TODAY’S STUDY: BACK TO THE DRAWING BOARD FOR U.S. ELECTRICITY SOURCING AND DELIVERY

Rethinking Policy to Deliver a Clean Energy Future

Hal Harvey and Sonia Aggarwal, 2013 (Energy Innovation)

Executive Summary

The electricity system in America, and in many other nations, is in the early days of a radical makeover that will drastically reduce greenhouse gas emissions, increase system flexibility, incorporate new technologies, and shake existing utility business models. This is already underway: it is not speculation. Managed well, this transition will give America a great boost, building a cleaner, more affordable, and more reliable grid, as well as an industry ready to profit from deploying its technologies around the globe.

America has an opportunity to lead the world in a vast power system transformation. As costs of renewable energy technologies decline, experience across the world is demonstrating that it is easier to integrate much higher shares of renewables, more rapidly, than previously thought. But a clear policy signal is required to drive efficiency and then switch to ever-greater proportions of clean power.

America’s power system is remarkably diverse, and there will be no one-size-fits-all solution for this transformation. Conversations about the best way to keep costs low, keep the lights on, and deliver a cleaner power system are often plagued by arguments over whether utilities or markets are king, or whether legislators or regulators are driving system evolution. There is no “right” answer to these questions: America’s power system is heterogeneous, and will remain so. Change will happen on a regional basis, and innovative partnerships must be forged between previously-siloed decision-makers.

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Depending on each region’s history and preference, well-designed markets or performance-based regulation can be used to accomplish power system goals of low costs, high reliability, and environmental performance. Top policy recommendations include:

1. Move away from rate-of-return regulation; use performance-based regulation that gives utilities the freedom to innovate or call on others for specific services. Separate the financial health of the utility from the volume of electricity it sells.

2. Create investor certainty and low-cost financing for renewable energy by steadily expanding Renewable Electricity Standards to provide a long-term market signal.

3. Encourage distributed generation by acknowledging customers’ right to generate their own energy, by charging them a fair price for grid services, and by paying them a fair price for the grid benefits they create. Set a clear methodology for allocating all costs and benefits.

4. Ensure that all markets (e.g., energy, ancillary services, capacity) and market- makers (e.g., utilities) include both demand- and supply-side options. All options—central and distributed generation, transmission, efficiency, and demand-response—should compete with one another to provide electricity services.

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5. Employ electricity markets to align incentives with the desired outcomes, such as rewarding greater operational flexibility. Open long-term markets for new services such as fast-start or fast-ramping

6. Before investing in technical fixes to the grid, first make operational changes that reduce system costs, enable more renewables, and maintain reliability. For example, coordinate between balancing areas, dispatch on shorter intervals and use dynamic line rating to make the most of existing transmission lines.

7. Mitigate investor risk by adopting stable, long-term policies and regulations with low impact on the public budget. Financial policies should be predictable, scalable, affordable to public budgets, and efficient for investors.

8. Reduce siting conflicts by using explicit, pre-set criteria; ensuring access to the grid; respecting landowner rights; engaging stakeholders early; coordinating among regulatory bodies; and providing contract clarity.

The U.S. power system is at an inflection point. New technologies offer great promise to increase reliability, reduce fuel costs, minimize capital investment, and reduce environmental damage. Capturing these benefits requires a new approach to utility regulation and business models—no matter if the power system is driven by a vertically integrated monopoly, by a competitive market, or by a hybrid of the two.

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Introduction

The electricity system in America, and in many other nations, is in the early days of a radical makeover that will drastically reduce greenhouse gas emissions, increase system flexibility, incorporate new technologies and shake existing utility business models. This transformation is already underway: It is not speculation. Managed well, this transition will give America a great boost, building a cleaner, more affordable and more reliable grid, as well as an industry ready to profit from deploying its technologies around the globe. Managed badly, we will spend too much time, money and pollution on obsolete power plants, leave our country increasingly exposed to system failure and let our energy technology businesses slip to the back of the pack.

The stakes are high: Every single part of our economy requires reliable, affordable electricity. And the world requires a climate that does not drown our cities, dry up our farms, decimate our planet’s biological diversity or leave us vulnerable to mega-storms.

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There are three factors driving change in America’s power sector. First, a large number of new technologies are becoming commercially viable. Power generation technologies like solar (prices down 80 percent in the last five years) and wind (down 30 percent in the same period) are gaining market share.1 Last year, the United States added more wind than any other kind of generating capacity.2 Smart engineers are rethinking the grid, to transform it from a static delivery system for electrons into an intelligent web that can optimize across many variables. New solid state equipment can deliver more functionality to grid operators and replace huge, expensive, vulnerable and hard-to-monitor transformers and switching systems. And fracking3 has transformed the economics of natural gas in America, making natural gas-fired generation an attractive option, though history has proven the value of a diverse set of power supply and demand-side resources to minimize price volatility.

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Second, the advent of competition has challenged the protected and privileged status of America’s utilities — catalyzing massive change in the energy industry. For a century, vertically integrated monopolies built power plants, strung transmission and distribution lines, billed customers and were rewarded with a predictable return on investment. That regulatory compact was upended in the last two decades as various parts of the nation’s grid were opened to competitive markets, many electric utilities were restructured into multi-state holding companies and regulators increasingly turned to “performance-based regulation,” wherein utilities or competitive service providers earn a profit when they, for example, keep costs low, deliver efficiency and keep the lights on. It turns out, however, that building a competitive market is devilishly difficult for a commodity that cannot easily be stored, flows to the nearest load regardless of contract intent, runs along monopoly distribution wires, is a prerequisite for all economic activity and requires real-time coordination across hundreds of power plants and thousands of substations. Well-structured wholesale electricity markets and performance-based regulation have proven effective at reducing costs and bringing important innovation to the fore.

Third, national security, public health, economics and climate change point to the need for clean energy. Society cannot continue to bear the public health and environmental costs caused by unmitigated carbon pollution — and public opinion increasingly demands clean, homegrown electricity for America. As a result (despite federal inaction), a majority of states have adopted policies to encourage greater investment in renewables, energy efficiency, demand-response and grid modernization.

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What does this all mean? What opportunities and threats does this conjunction of forces portend? This paper argues that there is no more business-as-usual: These trends will change the power system and utility businesses at their core. Profound opportunity is embedded in that change. Several studies have demonstrated that it is possible to power America’s grid using a very high share of renewables in the next 40 years, at very modest cost, and without relying on any technological breakthrough.4,5 That kind of transformation means cleaner air, better jobs, a more flexible power system and hope for future generations. It is a very big deal.

These changes require a breakthrough in policy and in business models. We must re-think power system incentives and regulation as well as the relationship of American citizens and their government with the power system. An America powered by 80 percent low-cost, reliable renewables is within our technological reach, but we are not on a path to achieve it quickly or efficiently. To succeed, we need to face head-on the task of modernizing our institutions and lining up the right incentives in the power sector.

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Power system planners are well accustomed to figuring out where, when and how to build large, centralized power plants and their transmission lines. They have mostly considered electricity demand to be an uncontrollable variable, to be met by central power plants, which are built based on demand projections, and dispatched to follow load. Today, though, demand-side resources like energy efficiency and demand-response allow system operators and consumers alike to reduce, shape and shift demand — in effect making it dispatchable. At the same time, renewable energy introduces variability in power supply. Utility systems will have more control on the demand side and less on the supply side — which is manageable if, and only if, there are physical systems in place to optimize the whole, and the regulatory structures to reward those who perform well at this optimization.6 Utilities and their regulators must re-think system planning, investment, markets and operation to optimize across both demand and supply resources to keep the system in balance. When they do this, they will unleash innovation, drive down prices and increase the resilience of the grid.

The world of electricity regulation is extremely complicated — and it is not likely to get simpler, at least in the near term. In order to capture the benefits of new technology — in cost savings, more reliability and better environmental performance — utility regulators will have to rethink their approach, and will need legislative permission to do so. This paper, building on seven studies organized and reviewed by more than one hundred and fifty of the top experts in the country, is a guide to that rethinking. It is written for state public utility commissioners, power company executives, investors, federal regulators, legislators, grid and market operators and their staffs, considering the demands of their jobs – to supply reliable, clean and affordable power…

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Conclusion

The U.S. power system is at an inflection point. New technologies offer great promise to increase reliability, reduce fuel costs, minimize capital investment and reduce environmental damage. Capturing these benefits requires a new approach to utility regulation and business models — no matter if the power system is driven by a vertically integrated monopoly, by a competitive market or by a hybrid of the two. Legislators and governors, state public utilities commissions (PUCs), the Federal Energy Regulatory Commission (FERC), ISOs, utilities, investors and other decision-makers will need to move deliberately and thoughtfully to create new standards, markets and business models. If they delay, consumers will incur steep, long-term costs, as the investments flowing from today’s structure are unlikely to meet tomorrow’s needs — and much less take advantage of tomorrow’s opportunities. And getting this right the first time is an imperative; it is much more expensive — if not impossible — to go back later and change the course of evolution in the asset-intensive power sector.

This paper argues for clear goals, backed by business decisions and regulations designed to maximize innovation and performance while minimizing costs. We recognize that translating these goals into specific business models and regulations is a big job, and this work will have to be customized for each organization and each region of the country. We are heartened by conversations with experts from all realms — PUC commissioners and staff, investors, academic experts, system operators, utility executives and NGOs — who see this challenge and are working hard on new systems.

Our strongest recommendation, then, is for policymakers — governors, legislators, and public utilities commissioners — to face this challenge directly, openly and forthwith. PUCs can open proceedings on how to build the electric system of the 21st century. Ensure that these conversations include experts in new technology, in systems optimization, and on the demand side as well as the supply side. Challenge participants to find solutions that meet all three public goals: minimize costs, increase reliability and reduce environmental damage. Insist that they demonstrate how new proposals bring in innovation. Stress-test recommendations for flaws. Launch and accelerate pilot programs, test markets and more. We can succeed. Now is the time to get going.

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