Monday Study – Making The Smart Grid Smart

Why Is the Smart Grid So Dumb? Missing Incentives In Regulatory Policy For An Active Demand Side In The Electricity Sector

Travis Kavulla, January 2023 (Energy Systems Integration Group)

The Smart Grid’s Unfulfilled Promises

It was 2009, President Barack Obama had just taken office, a huge federal stimulus to jolt the electricity sector into the 21st century had been passed, and utilities had their eyes fixed on a transformational opportunity: the smart grid.

“Change is in the air,” wrote Commissioner Rick Morgan of the District of Columbia’s Public Service Commission. “The smart grid that’s beginning to emerge in North America will rely on hardware like ‘smart’ meters, ‘smart’ appliances and thermostats, remote sensors, and sophisticated communications systems. These devices, when linked together, will enable utilities and their customers to respond in real time to conditions on the power grid, thereby creating new opportunities to reduce costs and increase customer value” (Morgan, 2009).

In the succeeding years, billions of dollars were spent in advanced metering infrastructure (AMI)—automated meters that precisely measure consumption or production at more granular intervals than the past’s monthly meter reads, relaying those data instantaneously between customers, substations, and utility back offices with high fidelity. If the transmission grid is the physical network on which the wholesale electricity market is founded, these smart meters are the physical basis for retail customer empowerment. They unlock the opportunity to make the sector into a genuinely two-sided market where sources of flexible demand and distributed energy resources actively participate in response to prices driven by grid needs that are transmitted through the smart meter.

Yet those ambitions have largely failed to materialize. To take but one concrete example, Pennsylvania’s FirstEnergy electric utilities commenced their AMI roll-out in 2014 and by mid-2019 had achieved a nearly universal, 98.5 percent deployment across all customers, spending $920 million to deploy just over 2 million smart meters.1 As part of the Pennsylvania statute that laid the groundwork for these investments, the FirstEnergy Companies were required to create at least one rate offering that made use of the technology by having a time-varying component—a reasonable requirement given the soaring rhetoric about the transformed customer experience foretold by the smart grid.2 Echoing Commissioner Morgan’s comments, Pennsylvania utility commissioner Rob Powelson, later appointed to the Federal Energy Regulatory Commission, wrote a separate opinion concurring in the AMI spending, but noting, “To be frank, it is pointless to have smart meters if you are still going to have ‘dumb’ rates.”3

The FirstEnergy Companies did introduce a time-ofuse rate. Between June 2019 and December 2021, the number of residential customers enrolled in it ranged from 44 to 97.4 Those numbers are not missing digits. Taking the figure at the upper range, that is approximately one residential customer for every 20,000 smart meters installed or an enrollment rate of five-thousandths of one percent (0.005%).

This sorry outcome is hardly out of the ordinary. The Brattle Group estimated in a 2019 survey that only 1.7 percent of all residential customers in the United States were enrolled in time-of-use rates (Faruqui, Hledik, and Sergici, 2019). Only a handful of state and provincial regulatory commissions in North America have determined to make time-of-use rates the default option for residential and small commercial customers. Everywhere else, utilities charge flat rates—the same perkilowatt-hour price in all hours.5 Thus have “smart meters” perpetuated “dumb rates.” While smart meters might convey more information to consumers about their energy usage, this on its own has been found to have no significant effect whatsoever on a household’s use of energy (List, Metcalfe, and Price, 2018). Again, whatever else smart meters achieve, if they are paired with “dumb rates,” they do not achieve outcomes around the shape and volume of demand. Prices matter.

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On the opposite pole, there exists a mostly hypothetical landscape where utilities and other businesses that serve retail electricity customers use smart meters to completely absent themselves of an intermediary function, letting the wholesale market and the retail market converge. We have one recent but catastrophic example of this in the United States: Griddy, the only American business exclusively dedicated to the use of the smart grid to pass through real-time wholesale price signals directly to residential customers.

Griddy imploded in the aftermath of Winter Storm Uri in 2021 as supply fell from outages at power plants and wellheads, demand rose in the face of extreme cold, and wholesale prices in the face of these supply shortages settled at Texas regulators’ pre-established “value of lost load” that also functioned as the wholesale market’s price cap (then, $9,000 per megawatt-hour). Passing through those prices as promised, Griddy customers received bills for thousands of dollars for mere days of electricity service—if they were lucky enough (or perhaps unlucky enough) to have it at all.6 Griddy constituted less than one-half of one percent of all customers in Texas, though their experience came to characterize a free-wheeling and inadequately regulated marketplace. Ironically, the state’s competitive retail market otherwise caused retailers to bear the costs of unhedged wholesale positions, protecting their customers, since customers themselves generally were served by contracts with fixed prices.7 Texas lawmakers outlawed the Griddy business model shortly thereafter.8 In Griddy’s bankruptcy proceedings, all its erstwhile customers were forgiven any obligation they had to pay outstanding charges to the company (Moritz, 2021).

These are the two extremes in how an electricity retailer might use the smart grid to transform the customer experience: not at all, signaling to customers that each and every kilowatt-hour they use has the same value as any other kilowatt-hour, or, on the other extreme, by making retail prices a mirror of wholesale prices, issuing customers a new price as often as every five minutes without any protection from extreme price spikes. Live in the cave or on the roller coaster, as it were. An appropriate outcome almost certainly lies somewhere in the middle.

The unfulfilled promises of the smart grid in mind, the main purpose of this paper is to understand the intersection between an energy transition that is badly in need of a more active demand side and the regulatory policies that have restrained that from happening. In an attempt to get back on track toward fulfilling the smart grid’s promise, I will also propose some solutions.

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This paper is organized in three parts:

• A survey of the growing importance of activating mass-market (which is to say residential and small commercial customers’) demand in the modern electricity economy, the AMI and smart-device landscape that makes this possible, and what utility regulatory commissions are doing (or, as the case may be, not doing) to activate this demand through their rate-design and retail-market-structure decisions.

• An examination of how this landscape fits into the incentives that face two very different business models of energy supply service: cost-of-service-regulated utilities that typically lack any genuine financial exposure to marginal energy costs and thus lack an incentive to activate demand, and competitive retailers that do face some positive version of this incentive, though it is diffuse and sometimes incomplete.

• A reform agenda which can be summarized simply: Every electricity customer in the United States should either take service under a time-varying rate as a default option or should be supplied by a provider that does have the financial incentive and ability to activate the customer’s demand in relation to the dynamic wholesale market on the customer’s behalf. Someone, somewhere must face the clear price incentive to actively manage demand in order for it to happen.

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Ratemaking and Technology, Supply and Demand, and the Imperative for Time-Varying Prices

Two Types of Retailers and Their Financial Incentives

A Reform Agenda for Retail Rate Design and Market Structure…Cost-of-Service-Regulated Monopolies…Competitive Retailers…

REFORM 1 Make Time-Varying Rates Opt-Out for Regulated Utilities and Default Service Providers…REFORM 2 Ensure That Competitive Retailers Are Exposed to All Relevant Grid Costs…REFORM 3 Put Competitive Providers in Charge of the Customer Bill…REFORM 4 Encourage Public Investment and Standards for Automated Devices…

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Conclusion: A Two-Sided Market Where Demand Acts as Demand

Regulation’s attempt to date to activate demand has been to jerry-rig it as a supply resource, bidding into energy and capacity programs. Or, sometimes demand activation has been relegated to niche utility programming, where all comers must subordinate their innovative spirit to become the vendors to a monopoly. This model of demand response—a term this paper has avoided, since demand inevitably is responsive to the incentives with which it is faced—has been a poor substitute for what should be our goal: a marketplace where smart meters and automated devices make possible a genuinely two-sided marketplace where demand is active.

The status quo of demand response has been defined by endless arguments about how the wholesale market for supply should accommodate demand acting as a supply resource. Is demand response really showing up?44 Has the regulator appropriately defined the baseline usage on which demand reductions should be established and compensated? What obligations does demand have to pay for the option to use energy, which it has foregone? These are immensely thorny questions, and, so long as demand response is a jerry-rigged supply resource, all of them need government-defined answers within the administrative construct that is the wholesale electricity markets.

In the paradigm this paper lays out, retailers’ end-use customers have agreed to pay them a retail price for what they might use, and the retailer has agreed to serve the customer at that price. When the marginal cost exceeds that price, an opportunity for shared savings emerges, and there is no need—except through private commercial agreement, not government intervention—to calculate a baseline. The retailer retains responsibility for privately managing the costs to serve demand, drawing on supply (owned resources, contracted resources, financial hedges, and the spot market) as well as demand (inducing its retail customers to reduce their needs). Under timevarying rates, customers are themselves faced instead with this incentive, since we must concede that certain retailers—cost-of-service regulated utilities—do not face that incentive.

When retailers serve demand, all demand is demand. In nearly every other market, we have empowered consumers to decide whether, when, and how to buy products—and those decisions inform but are not supplyside decisions. So too it should be in the electricity economy. Treating demand response as a lucrative source of supply will, in some ways, drive demand participation into an administrative construct, rather than a freer market that is characterized by demand’s genuine elasticity and its ability to say “no” to supply’s too-high offers to sell their goods, as other consumers do in every other two-sided market.45 It is high time for demand to act like demand, the co-equal and opposite force to supply, and not just a junior-varsity source of supply.

This role for demand is made possible by the consumerfacing, digital and internet-connected technological advances that have transformed our lives in so many ways—but not yet, not really, in the electricity sector, even if the smart meter hangs on the side of your house. Much of other sectors’ technological change does not seem to have made us better people. We can entertain ourselves to death on streaming services, have packages endlessly brought to our door by couriers, and camp out permanently on social media, all while disconnected from our families and nature. But the consumer technology revolution as applied to our electricity networks need not be consumptive. It can instead give us better information about what we are using and, importantly, allows us to adjust our consumption in ways that benefit us as well as the power grid that serves us, so long as regulators take steps to enable that. These are welcome developments in a time of what can seem like a throwaway culture, living up to an important and timely exhortation that “technologically advanced societies must be prepared to encourage more sober lifestyles, while reducing their energy consumption and improving its efficiency.”

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