NRRI 15-01-NRRI-Distributed-Generation

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The rapid growth of distributed generation (DG) over the past two years with the expectation of continuation through this decade has the potential to transform the U.S. electric industry. It has stimulated a dialogue, sometimes of a spirited nature, on core topics that relate to both utility operations and state utility regulation. The recent narrative on the electric utility of the future includes the efficacy of the existing utility business model and current ratemaking practices in financially sustaining utilities and DG providers, as well as in advancing societal goals. A new business model, for example, could enable DG to compete on a more equal basis with utility generation. Alternatively, existing or newly erected regulatory barriers and obstacles could prevent DG from reaching its full economic potential. The question also arises as to whether and how utilities might go beyond simply accommodating DG, to becoming active agents in growing DG for long-term profit.
One caveat is that states will vary on their efforts to exploit new technologies like DG and the smart grid. Some states will aggressively foster these technologies while others will perceive little or even negative benefits from encouraging them. Each state faces unique economic and political conditions that would rationally lead them to pursue a different path for their electric utilities.
At this time, the future growth of DG is unknown. For example, although the cost of solar PV has sharply dropped, it faces serious challenges. One challenge derives from its non-dispatchability. Another challenge is that, in the not-too-distant future, DG may have to operate without subsidies. Federal, state, and utility incentives provide substantial impetus to solar PV systems. A third challenge is the lowering of what the industry calls “soft” costs. F Some experts contend that the key factor in making solar more competitive in the future is to manage “soft” costs.
Smart technologies could assist in allowing DG to reach its full potential by (1) facilitating grid integration and (2) achieving accurate valuation of the benefits that the grid offers DG providers, and vice versa. If DG actually assumes a large role in the electric industry, as many observers predict or hope for, then state utility regulators might support more-than-incremental changes in both utility business models and their own practices, especially in defining the utility’s function and in ratemaking. After all, the appropriate business model and regulation are inseparable, as each relies on the other for fostering predetermined objectives. For example, a business model with the dual objectives of financially sustainable utilities and fairness to all utility customers calls for compensatory and symmetrical rates that accurately account for both the grid services required by DG customers and the benefits they provide to the grid.
This paper explores the challenges facing electric utilities and their state regulators as they grapple with the various questions inherent in advancing the public interest during a transition to higher reliance on DG. It begins by highlighting DG’s recent developments and future prospects, and enumerating: (1) DG’s unique features as a source of electric power and related grid services; (2) concerns it has raised; and (3) its relationship to the smart grid.
One area of interest is the implications of DG for both electric utilities and regulators. Specifically, what are available options for realigning or revamping the utility business model? A popular view today is that that utilities will have to operate under a new business model to thrive, perhaps even just to survive, in a market environment with DG playing a prominent role. Major or even incremental changes in utility business models could require all participating parties, including state utility regulators, to contemplate new practices that place more emphasis on utility performance while minimizing barriers to DG. It becomes imperative for regulators to eliminate any artificial barriers that might stifle DG development. Regulators might also support some ratemaking reforms to better advance regulatory objectives, even if utilities make no changes in their business model. Current ratemaking practices leave much to be desired, especially in view of smart technologies that enable utilities to execute more economically rational pricing (e.g., real-time pricing, pricing of DG energy and other services exported to the local utility, demand charges for residential service).
This paper covers the following topics:
1. Recent developments in DG, focusing on rooftop solar PV;
2. Rationales for a new utility business model in view of increased DG growth;
3. Functions that utilities could perform in facilitating or stimulating DG growth under different future business models;
4. The likelihood of and conditions that might result in a death spiral for utilities;
5. How current ratemaking and other regulatory practices affect DG development and the public interest;
6. The benefits that smart technologies could offer for integrating DG into the utility grid; and
7. The potential positive and negative outcomes from direct utility participation in the DG sector.
Stakeholders in the regulatory process disagree over what actions state utility regulators should pursue in promoting DG. This paper provides regulators with basic information to help guide their decisions about DG and the various actions that utilities can take in its development