Modernizing the Electric Distribution Utility to Support the Clean Energy Economy Carl Pechman, Ph.D. August 25, 2016 i [THIS PAGE INTENTIONALLY LEFT BLANK ] ii Acknowledgments The author wishes to acknowledge Dr. Bernie Neenan at the Electric Power Research Institute; Dr. Peter Fox-Penner and Frank Graves of the Brattle Group; Professor Donna Attanasio of The George Washington University Law School; Clint Vince and Emma Hand at Dentons; David Owens at the Edison Electric Institute; Ralph Cavanagh at the NRDC Council; Charles Zielinski at Bryan Cave; Professor William Kovarik of Radford University; Charles Goldman, Peter Capers, and Andrew Satchwell of Lawrence Berkeley National Laboratory; Andrew Nicholls, Dr. Jeffrey Taft, and Heather Culley of Pacific Northwest National Laboratory; David Jermain of DOJ Consulting; Dr. Levi Tillemann at the New America Foundation; Peggy Welsh; Marianne Smith; and Jeanette Pablo, Larry Mansueti, Dr. Jonathan Pershing, Roland Risser, Dr. Karen Wayland, Joe Hagerman, Dr. Henry Kelley, Greg Gershuny, Ben Steinberg, Alex Breckel, Eric Hsieh, Joe Paladino, Heidi VanGenderen, Skila Harris, and Gil Bindewald at the U.S. Department of Energy (DOE). All shared their insights, reviewed drafts and provided helpful comments and criticism. Many thanks to Dr. Kathleen Ratcliff for her invaluable research support. Last but not least, a very special thanks to Secretary Ernest Moniz and Melanie Kenderdine, who gave me the opportunity to work with a great team to craft the first Quadrennial Energy Review. It was an honor to be part of the team, and this report is a background paper produced as part of that process. I would also like to acknowledge the Federal Energy Regulatory Commission, my host agency, which provided me the opportunity to work with DOE on detail. The comments and observations within this document are solely my own and do not represent the views of the USDOE, the FERC, individual FERC Commissioners, or the U.S. Government. iii Disclaimer This report was prepared as an account of work sponsored by an agency of the United States Government. Neither the United States Government nor any agency thereof, nor any of their employees, makes any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of any information, apparatus, product, or process disclosed, or represents that its use would not infringe privately owned rights. Reference therein to any specific commercial product, process, or service by trade name, trademark, manufacturer, or otherwise does not necessarily constitute or imply its endorsement, recommendation, or favoring by the United States Government or any agency thereof. The views of the authors do not necessarily reflect those of the United States Government or any agency thereof. iv Table of Contents Acknowledgments .............................................................................................................................. iii Disclaimer........................................................................................................................................... iv Table of Contents ................................................................................................................................ v Table of Figures ................................................................................................................................ viii Table of Tables ................................................................................................................................. viii List of Acronyms ................................................................................................................................. ix Abstract ............................................................................................................................................... x Key Findings and Insights ................................................................................................................... xi Policy Implications and Options ........................................................................................................ xii Executive Summary .......................................................................................................................... xiii Chapter Summaries .......................................................................................................................... xiv 1.0 Introduction ................................................................................................................................ 1 1.1 The Current Situation—A Strategic Inflection Point .......................................................... 2 1.2 Overview ............................................................................................................................ 3 2.0 Defining a Utility, What It Does, and Its Structure ..................................................................... 6 2.1 Edison’s Central Station Generation Concept .................................................................... 6 2.2 Defining Utilities ................................................................................................................. 6 2.3 Ownership Taxonomy ........................................................................................................ 7 2.4 Interplay of Economies of Scale and Utility Taxonomy .................................................... 10 2.5 Federal/State Jurisdiction and the Regulation of Utilities ............................................... 12 3.0 The Benefits that Utilities Enable ............................................................................................. 15 3.1 Benefits of Diversity of Demand ...................................................................................... 15 3.2 The Value of Interconnection ........................................................................................... 15 3.3 The Continuing Importance of Utilities ............................................................................ 18 The Prospect of Electric Utility Obsolescence: The Death Spiral in the Context of Distributed Energy Resources ............................................................................... 18 Reports of the Death Spiral Are Premature .......................................................... 19 Lessons from Obsolescence in Other Industries ................................................... 21 v 4.0 Economic Regulation of Utilities ............................................................................................... 23 4.1 The Right Costs for Rate Design—A Balancing Act ........................................................... 24 4.2 Incentive Impacts of Regulation ....................................................................................... 27 5.0 Disruptive Technologies and Innovation Supported by Regulatory Mechanisms .................... 29 5.1 Development of Disruptive Technologies ........................................................................ 29 5.2 Energy Efficiency .............................................................................................................. 30 Development of Energy Efficiency ........................................................................ 30 Implementing Utility Energy Efficiency ................................................................. 31 5.3 The Resurgence of Non-Utility Generation ...................................................................... 33 PURPA as a Transformative Policy ........................................................................ 33 5.4 Distributed Energy Resources .......................................................................................... 35 Distributed Energy Resources as a Disruptive Technology ................................... 35 Net Metering as a Transformative Policy .............................................................. 35 5.5 Getting the Price Right ..................................................................................................... 37 Where Price is Determined ................................................................................... 37 The Importance of Product Specification .............................................................. 39 It’s Time to Re-Evaluate Costs and Rates .............................................................. 41 6.0 The Scope of Distribution Utilities ............................................................................................ 43 6.1 Limitations on the Scope of Utility Activities ................................................................... 43 6.2 PUHCA and Industry Restructuring .................................................................................. 43 Restrictions on Utility Scope in Industry Restructuring ........................................ 45 6.3 Energy Efficiency, Distributed Energy Resources, and the Scope of Distribution Utility Business Models ............................................................................................................... 47 Models for Provision of Energy Efficiency and Demand-Side Services ................. 47 Models for Integrating Distributed Energy Resources into the Grid .................... 49 6.4 When Limitation of Scope Is Warranted .......................................................................... 51 7.0 The Path Forward ....................................................................................................................