The Future of Electricity Retailing and How We Get There Frank A

1 The Future of Electricity Retailing and How We Get There Frank A. Wolak and Ian H. Hardman Copyright © September 2020 Frank A. Wolak and Ian H. Hardman Frank A. Wolak is the Director of the Program on Energy and Sustainable Development (PESD) and the Holbrook Working Professor of Commodity Price Studies in the De- partment of Economics at Stanford University, Stanford, CA USA 94305-6072. e-mail: [email protected] Ian H. Hardman is a Research Associate at the Program on Energy and Sustainable Devel- opment (PESD) at Stanford University, Stanford, CA USA 94305-6072. e-mail: ihhard- [email protected] Executive Summary Electricity retailing is at a crossroads. Technological change is eroding revenues from the traditional electricity retailing business model. However, many of these new technologies have the potential to create new products and revenue streams for electricity retailers. We assess the future of electricity retailing under two possible approaches by policymakers and regulators to addressing these challenges and new opportunities: a reactive approach and a forward-looking approach. A reactive approach would only address the technological changes that (1) actually occur and (2) have a documented negative impact on the electricity supply industry. However, this approach may not result in the adoption of the full range of available technologies or the realization of all of the economic benefits that these technologies can deliver to consumers and producers of electricity. A forward-looking approach anticipates the future products and services these technologies can enable and makes the necessary enhancements to the electricity infrastructure and regulatory rule changes to maximize the expected benefits that electricity consumers and producers can realize. This approach is, however, accompanied by the risk that investments and regulatory changes are undertaken to adapt to a future that ultimately does not materialize. Consequently, which approach or combination of approaches taken by a jurisdictions to adapt their electricity retailing sector should be based on its existing electricity infrastructure, current regulatory framework, current renewable generation resources, and future regulatory policy goals. This report identifies the key factors that a jurisdiction should consider in formulating a path to the future of its retail sector. Specifically, what initial conditions and policy goals should lead to a more reactive approach versus a more forward-looking approach. We also identify changes in a jurisdiction’s wholesale market design that can enhance the likelihood of success in achieving its future electricity retailing goals. We first survey the history, current state, and likely future of the new technologies driving change in electricity retailing. The global market for intelligent, interconnected devices, has grown markedly over the last two decades. Innovations like smart meters, direct load control appliances, programmable thermostats, and other smart home devices are allowing consumers to monitor and change their energy consumption habits remotely–drastically reducing the effort required to react to price signals or other incentives from their utility. For instance, between 2004 and 2018, the average cost of smart sensors fell by about 66%; smart meter costs fell by 20% in the decade prior to 2006; the prices of lithium-ion batteries–used for home and electric vehicle (EV) energy storage–and Photovoltaic (PV) grade polysilicon fell in price by 85% and 78%, respectively, between 2010 and 2018. Catalyzed by these price trends and average-cost based pricing of the sunk costs of the transmission and distribution networks, distributed solar has become a major component of the global market for renewable generation capacity. Declining equipment costs and generous financial incentives provided by local, state, and federal governments have increased the cost-competitiveness of distributed solar versus traditional grid-supplied electricity. Because of renewables mandates in many jurisdictions and economies to scale in deploying solar PV capacity, grid-scale solar systems have become far more common and actually surpassed the cumulative amount of distributed solar installed globally in terms of capacity in 2016. By 2018, a little over 40% of global solar capacity was distributed. Similarly driven by declining prices for lithium-ion batteries and smart devices, the transportation and heating sectors are poised to become major markets for grid-integration technologies. In an effort to reduce greenhouse gas (GHG) emissions and hedge future fossil fuel price increases, vehicles and heating infrastructure are beginning to switch from traditional fossil fuels to electricity. Combined with innovations in energy storage and distributed generation, electrification of transportation and heating equipment can provide resilience to power outages and price shocks in addition to grid reliability benefits. We then turn to a discussion of the regulatory barriers to electricity retailing efficiently adapting to these new technologies. Many barriers are the result of the existing regulatory process not creating the necessary initial conditions for many new technologies to be adopted or to be adopted in a cost effective manner. The lack of widespread deployment of interval metering is a prime example of this kind of barrier. Other barriers to change are the result of inefficient prices for regulated services, such as average cost pricing of the sunk cost of transmission and distribution network and annual average cost pricing of wholesale electricity to consumers for a unlimited quantity of energy. Allowing retail competition in electricity markets is one strategy for cost-effectively deploying these new technologies. Consequently, we survey the current state of retail competition in the United States and globally. Over the past three decades, electricity sectors in the United States have been re-structured through the formation of formal wholesale markets and retail competition. Some states have even implemented retail competition without formal wholesale markets. Outside of the US, countries in Europe, Asia, Oceania, and Latin America have adopted, or are beginning to adopt, with varying degrees of success retail competition in their electricity markets. In order to further explore the policy options appropriate for various jurisdictions, we conduct an in-depth review of deployment trends for interval meters, distributed solar, and dynamic pricing programs around the globe. Interval meters have experienced strong deployment trends in many developed countries. These meters made up 60.7% of all metering infrastructure in the US in 2019. The European Union has set the ambitious goal of reaching 80% market penetration by 2024–several Member States have already reached or surpassed this level of adoption. Many countries in Asia and Oceania have also reached high levels of interval metering penetration with over 70% in New Zealand and over 90% in China. Even though we observe strong adoption trends for interval meters, dynamic pricing of electricity is largely still in pilot mode. For instance, only eleven US utilities offered real- time pricing for residential consumers in 2019. Even considering the combined enrollment in dynamic and time-of-use pricing, only 7.1% of US customers had enrolled in 2019. Similar trends are evident in other countries. While smart meters are prevalent in Europe, only eight Member States offered dynamic pricing plans in 2018. There are a few outliers though. For instance, 75% of Spanish residential and commercial customers were on a dynamic pricing program by 2018. Global deployment of distributed solar generating capacity reached over 200 GW in 2018. Numerous ownership arrangements, generous subsidies, and net-metering tariffs have all made distributed solar an attractive option for consumers of all sizes. We argue that correcting the inefficiencies in the pricing of the sunk cost of the transmission and distribution network is likely to lead significantly more grid-scale solar investment to meet future renewable energy goals relative to distributed solar investments. With this background, we consider possible futures for electricity retailing. As noted ear- lier, the widespread deployment of interval meters is a determining factor in a jurisdiction’s decision to adopt a reactive versus forward-looking approach to the future of electricity retailing. We argue that regardless of whether interval meters have been deployed in a region or not, there are several retail market policies that regulators should adopt given these new technologies. These policies are designed to eliminate existing incentives consumers have to take privately profitable actions that increase the overall cost of supplying all consumers with electricity and shift a greater burden of sunk cost recovery on to other consumers. We suggest reforms to transmission and distribution network pricing that significantly eliminate the incentive for this behavior through the use of marginal cost pricing of delivered electricity and recovery of the sunk costs of the transmission and distribution networks through monthly fixed charges. We also suggest a mechanism for setting fixed charges for customers to address the equity concerns associated with this approach to recovering these sunk costs. Retail competition in the electricity sector has two primary goals. The first is to eliminate the need for regulation of retail prices because customers can switch

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