The Smart Grid Business Case

John CaldwellEdison Electric Institute

A Potential Roadblock to Smart Grid:Regulatory Ambivalence

Approved• Portland General

Electric AMI (5/2008)

• Duke Energy Ohio Infrastructure Modernization (5/2010)

• Oklahoma Gas and Electric Smart Meters (7/2009)

• Texas – New Mexico Power AMI (7/2011)

Conditional• Idaho Power AMI

(2/2009)• Pacific Gas and

Electric (3/2009)• American Electric

Power Smart Grid Pilot (3/2009)

• New York – Smart Grid Initiatives of 6 Utilities (7/2009)

• Baltimore Gas and Electric AMI (8/2010)

Rejected• Hawaiian Electric

Company Inc. Smart Meter Pilot (7/2010)

• Duke Energy Indiana Smart Meters (11/2009)

• Commonwealth Edison Alternative Rate Plan for Smart Grid Funding (5/2011)

The Regulator’s PerspectiveThree Questions That Will (Probably) Be Asked

1. Sounds wonderful – but will it “put bread on the table”? (Will it produce tangible, monetary benefits or savings to the ratepayer?)

2. Are we “shooting craps”?a) How probable is it that the benefits stream will occur?

b) Are the benefits contingent on some other activities (e.g., demand response)?

3. Will the “check be in the mail”? (How will the benefits be realized by the ratepayer?)

a) Will they be passed through automatically in a rate tracker?

b) Will they not be passed through until the next rate case?

The Business Case Challenge

Rigorous and

Defensible

Broad and

Inclusive

• Costs are Specific• Benefits are:

o Trackable, o Measurableo Verifiable

• Projections are Reasonable

• Risks are Accounted For

• All Benefitso Ratepayero Societalo Platform

• Must Take “Long View”

• Potential Transformational Impacts Considered

Preparing the Business CaseGeneral Principles

1. For each smart grid application, create “long list” of benefits

2. Characterize benefitsa) By recipient (e.g., shareholder, customer, societal)

b) By contingency (what else must occur for these benefits to be realized?)

c) By measurability

d) By verifiability

3. The value chain in each business case must be oriented to its relevant beneficiary

a) For the utility: shareholder benefits

b) For the regulator: ratepayer benefits

c) For the taxpayer: societal benefits

Smart Grid Benefits (and Costs) Not the Same for Everyone!

Consumer Utility (Shareholder) Society

Deferred Generation /

Transmission Capacity

Gain (from avoided rate increases)

Loss (from return on deferred investments)

O&M Savings Gain (but only after savings passed through in rates)

Gain (before savings passed through in

rates)

Outage Reductions

Gain Gain Gain

Demand Response Savings

Gain (in consumer surplus)

Loss (in producer surplus)

CO2 Emissions Reductions

No Monetary Benefit (without CO2 tax)

General societal benefit

AMI: The Complete Business CaseConsumer Perspective

Benefits• Peak/Off-Peak Pricing

– Change in Consumer Surplus (Not Savings!)

– Deferred Generation Capacity

• Reduced O&M– Meter Reading– Call and Billing Centers– Outage Response– Energy Theft / Meter Errors

• Enhanced Receivables Recovery

Costs• Peak/Off-Peak Pricing

– Change in Producer Surplus? (No!)

– Marketing / Administrative Costs

• Capital Costs for New Meters

• O&M for New Meters• Billing / Customer

Information Systems Upgrade

Incremental expenditures and savings are tracked by year, and converted into net present value. Length of study period should correspond with service life of principal assets.

A Good Deal???

Suppose Starbuck’s sells a medium cup of coffee for $2.00 and you buy two cups a day, five days a week. . .

. . . but then they raise the price to $3.00, so now you only buy one cup a day, five days a week.

CONGRATULATIONS!!! Starbuck’s has saved you 25% on your coffee costs!

Savings ≠ Benefits!An Example

Assumptions:• Flat rate energy price of 4.1 cents/kWh• Two consumption behaviors

– Peak (2:00 PM – 7:00 PM Weekdays): 1.33 kW/hour– Off-Peak (All Other Hours): 0.85 kW/hour

• Introduce peak / off-peak rate– Peak: 4.9 cents/kWh– Off-Peak: 3.7 cents/kWh

• Price elasticity– Peak: -0.6– Off-Peak: -0.1

Peak Pricing Example

Flat Rate

Supply Curve

Off-Peak Demand Curve

On-Peak

Demand Curve

Peak Pricing ExampleConsumer Loss Calculation for On-Peak Period

On-Peak Price

Original Flat Rate

Loss from purchasing electricity at new, higher price.

Lost value of reduced electricity

consumption.

On-Peak Demand Curve

Old Usage

New Usage

Peak Pricing ExampleConsumer Benefits Calculation for Off-Peak Period

Off-Peak Price

Original Flat Rate

Savings from old usage level at new, lower price.

Benefit of additional usage at new, lower price.

Off-Peak Demand Curve

Old Usage

New Usage

Consumer Benefits Calculation Summary

Off-Peak Benefits

Savings from original usage at lower price(Old Price – New Price) x (Original Hourly Consumption) x (# of Off-Peak Hours)

Benefit from additional usage½ x (Old Price – New Price) x (New Hourly Consumption – Old Hourly Consumption)

x (# of Off-Peak Hours)

On-Peak (Negative) Benefits

Losses from new usage level at higher price(Old Price – New Price) x (New Hourly Consumption) x (# of On-Peak Hours)

Lost benefit from curtailed usage½ x (Old Price – New Price) x (Old Hourly Consumption – New Hourly Consumption)

x (# of On-Peak Hours)

Consumer Surplus Calculation Results

Flat Pricing Demand Price Hours kWh Total Cost

Off-Peak 0.85 kW $0.041/kWh 7,456 6,344 $258.43

On-Peak 1.33 kW $0.041/kWh 1,304 1,730 $ 70.47

Total 8,760 8,075 $328.90

Peak Pricing Demand Price Hours kWh Total Cost

Off-Peak 0.86 kW $0.037/kWh 7,456 6,407 $235.33

On-Peak 1.16 kW $0.049/kWh 1,304 1,508 $ 74.57

Total 8,760 7,971 $309.90

Savings = $ 328.90 – 309.90 = $19.00

Consumer Surplus = [($0.041-$0.037) x (0.85 + 0.5 x (0.86-0.85)) x 7,456] – [($0.049-$0.041) x (1.16 + 0.5 x (1.33-1.16)) x 1304] = $11.41

Conclusion: Savings calculation overstates consumer benefits estimate by 66%!

A Note on Producer Surplus• Consumer Savings = Lost (Producer) Revenue• But Loss in Producer Surplus is Less Than Loss in

Revenue• The Benefits Stream Parallels that for Consumers (i.e.,

Gain During Off-Peak Hours, Loss During On-Peak Hours)– Off-Peak Benefits

• Serve original load - at higher price!

• Serve additional load (at higher price)

– On-Peak (Negative) Benefits• Serve reduced load – at lower price!

• Lost benefit of curtailed usage

Peak Pricing ExampleProducer Loss Calculation for On-Peak Period

Supplier Price When Customer Billed on Flat Rate

Supplier Price When Customer Billed on Peak

Rate

Loss from selling electricity at new, lower price.

Lost margin from reduced electricity

sales.

Supply Curve

Flat Rate Usage

Peak Rate Usage

Peak Pricing ExampleProducer Benefits Calculation for Off-Peak Period

Supplier Price When Customer Billed on

Flat Rate

Supplier Price When Customer Billed on

Off-Peak Rate

Increased margin from selling electricity at new, higher price.

Margin from additional sales at new, higher price.

Supply Curve

Flat Rate Usage

Off-Peak Rate Usage

Supplier Benefits Calculation Summary

Off-Peak Benefits

Increased margin from original usage at higher price(New Price – Old Price) x (Original Hourly Consumption) x (# of Off-Peak Hours)

Increased margin from additional usage½ x (New Price – Old Price) x (New Hourly Consumption – Old Hourly Consumption)

x (# of Off-Peak Hours)

On-Peak (Negative) Benefits

Margin losses from new usage level at lower price(New Price – Old Price) x (New Hourly Consumption) x (# of On-Peak Hours)

Lost margin from curtailed usage½ x (New Price – Old Price) x (Old Hourly Consumption – New Hourly Consumption)

x (# of On-Peak Hours)

Producer Surplus Calculation Results

Flat Pricing Demand Price Hours kWh Total Revenue

Off-Peak 0.85 kW $0.036/kWh 7,456 6,344 $230.78

On-Peak 1.33 kW $0.057/kWh 1,304 1,730 $ 98.12

Total 8,760 8,075 $328.90

Peak Pricing Demand Price Hours kWh Total Revenue

Off-Peak 0.86 kW $0.037/kWh 7,456 6,407 $235.33

On-Peak 1.16 kW $0.049/kWh 1,304 1,508 $ 74.57

Total 8,760 7,971 $309.90

Lost Revenue = $ 328.90 – 309.90 = $19.00

Producer Surplus = [($0.037-$0.036) x (0.85 + 0.5 x (0.86-0.85)) x 7,456] – [($0.057-$0.049) x (1.16 + 0.5 x (1.33-1.16)) x 1304] = - $9.50

Conclusion: Margin loss (negative producer surplus) is half of revenue loss.

Why Energy Savings is a Bad Metric

• It ignores the value of energy consumed

• It ignores collateral costs that may be incurred by consumers if energy use is shifted

• It ignores the corresponding losses incurred by producers from lower sales (however, these can be ignored if business case is from consumer perspective only)

Consumer Surplus is the appropriate metric for measuring the direct impact of changes in energy consumption behavior.

But Does This Mean that Real-Time Pricing is a Bad Thing?

Not Necessarily!!!

• Consumer surplus could (and usually does) increase

• Future rate increases (and perhaps even current rates) will be reduced due to deferred capacity expansion and/or lower capacity charges

• Traditional non-TOU pricing is a form of hedging (i.e., energy provider pays for energy in real time, while customer does not), which may result in a “hedge premium” that can be removed or reduced with TOU pricing

. . . And What About that Starbuck’s Deal? Here’s the Real Impact of the Price Increase

$0.00

$1.00

$2.00

$3.00

$4.00

$5.00

0 1 2 3 4 5 6 7 8 9 10

Pri

ce

pe

r C

up

Quantity per Week

Starbuck's Solution

$2

.90

$2

.70

$2

.50

$2

.30

$2

.10Original Price

New Price

Loss from purchasing coffee at new, higher price

Lost value of reduced coffee consumption

Loss from Purchasing Coffee at Higher Price

5 cups x $1.00/cup = $5.00

Lost Value of Reduced Coffee Consumption

Cup 6: $2.90 - $2.00 = $0.90 Cup 7: $2.70 - $2.00 = $0.70 Cup 8: $2.50 - $2.00 = $0.50 Cup 9: $2.30 - $2.00 = $0.30 Cup 10: $2.10 - $2.00 = $0.10

Total Loss: $7.50

Demand Curve

New Quantity Old Quantity

Sample AMI Business CaseRatepayer’s Perspective

Costs Benefits

Meters $ 60,100,000 Reduced Meter Reading Costs

$123,070,000

Remote Disconnect Collars $101,820,000 Billing / Call Center Savings

$ 8,730,000

AMI Operating Costs $ 10,160,000 Reduced Energy Theft / Meter Error

$ 30,440,000

Information Systems Upgrade

$ 5,720,000 Enhanced Receivables Recovery

$ 10,810,000

Marketing / Administration $ 20,000 Salvage $ 1,660,000

Deferred Generation Capacity

$ 17,800,000

Gain in Consumer Surplus $ 16,800,000

Total $177,820,000 Total $209,310,000

Assumptions: 20-year meter life, 8% discount rate, 20% residential customer enrollment in peak / off-peak rate.

Some Final Lessons

• Don’t oversell the case! (It’s only as strong as it’s weakest link.)

• Different stakeholders will have different business cases. Don’t ignore the distinctions!

• Multipliers multiply confusion (and grief!). Smart grid investments may create positive job multipliers, but reductions in staff due to automation may produce negative job multipliers

• Phantom benefits will only haunt the case: best if they are measurable and trackable!

• There’s no such thing as a risk-free investment. Acknowledge it in the case, and be willing to share it!

Who Bears the Risk?

Uti

lity

Customer High Risk

High Risk

Low

Risk

Rate Tracker for Cost

Recovery / Guaranteed Reduction in

Revenue Requirements

Over Time

Rate Case for Cost

Recovery / Guaranteed Reduction in

Revenue Requirements

Over Time

Rate Tracker for Cost

Recovery / Rate Tracker for Savings

and Benefits

Rate Case for Cost

Recovery / Rate Tracker for Savings

and Benefits

Rate Case for Cost

Recovery / Rate Case for Savings and

Benefits

Rate Tracker for Cost

Recovery / Rate Case for Savings and

Benefits

Performance- Based

Ratemaking?

Thank You!

Questions?

John Caldwell202-508-5175

jcaldwell@eei.org