Solar for Everyone, including Utilities
James Tong is vice president for Strategy and Government Affairs at Clean Power Finance, headquartered in San Francisco, which helps provide financing to facilitate residential solar power installations. Jon Wellinghoff practices law in San Francisco with Stoel Rives, LLP, serving as co-chair of the firm’s energy team. Previously, Mr. Wellinghoff served as chairman of the U.S. Federal Energy Regulatory Commission.
The Wrong Debate: Regulatory discussions on solar distributed generation (DG) continue to dwell on net energy metering (NEM). In this way, they focus on a narrow issue: what is the appropriate price for energy that solar customers export to the grid?
And discussions that do get past NEM inevitably get directed to a further question of similar import: what will the "utility of the future" look like as solar DG and other disruptive innovations gain prominence?
But are these the right questions at all? We believe it is more productive to start at square one and determine what the new grid architecture ought to be. If we agree that increasing consumer choice and the efficient delivery of energy services to all consumers are baseline goals, we should pose a rather different set of questions: namely, can we design the grid to (1) promote more energy efficiency, (2) reduce the emissions of pollution, including greenhouse gases, and (3) deploy more distributed energy resources (DER), such as solar DG and demand response?
Assuming these are desirable objectives for energy consumers, the next question is: what is the appropriate electricity market structure for the grid to achieve these objectives? We maintain that the best structure is one that, as much as possible, maximizes competition in the delivery of efficient energy services over a new distribution grid platform. The monopoly franchised distribution model is justified as long as it provides a public service that cannot be delivered sufficiently and cost-effectively through competition. If new technologies and businesses, however, can competitively provide such service, the model may need to change. Thus, we must first examine how competitive markets can best provide multiple grid services beyond simple delivery of electrons. Only then can we proceed to questions about the role of regulated utilities as owners of the distribution grid system, and how to compensate them appropriately for grid ownership and maintenance.
By asking the questions in reverse order and starting with NEM, current discussions over solar DG presuppose that minimizing the impact of disruptive innovations on regulated utilities is what's best for the public. This notion dramatically limits the scope of discussion and, in fact, will likely lead to suboptimal outcomes. It places incumbent utilities in an unassailable position by assuming that disruptive change is unwelcome; thus, they have little incentive to adapt and embrace innovation and competition. It also disadvantages innovators who might better serve the public.
Diminished reliability and unfair rates are not inevitable consequences of disruptions to the regulated utilities that own the grid. Nor are grid operations and ownership inextricably linked. In fact, new technologies, changing regulatory priorities, and shifting customer needs indicate that dissociating grid ownership from grid operations will greatly benefit the public and arguably the utilities, too. Specifically, we contend that the best way for a utility to embrace new innovations without disruption to the grid is to have the distribution utilities transfer their operations to an independent distribution system operator (IDSO) akin to an independent system operator (ISO) or a regional transmission organization (RTO) in the bulk transmission system.
Own the Grid, Not its Operation
Solar DG and other DERs (such as demand response, energy storage, microgrids, and advanced communications technologies) have been proven to provide valuable benefits to the larger grid when appropriately incorporated at the distribution level. These benefits include additional energy and capacity resources, improved grid resiliency, and ancillary services (such as voltage/VAR support, congestion relief and capacity support). In fact, benefits from DERs could potentially exceed those of traditional centralized generation. Federal Energy Regulatory Commission (FERC) Order 755 explicitly recognizes the advantages of DERs by requiring higher compensation to fast-response regulation services (typically provided by DERs) than to slower-responding regulation services from traditional central station generators. Similarly, in its initiative, The Integrated Grid, the Electric Power Research Institute (EPRI) acknowledges the vast promise of DERs that are planned and coordinated by the grid operator.
Nevertheless, today many DER assets - which often are not incorporated into the utility's resource planning mix - are owned by customers or third-party competitive providers. Furthermore, these third-party providers could and often do aggregate services that the DER assets provide, such as demand response. Therefore, allowing the current grid owner (the utility) also to operate the distribution grid presents a strong conflict of interest, especially if optimizing the use of those assets may reduce the need for grid expansion and utility investment. The grid operator has clear incentives to favor increasing the utility's assets rather than encourage customer-owned DERs.
To deploy DERs cost-effectively and fully realize their potential value to the grid, we recommend that utilities continue to own the grid while an objective and separate IDSO operates the distribution system. The concept has indeed been analyzed and advocated by others, including the Senior Vice President of the New York Independent System Operator Rana Mukerji and Open Access Technology International, Inc. in recent articles in Public Utilities Fortnightly (see, e.g.," From ISO to DSO," by Farrokh Rehimi and Sasan Mokhtari, PUF, June 2014, p. 42.).
In short, the IDSO will be responsible for: (1) maintaining the safety and reliability of the distribution system; (2) providing fair and open access to the distribution grid and information from that system; (3) promoting appropriate market mechanisms; and (4) overseeing the optimal deployment and dispatching of DERs. The IDSO - which in certain instances could be the same entity as the ISO - will be under the jurisdiction of the state public utility commission.
The regulated utility will continue to maintain the distribution assets and rate-base obligatory grid investments under established protocols. It will also retain billing function to its customers for distribution service. The rates and tariffs for service would continue to be determined by the public utility commission, but with input from the IDSO, the distribution utility, consumers, and providers of DER services.
A Litany of Benefits
Opening the regulatory system to competition by creating an IDSO will: (1) enable full deployment and integration of DERs; (2) improve utilization of existing grid resources; (3) allow for greater consumer choice and participation in the electric grid; and (4) spur the development of a "Transactive Energy Framework" in which independent energy agents in the distribution system can trade and combine their services to meet increasingly disparate customer needs.
A leaner, more focused monopoly will be a win for free markets and thus the public. But it also can be a win for the utility's shareholders by promoting a healthier and less risk-adverse utility. The resulting utility will face fewer encumbrances and more upside potential from investing in new technologies.
Utilities win in several ways:
Simpler Management. Utilities face a growing array of mandates and regulations from local, state, and federal agencies. Compliance is increasingly difficult and expensive, particularly because many of the requirements conflict. Furthermore, the inexorable widespread deployment of DERs will make the grid vastly more complex than it is today. It's unclear that utilities will have the in-house capabilities to cost-effectively operate the grid as these complexities increase; many already face problems recruiting talent to replace retiring workforces and meet current obligations. Having the IDSO assume grid operations will reduce the utility's obligations and associated costs, while providing a new "employment platform" where young system engineers can devise new creative strategies to optimize DER integration into the distribution grid.
Efficient Cost Recovery. In the NEM and value-of-solar debates, utilities argue for the proper "value of the grid" and request that solar DG owners pay for that value. An IDSO can more objectively determine the true value of all resources - including solar DG and other DERs - that provide services to the grid. It can also assist regulators in determining the appropriate cost-recovery mechanism to ensure that distribution utilities and DG or DER owners are fairly paid for their respective services.
Opportunities for Affiliates. The growth of DER, particularly solar DG, offers a variety of new profit opportunities for utilities' unregulated affiliates to operate outside their existing distribution service territories. Some, including Edison International and Integrys Energy Services, have already begun to invest in solar DG. However, such investments are relatively rare. Simply put, under the current structure, investing through regulated monopolies outweighs the risk-reward of investing in solar DG. Uncertain solar policies and potential legal issues create risks for unregulated affiliates to invest in solar DG, which depress the expected risk-adjusted rate of return. Meanwhile, the risk-adjusted rate of return for investments by the regulated monopoly may be inflated by the authorized return on equity from the regulators. Consequently, utilities today face stronger incentives to invest with regulated monopolies than with their unregulated affiliates.
An IDSO can reduce these distortions that can disadvantage unregulated affiliates.
First, the IDSO can mitigate regulatory risks associated with solar DG by instituting clear and consistent solar policies: reliable and transparent policy would make risk-adjusted returns more attractive. Second, the creation of the IDSO will send a clear signal to utilities and their shareholders that DERs are mainstream technologies. Such a signal may indeed incentivize utilities to invest more with their unregulated affiliates where returns (after correcting for all risks) can be superior to investments in the monopoly utility.
Nevertheless, distribution utilities will undoubtedly have concerns about handing over grid operations to an IDSO. Policymakers may therefore want to provide incentives for utilities to make that transition. Utilities, for instance, could potentially receive additional basis points on their regulated rate of return for operating distribution assets that are used and useful. This would be similar to an existing incentive for independent transmission owners, who get an additional return on equity for their investment when they join an RTO and cede operation of their transmission assets to the RTO.
Enabling the New Market
The utilities have a number of resources that can significantly drive down cost for DER providers, especially solar DG companies. These resources include a broad customer reach, call centers for customer service, and access to lower-cost capital. Programs could be structured in an open, transparent, and non-discriminatory manner so that all third-party DER providers could leverage these resources for a cost-based fee set by the state commission. Examples include:
• Consumer Outreach. Solar companies could pay a utility to educate consumers and generate leads, or they could contract the utility to leverage its call centers and billing systems to service solar customers.
• Simplified Billing. Solar customers could be given the option to participate in an opt-in program in which they can pay for energy from their solar system and from the grid on the same utility bill. This "onbill repayment" mechanism would simplify billing and help protect against customer default; by reducing credit risk for third-party solar DG providers, onbill repayment would lower the cost of capital for solar DG. Onbill repayment would be made available for a cost-based fee to all who finance and own solar DG systems.
• Project Registration. To guard against preferential treatment for the interconnection of solar DG systems, the IDSO would keep transparent records and establish a public dashboard to track which projects are in the queue for interconnection. Again, a cost-based fee could be assessed on third parties.
• Local Zoning Inspections. Where system inspections are required by the municipality, the municipality could allow the IDSO to perform all inspections for solar DG systems within its regulated territory, removing the need for multiple inspections by different municipal authorities. Consolidating inspections under one entity would help drive standards and reduce costs for customers. The IDSO would keep transparent records on inspections, including an explanation if a system fails the inspection. This would not only protect third parties against discriminatory inspection processes, but would also standardize best installation practices, keeping the contractors accountable for their workmanship and accountable to all grid users. A fee set by the state commission could be assessed to cover the cost of inspections.
A Utility Role In Front of the Meter
During the IDSO's distribution system planning, there may be appropriate opportunities based on system optimization and other parameters for DER assets to be located on the utility side of the meter. These assets could include storage (chemical batteries, capacitors, flywheels, etc.), distributed community solar PV, co-gen serving multiple properties, voltage regulation, district heating/cooling, or other resources. Under certain circumstances to be determined by the IDSO and commissioners, it could be appropriate to permit the distribution utility to invest in these assets as long as this is done in a non-discriminatory manner that provides similar opportunities for 3rd party DER resource providers.
For example, there are numerous instances where third-parties cannot readily realize the public benefits of solar DG, precisely because the benefits are public and hence not easily monetized. These instances include: (1) siting DG systems in locations with high grid congestion; (2) replacing or reducing use of fossil fuel generators with solar DG in areas already suffering poor air quality; (3) providing solar to households normally disqualified by solar companies (e.g., renters, condo owners, and homeowners with low electric bills or inadequate roof space); and (4) using solar DG systems as distribution assets to provide grid services. A recent paper published by the Solar Electric Power Association, for example, describes a variety of ways in which the smart inverters of DG systems can be used to provide both proactive and reactive grid services.
For these special cases, the sales, equipment and installation could be competitively sourced while the utility could provide the financing and recover the cost through rate basing the investment. In an ideal world, financing DG assets for these special use cases should also be competitively sourced. However, this may be impractical, as capital for solar financing in competitive markets remains in relatively short supply. (In a recent analysis, GTM Research finds that $18 billion is needed to finance all third-party owned systems between 2012 and 2016, while only $9.5 billion has been announced by third parties thus far.) In fact, these special instances of utilities owning solar DG on the utility side of the meter may stimulate additional supply for solar financing by lending it more credibility, providing more public data on system performance, and fostering standards on financing agreements and equipment specifications. Furthermore, a limited allowance for the incumbent utility to rate-base solar DG on its side of the meter may augment the incentives for the utility to cede operations to the IDSO.
A Less Centralized Future
The traditional electric distribution monopoly model is increasingly out of sync with prevailing electricity market trends and rapidly expanding DER adoption. In the days when serving the public meant building centrally located, large-scale infrastructure projects to accommodate an ever-growing demand for electricity, granting companies an exclusive franchise and rate-basing might indeed have been the best way to align investors' interests with the public interest. Today, delivering safe, reliable, and affordable electricity is not enough. The public demands more efficiency, less pollution, greater grid resiliency, and more individual control. Furthermore, new technologies and business models have eroded utilities' economies of scale advantage, and distributed energy systems increasingly meet evolving public needs better than the traditional centralized generation model.
Today's debates about utilities and the grid assume that grid operation by regulated utilities is inviolable because it serves the public. The real question is whether the current regulatory model is still the best way to do that. We think it's not. Does that mean utilities face an inevitable death spiral? No. We should reform utilities and change the way they recover costs. And the recovery of those costs must reflect which grid services are best delivered by a monopoly-owned asset and which should be provided in a competitive environment.
To encourage more innovation and fully harness its benefits, a new regulatory construct is needed - a construct that leverages providers and their technologies based on merit and free market competition. It is imperative that we separate grid operation from grid ownership and delegate operation to an IDSO. This does not mean utilities should stand aside as DER proliferates. On the contrary, this is an opportunity for utilities to be active participants in the ownership, maintenance, and upgrade of their monopoly assets. And it also provides their unregulated affiliates opportunities outside their monopoly service territories when they compete fairly by developing their own capabilities, acquiring them from others, or partnering with third parties.
Article image: © Can Stock Photo Inc. / Anterovium