Why the utility industry is ripe for disruption

Why the utility industry is ripe for disruption

[Editor's note: Peter Kelly-Detwiler will be a featured speaker at the upcoming VERGE Boston event on May 13-14.]

In March, the Harvard Business Review came out with a new piece on innovation by Larry Downes and Paul F. Nunes that may become an instant classic.

They posit that disruptor innovators often now come from entrants who aren’t even from the industry, that products can enter the market quickly, and masses of customers can switch in extremely short timeframes, resulting in what they call “Big Bang” disruption.

Many of these new disruptive products do well in an information technology world, with the advent of pervasive computing and mobile phones. The eBays, the Amazons, the IOSs and Androids thrive while everybody else struggles to understand how they build their apps to fit this new and evolving world.

Downes and Nunez warn, “Big bang disrupters may not even see you as the competition. They don’t share your approach to solving customer needs. And they’re not sizing up your product line and figuring out ways to offer slightly better price or performance with hopes of gaining a short-term advantage. Usually, they’re just tossing something shiny in the direction of your customers hoping to attract them…” If your competition is not gunning for you, but simply creating something new to see how it goes, how do you compete?

In the world of electricity, it could be argued that the landscape is different, that this paradigm does not apply. After all, generators still must produce electrons and regulated utilities still must deliver the electricity to ratepayers (even if competitive suppliers offer different prices for the electrons delivered). And utility investments still are approved by public utility commissions for a fixed rate of return.

And yet the innovative forces that have driven change in other industries are hard at work in the electric energy industry as well, and they are coming at it from all angles.

Most of the potentially disruptive innovation is coming from behind the meter, from new entrants – companies funded by angel investors and venture capitalists. The solar space alone is crowded with dozens of technologies and actors. Other companies focus on cost-effective storage, small wind, high efficiency on-site generators, electric vehicles and smart thermostats. We may well be watching the beginnings of a new – and very complicated – electric ecosystem evolving.

With the continued and rapid march of technology, it’s probably only a matter of time.

In markets where electricity prices are high, big-bang disruption is happening. Take Germany, where solar power on residential rooftops is much cheaper than in the United States (approximately $3 per watt vs. more than $5 in the U.S.) There, farmers and private individuals own more than 50 percent of the solar output in the country, and the output is now significant enough that CEO Peter Terium of RWE — one of Europe’s top five electric and gas companies — noted last year that solar was having a profound impact on his business: “Our core markets are changing remarkably fast.” With 32 gigawatts of solar — 40 percent of that on residential rooftops — consumers now interact with the market in ways that are unprecedented. Terium also said, "Almost no other industry is currently undergoing such dynamic change as the energy sector. …The success of this transformation of the energy industry will be decided at the local level."

In fact, with solar, as well as increasing end-use efficiencies. RWE now forecasts continually declining electric sales from 2011 to 2035, with the mid-afternoon demand dropping from just over 24,000 MW to 19,000 MW.

Australia is looking at similarly rapid and significant changes, and is expected soon to have the highest penetration of rooftop solar on the planet. Australian utilities also are dealing with similar dynamics, and looking to find new ways to remain relevant.

The Future of U.S. Power Markets

Three key items will interact to determine the future course of U.S. power markets:

1)     Technology

2)     Pricing of electricity, and

3)     Consumption and pricing information

Technology: New behind-the-meter technologies are sprouting everywhere. The number of electric vehicles is expected to surge to 1 million in the U.S. by 2020, with significant implications for the power grid. Solar prices, which fell by 27 percent just last year, have the potential to fall further. Other technologies may follow similar paths.

Pricing: An increasing number of regional power markets are moving to hourly pricing, to reflect the costs in supplying electricity at different times and to promote efficiencies. Texas is the most extreme example of what this scarcity pricing will look like. Last year, the Utilities Commission, in a bid to increase incentives for new generation, voted to allow hourly price caps to increase over the next several years. Prices, which averaged just over $50 per megawatt-hour last year, will be allowed to rise to as high as $5,000 in 2013, $7,000 next year, and $9,000 in 2015.

In most of the U.S., customers already can get hourly pricing from competitive energy suppliers, and approximately half the electrons sold are already on contracts indexed to the spot market. So, while hourly pricing is being introduced in many markets, for a large portion of customers, it is already here.

Information: The main critical elements are relatively simple: pricing and usage data. While very basic, without them, the smart gird will remain a simpleton. Smart meters that provide hourly usage to the customer at the end of the monthly meter read cycle are not very smart. If meters do not provide real-time usage to customers or their automated devices, those customers or devices cannot interact with the market and activate their latent elasticities. That is, they cannot make intelligent decisions about how much to consume within the context of both usage information and prices. (Elasticities are simply defined as how much your demand changes as a function of price. If a loaf of bread costs $3, you’ll probably buy one loaf. But if it goes on sale for $2, you might buy two loaves.)

For example, if prices in Texas on a hot day surge from 15 cents a kilowatt-hour at night to $5 during the afternoon peak the next day, and you don’t know anything about your usage or the price until a few weeks later, what good is scarcity pricing? But if you do know, you will change your consumption patterns.

Similarly, storage devices will “know” when to store power and when to release it, providing benefits not just for the storage owner, but for all consumers, because overall marginal costs will be reduced (not just for that day, but also because dampening volatility will reduce long-term wholesale forward curves for electricity; if you can wring out volatility, you can lower prices). These savings are significant: the Pennsylvania New Jersey Maryland Power Pool estimated that in one year, $5 million of demand response payments saved consumers over $500 million in energy costs. This improves overall economic competitiveness. It saves jobs.

For this marriage of technology, markets and customers to happen, the inevitable question becomes: Who should supply the pricing and real-time usage information to customers? Currently, the utilities have the same public-service mandate they always have had: to provide reliable electricity service to society. They still will need to provide electrons from the power plant to the customer. They increasingly will have to integrate a larger number of assets on the system. For example, they may take surplus power from customers’ solar units during the day, and provide power back to the customer at night.

Utilities will continue to serve as the central physical infrastructure, providing the most efficient and cost-effective spinal column. However, they also have the potential to become the central nervous system of the entire network. The full realization of “smart grid” will not and cannot happen without near-instantaneous pricing and usage information.

Utilities would be the logical choice to assume this role of information provider: The development of the requisite infrastructure is a big, capital-intensive undertaking and it relies on information from wholesale power markets and utility meters. Utilities already have access to the meter data, and they also have relatively large IT systems that can handle high volumes (although they will need to become much larger).

Under one conceivable model, the utilities could provide real-time hourly usage data (as well as years of historical data) online to anybody with an account-specific password. They could charge a monthly subscription rate for this service (it won’t be cheap to set up the additional IT infrastructure and change the existing business model). Retail energy providers, storage companies, micro-grid developers, electric car companies — any entity looking to figure out the economics and optimize participation of assets in the market — could access the data and incorporate it into their planning and their real-time activities.

With this approach, everybody wins. New market entrants aren’t faced with the current costly and labor-intensive approach of getting data that greatly impedes innovation and efficiencies. Customers are able to more efficiently interact with markets. Best of all, overall electricity prices would be lower, because customers are able to more aggressively respond to market prices and curtail when prices are high.

The technology genie already is out of the bottle. Solar and other behind-the-meter efficiency and generation technologies are coming. U.S. utilities are shortly about to face the challenges already evident in Germany and Australia — declining sales volumes, a need for new revenue streams and a strategic imperative to stay relevant to the customer. Their roles as we know them are in potential jeopardy.

So we could embark on an initiative to have utilities provide this information to their customers and vendors, and mobilize the resources to make it happen. Or we could simply muddle along piecemeal as we do today, impeding innovation, paying too much for our electricity, and becoming less economically competitive as a society.

We have some choices to make, but we must be clear about our decisions and make those choices soon. Failure to act is a choice as well, but it serves nobody in the long run.

Image by alexmillos via Shutterstock