Industry Market Trends

Are Electric Utilities Too Big to Fail?

May 24, 2013

Pacific Gas and Electric is struggling to compete with residential and private solar power in California. Credit: franky242. Pacific Gas and Electric is struggling to compete with residential and private solar power in California. Credit: franky242.

Pacific Gas and Electric (PG&E), the nation's seventh largest investor-owned utility, has more retail customers than any other. Like many utilities, they offer a variety of services, including the installation of solar PV systems that allow customers to generate their own power while selling the excess back through net metering.

Due to a number of factors including state utility regulations and dynamic market forces, PG&E, despite its size, is finding itself unable to compete on price with private solar contractors.

At the same time, its current residential electric rates, which run between 31 and 35 cents per kWh are high enough to drive more customers toward solar, where they become sellers rather than buyers. Even those for whom PG&E performs the installations, the solar panels are ultimately cutting into the company's profitability.

Similar "solar revolutions" have already occurred in Hawaii and Australia. This loss of revenue is likely to drive their prices even higher as solar costs continue to fall, a bleak prospect for the company that could potentially grow into a death spiral.

You might not be that enamored with your power company. But like them or not, we will still continue to need utilities and the grid, storage, and transmission infrastructure they maintain for the foreseeable future. And as abundant as the solar resource is, it cannot stand alone without supplementation or storage for those times that the sun is not shining.

At first glance this could appear to be a uniquely Californian dilemma, based on the state's regulatory environment and net metering laws.

But, in fact, it's part of a much larger trend. The advent of distributed solar, which has allowed customers to not only bypass the meter, but run it backward, has created an economic dilemma that can be seen in some ways as analogous to that of the music industry. In this case, customers are, in essence, "downloading" their power from the sun, eliminating the need to purchase it from the companies that have traditionally sold it.

In fact, industry trade association the Edison Electric Institute, recently issued a report entitled Disruptive Challenges, which questions the financial impact of changes coming to the retail electricity market via new technologies such as renewables and efficiency measures, both of which, however good they might be for the environment, will take away a large and growing chunk of their business.

Solar power today provides only a little over 1 percent of the total electric supply. But given the long-term nature of utility investments, which often have time horizons of 20 to 30 years, there is real concern that there could be "stranded cost risks" down the road, especially with solar equipment costs dropping like a rock and the market expected to hit grid parity next year. Indeed, investor groups are beginning to questions utilities about a potential coal bubble.

For most of its century-long existence, the utility industry has been cyclical in nature, generally responding to fluctuations in the economy, but steadily growing over the long term. But what, asks the report, "happens when electricity sales growth declines and that decline is not cyclical but driven by disruptive forces, including new technology and/or the further implementation of public policy focused on DSM (demand side management) and DER (distributed energy resource) initiatives?"

What we're talking about here is the difference between cyclical and secular trends. The first is temporary and usually within a narrow range. The other is powerful and long-term -- or permanent. It's certainly not an idle fear. It has happened before to a growing number of industries, whose services became obsolete virtually overnight. Just think, for example, about print media, photography, record companies, and now the U.S. Postal Service.

Secular change is already sweeping the utility industry in Germany, where solar is well ahead of the United States, thanks to aggressive government incentives. Solar installations, virtually all privately owned, delivered a full 22 percent of Germany's power last year. But with so much power coming from the sun, especially at peak midday periods, the traditional sweet spot for utility revenues, power companies are suddenly selling less power during the day and more at night, when rates are lower.

Big power plants were not designed to turn on and off frequently, and they don't run efficiently that way. The EEI report warns of "irreparable damages to revenues and growth prospects" under these conditions.

Under the current model, there seems be little choice but for prices to go up, perhaps dramatically, which in turn, could persuade even more people to go off the grid.

Here in the United States, we don't have the same kind of feed-in tariffs that Germany has, although 43 states have net metering laws, which provide a mechanism by which the utilities must buy excess power from subscribers at rates that vary by state.

These are the kinds of issues that Rocky Mountain Institute's eLab, a broad-based stakeholder consortium centered around the electric utility industry, in which PG&E is a participant, is trying and come up with new business models for tomorrow's utility environment.

Lena Hansen, RMI's facilitator of eLab told me, "If you put solar PV on your roof, you are providing excess electricity to the grid, but the grid is also providing a service to you (i.e., an uninterruptible backup system). So, right now there are conflicts over things like net metering. And it's all rooted in the lack of clear understanding of the value drivers and the cost drivers around the table. It sounds like a trivial thing, but if we can't work out the pricing, then we can't move forward."

EEI is asking that all users pay a flat fee for infrastructure (which many already do), plus a charge for solar users to cover "off-peak service, back-up interruptible service, and the pathway to sell [distributed energy resources] to the utility or other energy supply providers." Whether or not that works out remains to be seen. If not utilities could be facing a solar storm.

On top of all that are the costs that climate change is already imposing on utilities, an amount that, just for the period from the 2011 summertime drought through superstorm Sandy, is estimated in the hundreds of millions. Shortages of water, on which thermal power plants depend heavily, could drive those plants to reduce capacity or even shut down at times when they might be needed the most. This would not be good for the companies or for the customers they serve. Realizations such as these have caused industry executives like Xcel Energy CEO Richard Kelly to come out in favor of a carbon tax.

So here is the dilemma in a nutshell. Today's rate structures do not reflect tomorrow's technology or business models. Various interests are at cross-purposes, interests that will need to cooperate if we are going to have an orderly transition. This is not a problem that will go away by itself. Nor can we afford to allow the big utilities to collapse, or for that matter, to look to the government for bailouts.

What we need, according to RMI's Hansen, is "for everyone in the sector -- the utilities, the regulators, the solar companies, the environmental NGO's -- to have a shared and consistent understanding of what all the value streams are for renewable energy, and what the costs are to support their integration into the system. With that common understanding, it becomes much easier to develop and adjust business models and rate structures and things. I think that that would really change the conversation and affect the transition to more effective business models."