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Disruptive change in the electricity grid - the need for a new paradigm

March 1, 2015

We and other energy-policy commentators have written recently about the proposed monetization of Hydro One. Much of the discussion to date has been in the express context of efficiency and cost-cutting, or simply in the rubric of extracting value from Crown-owned assets to fund infrastructure projects.

But there is a broader, more fundamental context in which Ontario policy-makers and commentators should be considering the proposed monetization of Hydro One. Regulators, energy policy-makers and savvy utilities are increasingly concerned about looming disruptive change in the business of transmitting and distributing electricity.

Energy Efficiency and the Erosion of the Conventional Utility Revenue Model

For some years now, utilities have been concerned about the erosive impact of conservation and general energy efficiency on their revenues. Even as customer numbers and energy consuming applications have been increasing, technological innovations in energy using appliances have rendered the operation of households, businesses and industrial processes more energy efficient. These trends result from both rising energy costs, and from a general social awareness of the impact of human activity on the planet. Government and regulatory appetite for encouraging, or enforcing, energy efficiency and alternative energy sources has responded. The undeniable impetus for ways to do more with less energy consumption has, and continues to, grow. The result has been that per customer volumes of energy consumed have been generally flat (less is used per application, even as more applications are emerging), or even shrinking. This poses some financial challenges for utilities.

When per customer use was growing, and utilities were building to serve new customers, much of the revenue required by utilities was collected in the volumetric portion of their rates (a unit rate applied to the total amount consumed). This way, those customers who use more pay for more of the costs of the system. With customer usage declining, so too are revenues generated by volumetric charges. Changes to rates have lagged these trends, and utility revenues have been squeezed as a result.

The conventional utility reaction to manage these revenue impacts has been to seek to allocate a greater portion of costs to the fixed component of their rates (the monthly, flat rate “customer charge”). The Ontario Energy Board has even considered the option of a completely fixed rate distribution charge.[1] This approach is said to reflect the value to the customer of the grid being available to serve them, which value is not dependant on how much they use it. Up to a point, this approach stabilizes revenues in the face of declining per customer consumption.

This conventional utility solution only works until one (or both) of two things happens. If the fixed charge were to get higher than is palatable for regulators, the growth in the fixed charge could be capped, and declining volumes would result in “stranding of assets” (i.e. the recovery of certain costs would not be possible). Considering that the impact of the fixed charge approach is “regressive” from a low-volume (including low-income) consumer perspective, this is a very real risk. Alternatively, as self-generation technologies emerge and decline in cost, fixed charges could get higher than palatable for some customers, and the cost of being connected to the grid to back-up personal generation systems may become no longer worth the benefit of the connection. As these customers start to migrate off of the grid, the grid costs are left behind to be recovered from fewer remaining customers, the problem gets bigger, and the impetus for change accelerates. This 'grid flight' is already a reality facing centralized utilities operating in regions of the world where delivered electricity costs are high.

Disruptive Technology

Enter "disruptive technology", and the pace of this change in the utility business increases dramatically.

The most talked about example of a disruptive technology in the utility business is the combination of solar power and an affordable and powerful new battery system. The cost of photovoltaics is coming down quickly, at both grid scale and individual customer scale, and work on new and better batteries is proceeding at a furious pace. Batteries solve the “intermittency” problem of renewable electricity generation. These new systems provide increasingly affordable self-generation options which can be fuelled for free, can be scaled from residential on up, and can provide reliable energy on call. With additional security of supply through the redundancy provided by community (or industrial park or commercial complex) based micro grids, these systems become both viable and reliable. They essentially eliminate material line losses. They preclude the need to deal with power company bureaucracies. There are no frustrating billing or customer service issues. There is a whole stable of emerging distributed energy systems service providers primed for competition and customer service.

The technological advances and cost decreases offered by these technologies will disrupt the centralized utility business model of the last century.

Whither the traditional utility?

What happens to our current electrical utilities under this new model? They either change, or collapse in a messy heap of stranded costs and outdated solutions.

Successful adaptation will require a number of things. One of them is a regulatory rethinking of the transmission and distribution model, and business. Another, key thing is capital to invest in remaking that business. Yet another is the ability to take, and manage, emerging risks.

One of the challenges facing the utility sector is how to sustain current distributors while allowing their successors to emerge. It has been opined[2] that the time for utilities, regulators and policy makers to act on these challenges is now, while conventional utilities still have sufficient revenue available and sufficient fiscal health to remake their businesses.

Rethinking Hydro One

What should be abundantly clear is that things will change. In anything longer than the short term, the status quo is simply not an option. The sooner we focus on what to change, and how to change it, and forget about the whether to change, the better, and cheaper and less disruptive in the long run.

All of this brings us back to the discussion of Ontario’s electricity utilities, and the restructuring and the monetization of Hydro One. This discussion should not be confined to the context of protecting Crown-owned monopolies and mid-twentieth century notions of "public power". This discussion should be undertaken in the context of technology that is evolving so rapidly that simply keeping up is a huge challenge. The assumption and management of risk and the quick and strategic deployment of capital to capture emerging opportunities is an imperative. Ontario’s current, fragmented and provincially/municipally owned distribution sector is ill equipped for any of these things.

Tomorrow will most certainly look different from today. Electricity policy, including electricity policy in Ontario, must react. Clinging to historical notions of utility ownership and operation will only hasten what many informed commentators see as a looming disruption of our utility system.


[1] See generally the OEB’s Distribution Revenue Decoupling process, EB-2010-0060.

[2] There is a very well thought out paper by Elisabeth Graffy and Steven Kihm that addresses these topics in a recent edition of the American Energy Law Journal (Volume 35, No. 1).

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