TODAY’S STUDY: Utility Of The Future; An MIT Energy Initiative response to an industry in transition
Utility Of The Future; An MIT Energy Initiative response to an industry in transition
Ignacio Pérez-Arriaga, Christopher Knittel, et. al., December 2016 (Massachusetts Institute of Technology)
Important changes in the provision and consumption of electricity services are now underway, driven to a significant degree by a confluence of factors affecting the distribution side of power systems. A variety of emerging distributed technologies—including flexible demand, distributed generation, energy storage, and advanced power electronics and control devices—are creating new options for the provision and consumption of electricity services. At the same time, information and communications technologies are rapidly decreasing in cost and becoming ubiquitous, enabling more flexible and efficient consumption of electricity, improved visibility of network use, and enhanced control of power systems.
These technologies are being deployed amidst several broad drivers of change in power systems, including growth in the use of variable renewable energy sources such as wind and solar energy; efforts to decarbonize the energy system as part of global climate change mitigation efforts; and the increasing interconnectedness of electricity grids and other critical infrastructure, such as communications, transportation, and natural gas networks.
The MIT Energy Initiative’s Utility of the Future study presents a framework for proactive regulatory, policy, and market reforms designed to enable the efficient evolution of power systems over the next decade and beyond. The goal is to facilitate the integration of all resources, be they distributed or centralized, that contribute to the efficient provision of electricity services and other public objectives. This framework includes a comprehensive and efficient system of market-determined prices and regulated charges for electricity services that reflect, as accurately as possible, the marginal or incremental cost of providing these services; improved incentives for distribution utilities that reward cost savings, performance improvements, and long-term innovation; reevaluation of the power sector’s structure to minimize conflicts of interest; and recommendations for the improvement of wholesale electricity markets. This study also offers a set of insights about the roles of distributed energy resources, the value of the services these resources deliver, and the factors most likely to determine the portfolio of cost-effective resources, both centralized and distributed, in different power systems. We consider a diverse set of contexts and regulatory regimes, but focus mainly on North America and Europe.
This study does not try to forecast the future or predict which technologies will prevail. Instead, it identifies unnecessary barriers and distortionary incentives that presently impede the efficient evolution of the power sector and provides a framework that will enable an efficient outcome regardless of how technologies or policy objectives develop in the future. In addition, we recognize that regulatory and policy reform often proceeds incrementally and that each jurisdiction faces unique challenges and contexts. As such, we offer this framework along with guidance on the key trade-offs regulators and policy makers confront as they pursue opportunities for progressive improvements.
The measures identified in this study could produce significant cost savings. Low-cost information and communications technologies and advanced metering enable more cost-reflective prices and charges for electricity services that can finally animate the “demand side” of the power system and align myriad decisions with the optimization of net social welfare. Efficient prices and charges will unlock flexibility in electricity consumption and appropriately value the services that distributed energy resources provide. To date, power systems have been designed to meet infrequent peaks in demand and to comply with engineering safety margins established in an era when electricity customers were largely inflexible and blind to the true costs and potential benefits of their electricity consumption or production decisions. In many cases, this has resulted in costly and significantly underutilized infrastructure. Smarter consumption of electricity and, where cost-effective, the deployment of distributed energy resources, could deliver billions of dollars in savings by improving the utilization of electricity infrastructure.
At the same time, the need for proactive reform is clear. Customers now face unprecedented choice regarding how they get their power and how they manage their electricity consumption—regardless of whether they are aware of those choices or are acting on them today. New opportunities include the ability to invest in distributed generation, smart appliances, and energy efficiency improvements. At present, the vast majority of power systems lack a comprehensive system of efficient prices and regulated charges for electricity services. As a result, some customers are making inefficient investments and are overcompensated for the services that they provide to the power system. At the same time, many more opportunities that could deliver greater value are being left untapped because of inadequate compensation. For example, the combination of simple volumetric tariffs and net metering policies has contributed to the rapid adoption of rooftop solar photovoltaics (PV) in several jurisdictions, while exposing several flaws in current ratemaking. The rapid uptake of solar PV also demonstrates how quickly customers can react to economic signals—whether well or poorly designed—and the importance of proactive, rather than reactive, policy-making and regulation. In multiple jurisdictions, challenges that once seemed insignificant have quickly become overwhelming, and failure to act can catch policy makers and regulators flat-footed.
The framework proposed in this study is designed to establish a level playing field for the provision and consumption of electricity services, whether via centralized or distributed resources. The goal is to remove inefficient barriers to the integration of costeffective new sources of electricity services, rethink ill-designed incentives for certain resources, and present a system of prices and charges that can animate efficient decisions. With this framework in place, all customers and producers of electricity services can make efficient choices based on accurate incentives that reflect the economic value of these services and their own diverse personal preferences.
This study highlights several core findings:
The only way to put all resources on a level playing field and achieve efficient operation and planning in the power system is to dramatically improve prices and regulated charges (i.e., tariffs or rates) for electricity services.
• To establish a level playing field for all resources, cost-reflective electricity prices and regulated charges should be based only on what is metered at the point of connection to the power system—that is, the profile of injections and withdrawals of electric power at a given time and place, rather than the specific devices behind the meter. In addition, cost-reflective prices and regulated charges should be symmetrical, with injection at a given time and place compensated at the same rate that is charged for withdrawal at the same time and place.
• Increasingly affordable information and communications technologies (e.g., advanced meters or interval meters) enable detailed monitoring of electricity withdrawals and injections and therefore facilitate more efficient prices and charges. Without more accurate consumption and injection data from all customers, it is impossible to capture the full value of electricity services.
Flat, volumetric tariffs are no longer adequate for today’s power systems and are already responsible for inefficient investment, consumption, and operational decisions.
• Peak-coincident capacity charges that reflect users’ contributions to incremental network costs incurred to meet peak demand and injection, as well as scarcitycoincident generating capacity charges, can unlock flexible demand and distributed resources and enable significant cost savings.
• Granularity matters. The value or cost of electricity services can vary significantly at different times and at different locations in electricity networks. Progressively improving the temporal and locational granularity of prices and charges for these services can deliver increased social welfare. However, these benefits must be balanced against the costs, complexity, and potential equity concerns of implementation.
• Care must be taken to minimize distortions from charges that are designed to collect taxes, recover the costs of public policies (such as efficiency programs, heating assistance, subsidies for renewable energy, cross-subsidies between different categories of customers, etc.), and recover residual network costs (i.e., those network costs that are not recovered via cost-reflective charges).
• Policy makers and regulators must be wary of the possibility of societally inefficient “grid defection” if residual network costs and policy charges become too high. This may suggest an upper limit on the portion of these costs that can be collected in electricity tariffs rather than through broader taxes or other means.
The regulation of distribution utilities must be improved to enable the development of more efficient distribution utility business models.
• Forward-looking, multi-year revenue trajectories with profit-sharing mechanisms can reward distribution utilities for cost-saving investments and operations, aligning utilities’ business incentives with the continual pursuit of novel solutions.
• Several “state of the art” regulatory tools, including an incentive-compatible menu of contracts, an engineering-based reference network model, and automatic adjustment factors to account for forecast errors, can better equip regulators for an evolving and uncertain electricity landscape.
• Outcome-based performance incentives can reward utilities for improvements in quality of service, such as enhanced resiliency, reduced distribution losses, and improved interconnection times.
• Incentives for longer-term innovation are needed to accelerate investment in applied R&D and demonstration projects and learning about the capabilities of novel technologies and practices that may have higher risk or longer-term payback periods. The structure of the electricity industry should be carefully reevaluated to minimize potential conflicts of interest.
• Network providers, system operators, and market platforms constitute the critical functions that sit at the center of all transactions in electricity markets. Properly assigning responsibilities for these core functions is thus critical to an efficient, well-functioning electricity sector. It is also critical to establish a level playing field for the competitive provision of electricity services by traditional generators, network providers, and distributed energy resources.
• As experience with restructuring in the bulk power system has demonstrated, structural reform that establishes financial independence between distribution system operation and planning functions and competitive market activities would be preferable from the perspective of economic efficiency and would facilitate more light-handed regulation.
• If financial independence is not established, several additional measures are critical to prevent conflicts of interest and abuses of market power. These include stricter regulatory oversight of distribution network planning and operation, legal unbundling and functional restrictions on information exchange and coordination between distribution system operators and competitive subsidiaries, and transparent mechanisms for the provision of distribution system services (such as public tenders or auctions).
• Maintaining a data hub or data exchange may constitute a fourth critical function. Such a hub or exchange would serve several purposes: securely storing metered data on customer usage, telemetry data on network operation and constraints, and other relevant information; allowing non-discriminatory access to this data to registered market participants; and providing end customers with timely and useful access to data on their own usage of electricity services. Responsibility for this function should also be carefully assigned, with priority given to data security and customer privacy considerations.
Wholesale market design should be improved to better integrate distributed resources, reward greater flexibility, and create a level playing field for all technologies.
• Wholesale markets should enable transactions to be made closer to real time to reward flexible resources and to enable better forecasting and control of variable renewable resources and electricity demand.
• Wholesale market rules such as bidding formats should be updated to reflect the operational constraints of novel resources such as demand response and energy storage, as well as new patterns of operation of conventional power plants.
• More efficient pricing of reserves can help wholesale markets function better, improve price signals for energy and operating reserves, and strengthen the link between these two services.
Widespread connection of distributed energy resources, smart appliances, and more complex electricity markets increases the importance of cybersecurity and heightens privacy concerns.
• Robust regulatory standards for cybersecurity and privacy are needed for all components of an interconnected electricity network.
• To keep pace with rapidly evolving cybersecurity threats against large and complex electric power systems, electric utilities, vendors, law enforcement authorities, and governments should share current cyber threat information and solutions quickly and effectively.
Better utilization of existing assets and smarter energy consumption hold great potential for cost savings. At the same time, economies of scale still matter, and the distributed deployment of solar PV or energy storage is not cost-effective in all contexts and locations.
• The value of some electricity services can differ substantially depending on where within the power system that service is provided or consumed. This variation in “locational value” underscores the importance of locationally granular prices and charges and makes it impractical to define a single value for any distributed resource.
• Distributed energy resources can be sited and operated to provide services in those areas of the power system where their services are most valuable. Understanding the specific services that have locational value is thus critical to understanding how distributed resources can create value in power systems.
• Unlocking the contribution of resources that already exist—such as flexible demand, electric vehicles, power electronics, or distributed generation that is already deployed—can be an efficient alternative to investing in electricity generation and network capacity.
• Economies of scale still matter, even for distributed energy resources. For resources that can be deployed at multiple scales, such as solar PV and battery energy storage, incremental costs associated with failing to exhaust economies of unit scale can outweigh locational value. This can result in a “distributed opportunity cost,” making distributed deployment of these resources inefficient. Trade-offs between the incremental costs and additional locational value associated with deploying distributed resources on a smaller scale must be considered in each context.
• For resources that exhibit significantly higher unit costs at smaller scales, such as solar PV and battery energy storage, distributed deployment is likely to be inefficient in many locations. Exceptions may include areas that have heavily congested networks or that are experiencing rapid growth in electricity demand. In these areas, locational value may be significant.
• New innovations may transform economies of unit scale for solar energy or storage technologies, enabling more ubiquitous distributed deployment of these resources.