October 03, 2014

Bringing Utilities into the Sun: Measuring and Mitigating PV Impacts

Electric utilities in the United States are wary of solar power, worrying that accelerating deployment of distributed generation will hurt their bottom lines. This blog post reviews recent efforts to measure utility impacts and to design strategies to maintain utility profitability.

Electric utilities in the United States are wary of solar power. For example, a 2013 report from the Edison Electric Institute, an electric utility trade organization, characterized solar power as a “disruptive threat” to traditional electric utility business models. That report cautioned that distributed solar power could pose the same kind of challenge for utilities that cell phones posed for copper-wire phone companies. The basic fear is that decreasing costs of solar power and increasing utility bills will drive ever-greater deployment of distributed solar, reducing customer numbers and threatening utilities’ bottom lines.

Of course, solar power currently contributes only a very small portion of power in the United States (0.2% in the nation, and 2% in the most solar-friendly jurisdictions), suggesting that the U.S. solar industry has a long way to go before it significantly impacts utilities. Indeed, a recent study from Lawrence Berkeley National Laboratory (LBNL) concludes that “utilities, policymakers, and solar stakeholders likely have sufficient time to address these concerns in a measured and deliberate manner.” However, the potential impact on utilities is not entirely theoretical. The Economist reports that renewable energy development is partly responsible for a decline in value of European utilities that amounts to roughly half a trillion Euros. (Of course, the Economist also notes that renewable energy is not the sole driver of impacts on European utilities; other contributions include over-investment in fossil-fuel generation assets and dwindling energy demand.) Policy makers in the United States should try to prevent similar impacts to U.S. utilities.

Although some scholars, such as the Rocky Mountain Institute’s founder Amory Lovins, argue that policy makers should not protect utilities, I believe that finding ways to measure and mitigate utility impacts is important for several reasons. First, and most importantly, utilities play a critical role in managing and updating the energy grid. If utilities lose value and cannot attract capital, they may not be able to finance significant grid upgrades that will be necessary to integrate and manage variable sources of renewable energy. Second, utilities’ longstanding guaranteed profitability has attracted significant investment from pension funds. If utilities lose value suddenly or dramatically, pensioners could feel the pinch. And finally, to the extent utilities view renewable energy as a threat, they are likely to wield their political power to slow or stall renewable energy development. Understanding and reducing impacts to utilities could prevent such unintended consequences. Moreover, as allies of solar power, utilities could dramatically expand deployment.

My colleague Nate Larsen’s blog post this week, Distributed Generation Rate Reform Around the U.S., discusses potential measures in several states that aim to restructure utility billing practices to account for impacts from distributed energy generation such as solar power. Nate’s post highlights examples of policy options currently under consideration as part of a comprehensive assessment of various utility reform policies. His roundup of state efforts is a valuable contribution that illustrates a common approach: increasing fixed charges to ratepayers and adding fixed charges to net-metered customers. This particular approach mirrors recommendations from the Edison Electric Institute’s report.

However, fixed charges are by no means the only policy option for mitigating PV’s impacts on utilities. LBNL’s recent study reveals several strong policy options that could maintain utility profitability even in the face of dramatically expanded solar deployment. That study examined scenarios in which solar power accounted for 2.5% or 10% of total retail electricity sales. The 2.5% scenario mirrors deployment levels in utility jurisdictions with the greatest solar penetration (excluding Hawaii, a special case), while the 10% scenario far exceeds current deployment. The study quantifies impacts of these levels of solar deployment on two model utilities: one vertically integrated utility typical of the Southwest; and one “wire-only” utility typical of the Northeast (which owns only the distribution grid, and not the transmission grid or generation assets). The study finds that while ratepayer impacts would be modest—raising electricity rates by less than 3%—impacts on utility earnings and shareholders could be severe. For example, increased solar deployment could reduce both model utilities’ return on equity by between 8% and 15%. More dramatically, 10% solar deployment could reduce the Northeastern model utility’s earnings by up to 41%, an outcome which resembles the current plight of some European utilities. LBNL also examines a variety of policy options to mitigate these utility impacts.

Notably, LBNL projects that several policy options may be sufficient to offset impacts on utility earnings or return on equity. In other words, distributed solar power does not have to harm utility profitability, and LBNL’s report identifies several policies that may offset impacts to utility earnings or returns on equity. For example, LBNL asserts that alternative ratemaking approaches—including more frequent rate cases, less lag between rate cases and rate implementation, and the choice of different test years in rate cases—could more than offset utility revenue impacts. Similarly, LBNL notes that shareholder incentive mechanisms, like those that many states use to encourage energy efficiency, may significantly offset reduced utility earnings and return on equity. Intriguingly, LBNL did examine the imposition of fixed charges, noting that while fixed charges seemed to help the model Southwestern utility, high fixed charges could actually worsen the situation for the wires-only Northeastern utility (because the customer base in the Northeast is growing more slowly).

The option LBNL examines that I find most interesting is utility ownership or financing of PV installations. Even owning or financing only 10% of solar installations could significantly offset utility impacts. However, the potential impact of utility ownership is much more significant in the Northeast, where the model utility does not otherwise own generation, than in the Southwest, where the model utility does. The option of utility financing or ownership is particularly interesting because it can also help reduce the costs of, and improve access to, solar power. Utilities generally have a low cost of capital, which would allow them to build solar facilities with lower soft costs than others generally can. Moreover, utility financing (in which a customer purchases a solar facility through on-bill payments over time) could allow those who lack significant access to capital to nonetheless enjoy the benefits of solar PV. In other words, utility ownership or financing of solar power could solve multiple problems simultaneously.

LBNL’s new report is a very valuable resource for those considering how to measure and mitigate impacts on utilities from solar PV or other distributed energy sources. However, this report by no means solves the puzzle of how to harmonize the stability of utilities with accelerating distributed renewable energy development. For example, LBNL cautions that there is no one-size-fits all approach; utility regulation and business models vary throughout the country, and sensible policy reforms will need to vary as well. More significantly, LBNL itself candidly notes that many of its proposed strategies involve difficult trade-offs between different policy goals. For example, LBNL notes that allowing utilities to earn renewable energy credits from customer-sited PV arrays would bolster utility profitability, but would also diminish the efficacy of renewable portfolio standards by reducing the amount of renewable energy development necessary for compliance. Similarly, many strategies that favor utility shareholders work against ratepayer interests.

LBNL’s report presents a valuable array of options, but careful consideration of each is necessary in order to find the best way to promote renewable energy while avoiding debilitating impacts to utilities. The Green Energy Institute is considering these and other policy proposals to help develop carefully tailored strategies to encourage utilities to be eager participants in a renewable energy future.