MEMO TO UTILITIES: Innovate or Else

For investor owned electric power utilities, our current economic, market and ratemaking conditions today look a lot like the beginning of the 1970’s.  After a period of real growth, demand has stalled along with the economy, new technologies are being introduced and loom over the industry, and the spending binge of the Federal government risks a wave of high inflation on the horizon.

Utilities today are trying to ease into the future following the lead of politicians and regulators to add more renewable energy, reduce greenhouse emissions from fossil fuels, adopt smart grid technologies and do it all faster.  Going along to get along may end up being the riskiest strategy of all for traditional utilities in the years ahead.  The lessons of history across industries are that those who do not innovate, adapt and change in the face of changing conditions get swept aside by new entrants, using disruptive technologies to change the rules of the game.

“Those who do not learn from history are doomed to repeat it.”

For over one hundred years the traditional central station utility business model has served us well.  It provided high quality, reliable service.  It drove down the marginal cost of new power plants.  It leveraged average cost pricing to provide the best value for ratepayers.  And utilities learned the most important core competencies very well:  keep the ratepayers quiet and the regulators happy.

This steady as you go incremental approach to growth worked well in the turbulent days of the 1930’s and 1940’s to maintain stability.  It also worked well is the post World War II growth of suburbia, the return of the warriors to create a post-war industrial boom, and the continued extension of the power grid into rural and remote areas of the country. America became a great trading country and economic power to match its great military strengths in this age.

For generations coal was the fuel of choice because it was cheap, available and ours as the saying goes.  Oil fired generation served coastal regions where deliveries were easy and prices were low. As America grew the power industry grew right along with the economy.  Life was good.

Then along came the 1970’s with international conflicts, oil price spikes, nuclear power and its scourge of inflation.  Rising costs and new technology in this inflationary period almost killed the electric power industry under the combined forces of ratepayer revolt over rising utility rates, rising marginal costs reversing the trend of the previous fifty years, and politicians and regulators looking for someone to hang for the problems it caused them.

There are some who blamed the environmental movement for changes that piled on problems for the electric power industry, but that misreads history.  If anything, the growing public demand for a cleaner, healthier environment to raise young families, clean up the air and water, and stop despoiling the countryside was in perfect harmony with the growth and awakening of the American Dream.

The growth in demand and the adverse impact of inflation on rates blended perfectly with our growing environmental awareness and ultimately produced wholesale competition in power generation in an attempt to use the market place to drive down rising marginal costs for incremental power additions.  It worked beyond our wildest dreams.  As utilities divested older dirtier power plants, new owners bought them, fixed up the place, and turned them back on running them much more efficiently, investing capital in new equipment, and dramatically reducing their adverse environmental impacts.

In an independent study we did at Global Energy Decisions called “Putting Wholesale Competition to the Test” we studied the performance of divested power plants before and after their sale.  The study was designed to brief Congress on the relative performance of power plants under traditional utility regulation versus wholesale power competition.  We found that those “fixer-upper” power plants turned from ‘dirty ole dogs’ to ‘all-stars’ when operating under competitive market conditions.  The most amazing result of the study was the finding that the sum of the energy efficiency from the divested power plants after repowering was enough to power 25 million American homes for one year!  That is the power of competition at work.

So what?

Today the electric power industry faces a new set of challenges to its business model from the three-headed hydra of renewable energy, emissions reduction and smart grid.  If it studies its own history it will realize that it must innovate or face another near-death experience in the face of these challenges.

Some utility executive will respond, I suspect, telling me they are innovating.  Look at their investments in smart meters.  Look at the growth in renewable energy in their portfolio.  Look at what they have already done to clean up emissions by adding scrubbers to older plants or replacing them with newer ones.  All of that is true, but it is not likely going to be enough to save them from the barbarians at the gate.

What must utilities do to thrive and change for the future?

  • GIVE CUSTOMERS MORE CONTROL OF THEIR ENERGY FUTURE WITH INFORMATION AND CHOICES.  Just like letting your daughter go out on her first date, utilities must learn to trust their customers will do the right thing when given the best information and options.  Utilities are accustomed to controlling their customers not enabling them.  This must change.  Your customer is going to ‘date’ new entrants—get used to it.  Wholesale power generation competition diminished utility power plant construction as the core of the central station generation business model.  But utilities converted power plant construction to supply procurement and still manage the utility portfolio essentially the same top down way.  Regulators desire for more RPS market penetration is getting utilities back in the business of supply ownership in small doses focused primarily on renewable energy to meet targets.  These strategies are necessary for regulatory compliance today but are not sufficient to meet the fundamental change needed to trust customers and enable them to make informed choices to meet their energy needs.  To avoid losing customers to aggregators in the future the regulators must find ways to enable the utility invest capital and provide services to empower aggregated customers live into a distributed energy resources future using virtual power plant strategies to harness demand response, energy efficiency and distributed resources making customers a partner with their utility for a clean energy and environmental future.
  • SMART METERS ARE NOT THE SAME AS A SMART GRID.  Utilities are wasting customer goodwill by starting the deployment of smart grid technologies with smart meters.  The benefits for customers are too far off, but the costs are too real to make this strategy successful.  I know, the Federal Government is stimulating this transition, but it is doing a lot of other suboptimal things too.  Utilities should focus on distribution system automation, transmission expansion to interconnect renewables and the hard work of upgrading the backbone transmission infrastructure before any of those smart meters will be used and useful for anything more than reducing utility meter reading costs. The states are today a big impediment to the changes in interstate electric transmission needed to live into the smart grid promise because they want to protect their authority over siting, funding and control over resources.  Imagine the internet built state by state—it’s the same problem.  It won’t work.
  • CUSTOMER AGGREGATION AND HOME AREA NETWORKS.  Utilities must turn their service model on its head focusing on technologies available today—not just smart meters—to enable the faster evolution of home area networks and net zero building efficiency to transform their relationships with customers into one of self help, self management and participation in the clean energy aspirations.  PG&E recently fought a losing ballot war in California trying to prevent community customer aggregation.  Instead it should have invested that money in facilitating it and then offering those customer groups a wider menu of efficiency, demand response, distributed generation and other services.  Doing so makes PG&E and other utilities partners with customers not trolls at the bridge. The biggest threat utilities face in the future is loss of control over the gateway to the customer from the EnerNOC, Microsoft HOLM, CSCO, Google Energy and other new entrants seeking wallet share growth in equipment and services from those customers.  The Utility has a better than even chance to capture that revenue growth since customers know it, trust it and already have a business relationship with it—don’t waste that competitive advantage.

And that is the message to Utilities in the memo

Don’t let your customers get away while you worship at the central station generation business model of the last hundred years.  Fuel demand for power generation is the growth engine of the utility future-–not industrial demand (that went offshore), not commercial demand (that’s going cogen or to EnerNOC-like energy managers.) Utilities must quit treating residential customers as if they are the provider of last resort.  Imagine the next hundred years as a time of customer aggregated demand, distributed energy resources linked with tools to engage customers as partners in living into the clean energy economy and controlling their own energy costs.  Give them access to technology they can use.

A million solar roofs is an audacious goal but a million aggregated customers looking for someone to serve their needs when the utility cannot satisfy them represents the clear and present danger to the traditional utility business model—unless the utility finds ways to adapt in ways to be the aggregator of choice in a competitive distributed energy (plus other stuff) future.

The real threat to the utility business model is that the game is no longer just about energy.  It is about information, choice and control over options and their competing price impacts on rates. It is about transformation of the business relationship from buying commodity energy to buying bundled lifestyle-based service packages that include but are not limited to energy services. It is about our aspirations for a clean energy future we can afford and a control over our impacts we can feel good about for our future.

The real competitive threat to utilities is not wholesale power generators but new entrants who aggregate energy and other services such as telecom, internet, security, entertainment, insurance, and self-sufficiency in packages that life into their segmented lifestyles, business needs or aspirations.

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