Regulators and the energy industry in North America will need to prepare for major change in the next five years. No one knows this better than Joe Kelliher, the Executive Vice President of Federal Regulatory Affairs for NextEra Energy Inc. and the former Chairman of FERC, the US national energy regulator. He has seen seismic shifts in the regulatory landscape before, and thinks more may be just ahead.
“Technological change can result in dramatic change in regulatory policy, markets and even industry structure,” Mr. Kelliher warned. Speaking at the APPrO 2015 conference in Toronto November 17, he laid out a series of issues likely to influence the process of renewing electrical infrastructure. Tensions are developing between customers who want the new technology and others who feel that widespread adoption and cross subsidies could leave unfair cost burdens on others. Regulators will likely find themselves in the uncomfortable position of balancing the views of divergent groups while trying to protect traditional principles of economic efficiency. Adding to the challenge, they will need to do this in the midst of a market in which industry economics and the boundaries of the sub-sectors are shifting in historic ways.
The electricity sector is different from a stock exchange or most other markets with multiple competing suppliers. The electric grid is a single integrated shared system, big parts of which carry a mortgage that hasn’t yet been paid off. Although regulators have well-developed rules and principles to ensure that consumers shoulder their fair share of the costs, these principles could be tested if large numbers of customers believe they can scale back their purchases dramatically or disconnect entirely, leaving others to pay the mortgage on existing infrastructure reliant on aging technology.
For those who watch regulatory matters, the backdrop for this drama is a growing pattern of regulatory thinking that appears to put the large utilities on notice that they may be unable to recover as many of their costs from ratepayers as they often have done in the past. A series of regulatory decisions have addressed the sharing of cost responsibility for stranded assets between ratepayers and shareholders. Canada’s National Energy Board in 2013 found that when market characteristics change, utilities may have to accept that some of their assets drop in value with little or no compensation from the regulatory system. Later developments appear to have softened the 2013 decision but the sense of increased risk in the utility sector is unmistakable.
Although attractive technology innovations have been cropping up quickly in the energy sector, non-technological factors could delay their deployment. Millions of customers may have to wait years before enjoying the benefits of the latest options for distributed generation, renewables, storage, micro-grid, and load management, while stranded asset and rate design issues are sorted out.
The effect of new technology entry
Mr. Kelliher believes that the proliferation of Distributed Generation (DG) “threatens baseload generation in high cost areas and perhaps moderate cost areas as DG cost improves.” Noting that DG penetration is often exacerbated by regulatory policies that support DG with cross subsidies, he says, “DG penetration could create substantial stranded costs” and raises legal questions in the U.S. about jurisdiction over DG sales and local distribution facilities.
With respect to storage, he points out that some experts think that “costs may decline to the point where there may be no need to add U.S. peaking capacity after 2020. Further, storage increases the value of renewables, both wind and solar.” Storage may also create pressure on utility reserve margins as storage economics improve.
There has been “striking progress on both cost and performance of renewable energy in recent years. We are at the point where utility scale solar plus storage is roughly on par with new nuclear - with greater confidence on the cost of solar/storage. 60% of U.S. generating capacity added this year will be wind or solar.”
Progress in energy efficiency and load management technology is leading to “low demand growth partly due to technology,” Kelliher says. “Energy efficiency pressures basic rate design, where most fixed costs are recovered through variable charges. Rate design reform will be controversial.”
Historical parallels
Although it’s generally accepted in theory that utilities bear technology risk, in practice regulated electric utilities in North America have usually been able to ride through the transition to new technology without serious financial dislocation. It’s not clear to what extent that pattern will hold in the years ahead. That makes more people than just those who own utilities rethink their business plans.
Mr. Kelliher reviewed how technology has changed the U.S. electric industry. “Gas turbine technology marked the end of natural monopoly in generation. That made electric competition policy possible. … In 1978, 98% of U.S. electricity was generated by vertically integrated utilities – 5 years later non-utility entities accounted for the majority of generation additions. Competition led to other policy changes – transmission open access, RTOs, and other changes, giving rise to non-utility generators, affiliated gencos, divestitures and spin-outs.”
When telecom was being reformed, Kelliher notes that “there was an inequity in that low income consumers bore a lot of the fixed costs of the system.” Regulators developed ways to deal with that problem in telecommunications. However it’s not clear if the same solutions will work in the electricity sector.
The changing role of regulators
Although inventors of new technology don’t set out to change the way an industry is regulated, in many cases that is exactly what they do.
For example, regulators overseeing the telecommunications sector have a very different set of responsibilities today than they did when there were just a few dominant phone companies. In another example, if new technology changes the cost and quality of an entire category of energy services, then the regulator may have to rework any systems that were previously designed to ensure that customers saw a reasonable balance between cost and quality of service.
Technology can cause the role of the regulator to shrink. If innovation gives rise to active competition that didn’t previously exist in a certain field, it can eliminate the public interest rationale for classic utility regulation, Mr. Kelliher observes. At the same time it can create new issues for a regulator to oversee.
If DG penetration reaches a certain level, will that change the jurisdiction which oversees distribution? In the U.S. there is no bright line between transmission and local distribution facilities, and the line between the two will be blurred with two-way flows of power. However Mr. Kelliher reminds the industry that U.S. wholesale regulators will have no desire to start regulating distribution lines.
“Utility laws and regulations reflect embedded assumptions about technology,” he says. U.S. electricity law and policy was rooted in assumptions about natural monopolies in generation for many years. Those assumptions had to change, and regulation with them, when technology proved otherwise.
How to strike a balance
Mr. Kelliher prompts the energy sector to ask a long term question: What is the correct relationship of technology and regulatory policy?
“Regulation can impede or even block the deployment of new technologies in a comprehensively regulated industry, requiring use of black rotary phones, for example. But regulation can also command the use of technologies that are unproven or uneconomic, as happened under PURPA 1978,” he says.
He cautions that regulation can promote certain technologies by masking their cost through cross subsidies. In cases where the cross subsidies are significant, or where public policy has affected technology choices, the case for stranded asset recovery is much stronger.
“The best outcome is when technology improves to the point where cost and quality benefits are real, and where the regulator acts as a facilitator,” Kelliher says.
Regulators may need to develop systems to assess which investments are significant beneficiaries of non-market subsidies, and consider appropriate regulatory treatments in those cases.
Impact of new technology remains to be seen
“The nature of the impact of new technology will depend largely on how economic the technology is and whether regulatory policy is supportive,” predicted Mr. Kelliher. “In a perfect world, regulatory policy can remove barriers to new technology whose economics are proven. Alternatively, regulatory policy can promote the development of new technology that is nearly commercial. Both those cases have the potential to lower costs and improve quality of service. But problems can arise when government tries to force new technology that is highly uneconomic that does not lower costs or improve service.”
Mr. Kelliher gently warns that it’s not entirely clear how the social equity issues will play out in the coming phase of technological transformation. Unfortunately for those who would like to see new technology disseminated quickly, it may be necessary to sort out who pays for which transition costs, before the promising new technologies of the future will be able to find long-term homes.
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