Commentary: Why electric utilities must update their business models

Due to a variety of factors, the traditional business model for the nation’s investor-owned electric utilities, such as TXU or Reliant Energy, is in trouble.

In fact, these factors – led by a rapid movement away from the decades-old system of generating electricity from large, centralized power plants and distributing it to customers over an interconnected grid – is rapidly giving way to a new, decentralized structure that features varying types of distributed energy resources (DERs), most notably rooftop solar.

In utility parlance, distributed generation technologies are “disruptive.” Along with the growth in energy-efficiency measures and other technologies, DERs have significantly slowed electric load growth and – though it may not be recognized as such quite yet – could ultimately sound a death knell for utilities that have historically made money based on the volume of electricity they sell.

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Put another way, utilities may soon face a future in which they will have trouble recovering fixed costs and making a profit.

It remains to be seen how utilities will react to these developments — and how the changing landscape will pan out for consumers. But we all have an interest in a stable model that keeps the lights on. If a local distribution company goes bankrupt, customers would no longer be able to switch electricity providers, even in areas that allow competition. And, since there are only one set of poles and wires, the utility bankruptcies could mean the government would have to take over to ensure the continued operation of the grid.

In response to these developments, several states including California and New York are looking at alternative business models to incentivize and integrate distributed resources into the grid.

Some experts have suggested that the “platform” business model, which creates value by facilitating exchanges between two or more groups, should be applied to the electric industry. Supporters of such a model envision the electric grid evolving into a platform on which DERs – including rooftop solar, energy storage, electric vehicle batteries and energy-efficiency products – bring in new revenue to the utility. However, so far most new products —like the Nest thermostat — save customers money but reduce utilities’ revenue.

During the spring semester, I taught a course with Fred Beach that delved into these issues. The graduate-level class, funded by the Energy Institute at the University of Texas, required students to examine six new and proposed business models and draft a report summarizing their findings.

Students analyzed each of the models to examine how they recovered fixed costs, made a profit, incentivized DERs and engaged customers.

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The report found that although many of the new models appear to be effective in promoting DERs, utilities probably would struggle in a high-DER scenario. Specifically, the students found that most of the cost-cutting benefits would be achieved as DER spread. However, once the deployment of additional rooftop solar, energy storage and other energy resources reached a saturation point, they would no longer benefit the electric grid — while still providing savings to customers who implemented them — and become a cost burden for utilities to integrate.

In the end, the students found that the loss of revenue ultimately could lead utilities to revert to a standard cost-of-service model to recover costs.

Their report also concluded that when rooftop solar and other DERs achieve mass deployment, conventional electric utilities may find that nonprofit business models such as electric co-ops, municipal utilities or nonprofit corporations have the most stable futures. In any case, their future profit potential is very limited in the face of expanding, customer-owned distributed resources.

As for operation of the electric distribution grid, the students’ research suggests that an independent system operator like the Electric Reliability Council of Texas may be a more efficient way to operate the grid on a local level.

Duncan is a research fellow with the Energy Institute at the University of Texas. He formerly served as general manager of Austin Energy, the city’s municipal utility.

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