility monopoly.
Andre Begosso (email@example.com) is a senior manager in Accenture’s utilities strategy practice. Tim Porter (firstname.lastname@example.org) is a senior executive in the practice and is the retail lead for utilities. Robert Laurens (email@example.com) is a senior executive in the practice and is the head of strategy for utilities. The authors acknowledge the contributions of Sarah Callaghan and Curtis Bech, Accenture analyst and manager, respectively.
Since the emergence of competitive retail markets in United States in the late 1990s, the power retail business has been through its fair share of booms and busts. It was first adopted as a growth engine by a number of utilities and other market participants. It was subsequently dropped by most utilities when the market collapsed and restructuring came to a screeching halt in the early 2000s. The market has resurged since then with independent power retailers leading the way with a continued focus on commodity sales.
Nevertheless, the competitive retail electricity market in the United States has progressed slowly over the last decade. The lack of a national blueprint for utility restructuring has created a patchwork of disparate market structures, making standardization difficult to achieve. This has been further complicated by the overarching political agendas of state regulatory commissions and their desire to protect consumers. A hodgepodge of transitional regulated rate caps froze retail commodity costs in many markets, limiting consumer switching and stunting competition. Thus, power retail has been relegated to an afterthought by most in the utility industry for many years.
Today, 21 states are considered to have competitive electricity markets. However, a closer state-by-state assessment of the progress of deregulation reveals that only four states (e.g., Texas, New York, Connecticut, and Massachusetts) have enough switching to be considered truly competitive (see Figure 1). Despite the other 17 states’ competitive market structures, their switch rates aren’t sufficient to represent real competition. This restricts the entrance of new competitive retailers and makes these markets effectively closed.
A series of events in the past two years has positively affected the power retail market and brought a renewed interest and life to this market. First, frozen utility price caps have been expiring since 2008, and this has opened new markets to competitive retailers. For example, PPL’s territory opened to residential competition in 2010, PECO’s will open in 2011, and Allegheny Energy’s will open in 2012. Second, the market conditions of the past year and a half—low gas prices and load reduction caused by the recession—temporarily created unprecedented headroom for competitive retailers. Last, traditional wholesale marketers have seen their markets slowly eroded as municipalities and electric cooperatives have built their own generating capacity, and these marketers have turned to retail as a way to expand their portfolios. The combination of these events has given power retailers the opportunity to build and expand in new markets.
The market is poised to see even more changes and growth with the introduction of smart-grid technologies and adoption of electric vehicles (EVs), photovoltaic (PV) distributed generation, home area networks (HAN), and non-AMI dependent home automation technologies. With more consumers purchasing such technologies, power retailers have the opportunity to move beyond commodity sales and offer new products and services in both regulated and competitive markets. Smart grid might be the impetus for a boom that the power retail market has awaited for decades.
Power retail is the ultimate bridge between generation and load, but most utilities have taken it for granted because of the regulated monopoly in which they operate. The introduction of beyond-the-meter technologies will challenge the monopoly and force regulated utilities to re-think their relationships with customers beyond business-as-usual activities (e.g., billing, outages, connect and disconnect). Moreover, it will allow power retailers to compete with utilities under a regulated monopoly umbrella. Power retailers will leverage these smart-grid technologies to enable the introduction of new products and services, leveraging the same capabilities and skills developed in competitive markets. They also will have the opportunity to insert themselves between the final consumer and the local utility in regulated markets and to expand their services in competitive ones. By doing so, power retailers expect to create a deeper relationship with customers, which ultimately will be translated into better economics for the business. In short, power retail has the potential to finally deliver on the promise of growth over the next decade.
Regulated or Competitive?
Power retailers historically have focused on selling commodity power, but that is about to change. The change won’t happen because the other 29 states are going to embrace competitive markets or because the current 21 competitive states will make competition easier. The change will happen because evolving technologies will allow customers to manage their energy consumption, as well as generate their own electricity. This change will turn the current centralized generation model upside down and shift the control from the utility to the customer. The more utilities try to shift risk from themselves to their customers by either increasing tariffs for energy efficiency programs or by demand response, the faster these technologies will become competitive, i.e., in-the-money. Power retailers and others, such as security companies and equipment providers, already are active beyond-the-meter market, while most utilities still are debating whether this change will or won’t happen. The reality is simple: Technology will make the distinction between regulated and competitive markets much less relevant.
The evolution of smart-grid technologies does in fact have an attractive value proposition for customers. The continually growing slate of available technologies potentially will provide customers with the ability to lower their electricity expenses, to take control of their usage, and to become stewards of their carbon emissions. For power retailers, it drastically expands the market by removing a barrier that has kept the market from reaching its full potential. The evolution of smart-grid technologies will provide an avenue for power retailers to reach inside consumers’ homes without interference from distribution utilities or state public utility commissions.
While the utility landscape will look dramatically different over the coming decades, it’s important to note that the penetration of these technologies won’t be homogeneous across all states, and it probably won’t happen in a revolutionary manner, but rather as an evolution. As market awareness increases among consumers, so will the penetration of these technologies.
In particular, a combination of three technologies—EVs, PV and HAN—likely will be offered in increasing scale by competitive retailers. By bundling these smart technologies with commodity sales, competitive retailers will be able to increase their revenue potential per customer, while keeping in check their incremental costs of acquisition and support, including billing and customer service.
The technologies deliver a higher lifetime value from each customer. In other words, the economics of the retail business improves significantly with smart-grid technologies—by more than 50 percent in a competitive market—while creating a completely new revenue stream in a regulated market (see Figure 2).
The increase in penetration of smart-grid technologies in regulated markets also will act to accelerate the transition from regulated markets to competitive and open power markets. The rationale behind this argument is simple. As technology penetration increases, the load served by the utility decreases, leading to slower capital recovery. To counter this, incumbent utilities would have to ask for rate relief and increase tariffs to further improve the cost effectiveness of these technologies. One can quickly see the cyclical nature of this death spiral as utility actions will continue to increase the unit cost of grid power and, at the same time, fuel customer adoption of distribution generation and demand-side management technologies.
A closer examination of the economics for PV technology shows that the installation of PV equipment has a detrimental commodity impact, yet simultaneously provides a positive financing return on the leasing of the equipment for the retailer. For utilities and power producers in a competitive market, where power providers sell their power in the open market, the impact of the penetration of this technology would push inefficient generation out-of-the-money while the transmission and distribution organizations would be affected by lower volumes and a decline of implied rate of return. In a regulated market, the incumbent utility would face the full loss of the load and return on the associated assets, while the retailer would capitalize the return on the financing plus the potential of additional services.
Looking particularly at the PV technology, this technology might be expected to achieve grid parity in many states over the next decade (see Figure 3). As the technology reaches grid parity—i.e., the price at which retail rates are equal to, or higher than, the PV levelized cost of energy—the market likely will continue expanding and driving future solar installations. The Energy Information Administration projects that growth in the next couple of years will continue to be led by the commercial segment (with 350 MW installed in 2009), followed by residential (80 MW) and utility scale projects (50 MW). Also, the residential sector likely will become more prevalent in the later part of the decade, with increasing consumer awareness of PV technology and its benefits. Retailers will be fundamental in driving penetration of PV technology in this area by offering their customers a way to lower the purchase cost by either financing or leasing PV installations. Financing and leasing options will drive PV market growth because installed cost is the biggest barrier, the relative lack of low-cost financing for PV installations is a factor that’s hurting the growth of new PV installation in the United States. Retailers also might use financing as a loss leader to gain access to long-term contracts for the supply of the electricity commodity in competitive markets.
This trend likely will be irreversible not only because of the economics presented in Figure 2 and Figure 3, but also because of several policy initiatives currently being examined in Congress, which, if implemented, could accelerate PV adoption. One such policy example is the proposed 10 million solar rooftop program. Under this program, the federal government plans to allocate $250 million of funds in 2012 to states and an undisclosed amount thereafter through 2020 to carry out the program. With a 20-percent cost share, states would be able to use these funds to provide rebates for distributed generation PV projects. Additionally, the implementation of a national RPS, green energy bank and extension of cash grants could act as further catalysts for PV market growth. Of course, then mid-term election might shift political winds and some of the incentives might disappear, delaying but not preventing grid parity at the end of the day.
Further, PV technology is just one of many potentially game-changing smart technologies. In the future, power retailers will offer PV technology in tandem with other technologies across all states in an effort to develop and exploit different customer value propositions. For example, charging stations might be coupled with PV technology in home installations to create true zero-emissions cars. Power retailers are well positioned to tackle this market, bundle new technologies with the right financial incentives (e.g., 30-percent investment tax credit) and get in front of customers, applying many of the same skills they currently have while also leveraging partnerships or, longer-term, acquisitions to expand their workforces and close some capability gaps.
The key change would be a change of focus, from focusing on selling the commodity to selling a broader array of services, and developing a solutions-based relationship. Utilities, especially in regulated monopolies, will have to play catch-up to acquire the skills and capabilities to interact with customers beyond business as usual, and to develop the ability to manage a large numbers of small projects.
Strategy for Regulated Utilities
The picture painted here isn’t good news for utilities. It’s almost inevitable that power consumption levels will plateau and even start declining over the short term. Losses in load will affect utilities in three different ways. First, will be the continuation of depressed power prices as load is shed. Second, is the acceleration of rate cases. As volume decreases, the implied return on equity is reduced, forcing utilities to go to the public utility commissions more constantly for rate relief and tariff increases. The increase in tariffs will put these technologies even further in-the-money and likely will accelerate their penetration.
Third, and most important, as load continues to be shed, utilities will have to postpone investments in new generation facilities at a time when the new baseload fleet will have to be replaced. Utilities will have to explain to public utility commissions why building large central plant generation units is more cost effective than other emerging technologies such as distributed renewable generation—an increasingly difficult argument as alternative technologies reach cost parity.
The new power retail market is a real threat to the current utility business model. Regulated utilities and load-serving entities might be completely by-passed by the power retailer acting beyond the meter, and, ultimately, they might be relegated to being providers of last resort or just asset managers. Because the technology will be deployed beyond the meter, beyond the control of the regulator, there’s very little utilities can do about it from a regulatory point of view. However, a proactive strategy that puts the utility in front of the customer to participate in this market will help reduce the negative impact of these changes.
Most utilities in both competitive and regulated markets still have brand image recognition in retail power markets. However, few utilities have used it to improve their relationship with customers. In this brand new market, utilities will need to be proactive in their thinking about new technologies and recognize that there are many technologies competing for the same market. They also need to realize that it’s difficult to predict which technologies will emerge as winners. As a result, dealing with, and accepting, risk and uncertainty will have to be a part of any strategy.
However, this doesn’t mean utilities will abandon their traditional cost-of-service business model. Utilities have an opportunity to understand the impact of smart technologies and proactively engage in a simultaneous protect-and-grow strategy that will prepare their businesses for the future. A strategy aimed at protection will focus on minimizing or reducing the impact new technologies will have on the current core business in the short-term. At the same time, engaging in a growth strategy will help to build the new skills and capabilities necessary to prosper in the new market, while accelerating the deployment or maximizing the impact of technologies that will enhance the core business.
Doing nothing isn’t the prudent option because the utility can’t forever impede or eliminate the threats posed by emerging technologies.
The New Reality
Power retail will be a foundational business for utility companies that hope to succeed in a world after implementation of smart-grid technologies. It will allow a company to continue being connected to its customers while offering a wide array of products and services based on smart technologies. Controlling that gateway will be critical in this new beyond-the-meter era. Failure to recognize this new business environment might lead not only to disintermediation between the utility and the customer; it can ultimately diminish the utility to the role of asset manager and provider of last resort. The time to recognize this new reality is now, as competitors are already entering the market. Traditional utilities have a long road ahead in which to play catch up.