Getting smart about the grid

The ‘smart grid’ will be the foundation stone of the low-carbon electricity system of the future – and, in the US, is set for billions in stimulus funding. But there is a regulatory Gordian knot for investors and developers to cut through, says Cameron Brooks

In the US, building a ‘smart grid’ for the nation has emerged as a new national priority, with $4.5 billion earmarked in the stimulus package to that end. And, while there seems to be very little debate about the need, modernising the grid is a challenge made complex by the patchwork of regulation that governs the electric industry. What path emerges in the coming months will be critical and investors will be wise to pay close attention not just to federal funding, but also to the critical role of state regulators, when looking at opportunities in this area.

For many, the smart grid carries the promise of the ‘great enabler’ of the electricity system of the future. It is the infrastructure that will deliver clean energy from generation plants in the plains and deserts. It is also how we will connect distributed renewable power generation at home and what electric cars will both draw energy from and feed power back into. A new breed of smart appliances will communicate with it to lower bills and carbon emissions – and, by using information technology to manage better the peaks and troughs of power load, the smart grid will increase the reliability of the electricity infrastructure.

A recent report calculated that the US market for enabling technologies for the smart grid, including communications, sensors, controls, distributed resources and transmission, was worth approximately $17 billion in 2008 and is expected to grow to over $39 billion in five years.

However, many of these technologies are sitting on the sidelines. Large-scale renewable energy resources far from population centres lack high-voltage transmission lines. Similarly small-scale distributed energy generation and energy efficiency technologies are hampered by the grid’s inability to accept two-ways flows of electricity. And the dominant factor leading to the tremendous underinvestment in infrastructure upgrades of the past few decades is the residual policy framework of the utility industry.

The federal government is moving to address this challenge. The American Recovery and Reinvestment Act (ARRA) signed into law in February includes several provisions targeting grid modernisation. Notably, the Department of Energy (DOE) will receive $4.5 billion to fund matching grant programmes for smart grid deployments. Preliminary solicitation notices were announced in late April.

Other provisions in ARRA seek to address the challenge of transmission infrastructure. For example, the Western Area Power Authority’s traditional authority to deal with transmission only in the context of the large federal fleet of hydroelectric resources has been expanded to include building transmission lines to resource rich areas for renewables. The legislation includes the ability to borrow $6.5 billion to fund loans for new transmission projects.

The focus on expanding transmission is an important step, because the national infrastructure is fundamentally misaligned. There simply aren’t wires to the resource-rich areas for wind and solar generation. But, most observers believe, expanded transmission capacity is necessary but not sufficient. “We define a smart grid as a dynamic, ubiquitous two-way communication system involving the entire grid that allows for greater choice by every stakeholder on the grid,” said Katherine Hamilton, executive director of the GridWise Alliance, a public-private advocacy group, testifying before Congress earlier this year. “We do not consider building new transmission lines to be part of the smart grid.”

The Gridwise Alliance advocated in a 2008 report that a $16 billion national investment would catalyse private investment and trigger projects valued at over $64 billion and create 280,000 jobs. (These figures put the smart grid industry on a par with the cellular or cable industries, each of which is estimated to account for 300,000–400,000 direct and indirect jobs.)

All definitions of the ‘smart grid’ converge on the integration of communications equipment and intelligent applications into the electricity system. At the foundation are smart meters from companies such as Itron, Elster or Landis & Gyr that allow two-way communications between the home and the grid. Most of the meters in the US are simple mechanical devices, read by utility personnel once a month. Advanced meters offer data storage, communications capabilities and can provide real-time feedback to consumers and electricity suppliers.

Today, more than 70 utilities have filed some form of advanced metering infrastructure (AMI) plan which, in full deployment, could represent more than 70 million meters, close to half of the 150 million nationwide. But approvals have been granted for less than half that amount and less than 2 million smart meters had actually been installed by the end of 2008.

Only two states have approved full-scale deployments – California and Texas, which account for more than 50% of current deployment. In September, the California Public Utilities Commission approved Southern California Edison’s $1.63 billion programme to install 5.3 million smart meters. The previous month, the Public Utilities Commission of Texas approved Dallas-based Oncor’s plan to install 3 million meters together with in-home displays.

Meanwhile, Austin Energy, a municipal utility, is in the process of installing smart meters for each of the more than 400,000 customers in its service territory, along with 10,000 transmission and distribution grid sensors. In Colorado, Xcel Energy is in the final stages of deploying a fully integrated smart grid project to nearly 15,000 customers in Boulder, investing a reported $100 million.

While advanced meters may form the foundation of the smart grid, they have a long value chain, enabling upstream innovations of benefit to the utilities – such as increasing automation of substations and allowing for more active management of physical assets – and downstream innovations for the consumer. Venture capitalists have led a wave of investor interest in the smart grid, with many notable deals in 2008 and 2009. In the fall, a consortium including Altira, Goldman Sachs and New Enterprises Associates, put $120 million into Gridpoint, which offers utilities a platform to manage networks of distributed energy resources, bringing total investment in the company to over $220 million.

Other examples include $75 million for network provider Silver Springs Networks from Kleiner Perkins Caufield & Byers in the first announced investment from its Green Growth Fund. Last August, MissionPoint Capital Partners and London-based Zouk Ventures led a $40 million investment in the wireless mesh networking company Trilliant. This followed investments earlier in the year into SmartSynch, which makes internal communications systems for meters ($20 million from Credit Suisse and others) and Optimal Technologies, which offers an electricity allocation solution ($25 million led by Goldman Sachs).

Google entered the smart grid arena in early 2009 with plans to launch its “Power Meter”, a free application that will give consumers insight into their real-time power consumption. Tendril Networks, also focused on a home area network product, received a $12 million investment in March 2008 to support its home energy management platform.

Yet as leaders in Washington press forward with ambitious efforts to modernise the electric grid and investors fund new technologies, these efforts will only lead to transformation if there are similarly ambitious leaders at the state level. Transforming the grid from a centralised producer-controlled system to a distributed, consumer-interactive network will require dynamic pricing (allowing utilities to charge different rates at different times), egalitarian access to the grid and open standards of communication. Here, history has determined that the key regulatory decisions affecting electricity rates, interconnection and consumer choice will take place in the states’ legislatures and regulatory commissions.

“Today, the electricity we use is carried along a grid of lines and wires that dates back to Thomas Edison – a grid that can’t support the demands of clean energy” Barack Obama

No amount of stimulus funding into hardware and demonstrations will bring about changes in regulation, although there are provisions within the stimulus legislation that signal a new, more active role by the federal government. Notably, Section 410 of the ARRA ties funding of state energy programmes (the primary funding for the state energy offices) to assurances from each governor that state regulators with rate-making authority will institute energy efficiency policies, that state and local governments will adopt new building codes, and that the state will prioritise grants for efficiency and renewables. Many observers also note that a fundamental realignment of the roles of key agencies such as the Federal Energy Regulatory Commission (FERC), the National Institute of Standards and Technology and the Department of Energy may be under way, further advancing federal pressures for change.

Still, the evolution of the electric grid over the last century has left a byzantine patchwork of regulation on top of what amounts to a series of radial market designs. Region by region, central generation fleets send power down the wires to largely passive, fixed-rate customers. Monopoly franchises allowed for great economies of scale that made electricity a declining cost commodity for most of the last century, but left most customers disengaged from the marginal costs of their consumption through fixed rates schemes.

According to the Government Accountability Office, peak demand for electricity disproportionately drives costs up. The 100 highest priced hours of the year (about 1%) account for up to 20% of total electricity expenditures. And while overall demand for energy is growing, peak demand is growing faster.

The good news is that many states have begun tackling the tough questions that surround dynamic pricing, decoupling fixed system costs from variable retail rates and cost recovery for new investments. For example, the Pennsylvania legislature passed a law in 2008 requiring reductions in both total energy consumption and peak loads of 3% by 2013. Under the new law, utilities are required to file plans for procuring smart meters with the public utilities commission by August. Similar measures have been enacted in Maryland and Ohio.

According to FERC, about 8% of all customers are on some form of “demand response” rate structure, whereby they agree to reduce their consumption when demand peaks, in exchange for lower rates. These contracts total about 41GW (or around 6%) of the more than 750GW of peak load (up from 38GW in 2006). But most of these customers are large, industrial users. For the smart grid revolution to succeed, the technological and regulatory innovations must extend into the millions of households around the country.

Kurt Yeager, who led the Electric Power Research Institute for many years, now heads the Galvin Electricity Initiative and has become a champion for industry reform. It is not only electricity demand that is growing, but the quality of electricity needed. GAO figures show that the stability of the US grid has been on the decline since at least 2000. Today’s grid offers “three-nines” reliability (99.9%), which translates into almost nine hours of disruption each year – with the average US customer experiencing double the outages of the average EU citizen. These disruptions, Yeager argues, translate into economic losses due to reliability of over $150 billion and efficiency losses of over $100 billion annually. In his view, the key element of the solution and the fundamental building block of the smart grid is the “microgrid”, but regulatory barriers exist in most jurisdictions.

As the conversation about smart grid continues in the coming months, investors will be wise to pay close attention to the regulation, not only the technologies, that will shape the revolution. In this regard, it is the states that will decide upon which path we proceed.

Cameron Brooks is the president of Tolerable Planet Enterprises, a Boulder-based strategic consulting firm focusing on clean energy and the smart grid.