Changing Energy Systems: Implications for Regulators and Policy Makers

Introduction and Overview

Energy delivery systems are changing – fundamentally and possibly very quickly – because of the combined effects of several factors: technology, environmental demands and growing concerns about system performance on costs, reliability and resilience.

The systems may be changing but the customers aren’t and there is peril in looking too closely at other industries such as telecoms for clues to the way the future might unfold. Energy is boring and that is how customers like it.

For public policy makers it isn’t boring at all. Public policy has a big stake in the speed and nature of the coming transformation. While local energy sources (including efficiency measures) will grow in importance it seems unlikely that individual consumers will become autonomous or that energy will be delivered through the ether without benefit of wires or pipes. In other words, the wires, the pipes, the monopoly businesses that own them and the regulators that oversee it all will be with us for some time.

For both policy makers and regulators this is far from business as usual. If there is a compelling argument for a more strategic conversation about the upstream energy system there is an even more compelling argument for that sort of conversation downstream – and it needs to engage policy makers, regulators, everyone in the energy service delivery value chain and customers.

A Bit of History

About seven years ago the Canadian Gas Association (CGA) and Pollution Probe agreed to collaborate on an entirely immodest effort to change energy thinking in Canada. The goal was to shift the conversation from being singularly focused on upstream oil and central power to include the downstream system – the customer and the retail delivery system. The initiative acquired the moniker “QUEST” or Quality Urban Energy Systems of Tomorrow.1 At that time – in 2007 –more attention to the downstream was an idea based on common sense, a small base of experience, and understanding of emerging technologies but it was far from mainstream in fact or perception.

Why common sense? Simply put, because in the search for better environmental performance, the lack of attention to the downstream meant that we were leaving half of the potential on the table.(The following points are all common knowledge and easily verified by reference to public sources such as the International Energy Agency, the U.S. Energy information Administration or Natural Resources Canada.)

  • Much of the decline in carbon intensity in the U.S. and Canada that we had been seeing for some time was driven by efficiency not by reduced carbon in fuel supplies.
  • It was easily demonstrated that efficiency gets gains at very low or negative cost – unlike decarbonisation of the energy system – and cost is always a primary consideration no matter how much one worries about carbon and climate.
  • End use efficiency can have a big multiplier effect upstream due to system losses.
  • By thinking about full system efficiency – essentially heat management – ways could be found to use more of the energy that is otherwise rejected – fully half of the total energy that comes into the Canadian energy system.
  • To round it out, many local sources looked increasingly promising if not quite economic – waste as an energy source, local renewables such as solar, biomass, geothermal, deep water cooling, and on it went.

A few years on what we knew in 2007 is just as true today and several other factors have intervened to make the case still more compelling.

  • The potential cost of replacing, upgrading and “smartening” our traditional energy infrastructure is growing ever more daunting and we have much slower population and economic growth with which to soak up the associated costs.
  • Cost aside, no-one wants to see anything built in their vicinity and “not in my back yard” often extends hundreds of linear kilometers.
  • Renewable energy especially bio-fuels and distant electric power bring their own challenges: cost, land intensity, environmental effects, and infrastructure requirements. And, just like everything else, they need to be built in someone’s back yard.

We have also come some way back toward a more clear-headed view of the policy interest in energy. We have long understood the importance of diversity in support of security, reliability and resiliency. But that home truth had been swamped in the great carbon panic leading up to Copenhagen in 2009.

The term “carbon panic” is used advisedly. Let us start by acknowledging that significant reductions in carbon from energy production and use is essential insurance and that it can be cost-effective even in the short term if done in a way that brings other dividends – such as efficiency or other environmental benefits. But by late in the last decade climate action had acquired a sort of frenzied urgency and proposals were being advanced that failed the most rudimentary test of energy literacy: an understanding that safety, reliability, cost, and multiple environmental effects all matter and that failing to account for them was a certain recipe for loss of public support.

Most recently two other big factors have become much more prominent.

Public attention is increasingly turned to environmental risks – hurricanes, ice storms, floods – all of which raise questions about resiliency. This is hardly new but it has become much more salient.

And technology may finally be evolving to potentially “disruptive“effect, not through any one silver bullet but by the convergence of several technological streams:

  • Unconventional gas development has transformed both the availability and price of natural gas supplies.
  • The declining cost of solar electricity and the growing potential of distributed storage in combination with small scale (mainly gas fired) combined heat and power systems have radically increased the potential of distributed power.
  • Advances in battery systems may bring battery electric vehicles more into the mainstream.
  • The massive and pervasive effects of information technology have made more complex, multi-directional, multi-source integrated systems practical.

In short it increasingly feels as if we are on the cusp of a true energy transformation – possibly the first in over a century. Let’s think about what that could mean.

A Look to the Future

It does mean one way or another that the world of energy utilities will change fast and potentially radically. However, before we mourn or celebrate the death of the electric utility as some commentators have been doing of late it is first useful to reflect on just how wrong our energy predictions can be.

Recall the pressures on gas utilities dating back a decade or more – the pressures that induced CGA to take the initiative to create QUEST.

By 2007 gas utilities were facing several challenges:

  • Concerns were growing about cost and availability.
  • Per customer volumes were steadily declining due to efficiency and competing fuels and supply technologies.
  • Extending gas systems to grow the customer base was expensive, especially into low density developments without large anchor loads.
  • Many of the big thinkers in energy were entirely focused on carbon; so called distributed combustion had to go and the world had to be transformed to one that was essentially all electric.
  • Some of the gloomier prognosticators mused about the coming death of the gas distribution utility.

It is useful to keep the above in mind as well as what has happened since as we contemplate a different set of circumstances which in the minds of some herald the end of the electric utility.

At the very least the energy delivery world is assuming a different form, much of it along the lines of the QUEST vision – more distributed in the case of electric power and vehicle fueling, less distributed in the case of heat. The big question is: whither grids?

Ironically one leading light in the U.S. industry has been reported envisaging a world where the electric grid might be eliminated with power coming from solar combined with fuel for micro-CHP systems supplied by the gas grid. So now it turns out that the gas grid is the one that won’t go away. So much for predictions.

And of course the other grid that has come increasingly into serious market contention is the thermal grid. Thermal grids have various advantages – the potential to use bio-mass as a primary fuel or to be multi-fueled; scale economies that allow them to be complemented by geo-thermal sources, rooftop solar or waste heat capture; and a natural pairing with the power system through CHP systems. Thermal grids will likely become more commonplace.

As to the electric grid, entirely autonomous buildings seem to be a very unlikely prospect. Even if they are potentially feasible, it seems likely – in urban areas at least – that the cost of local power generation and storage sufficient to meet all electric loads including peak would be greater than the cost of maintaining grid connection, even paying a reasonable – and fair – share of the costs of that grid.

Micro grids are already emerging and it seems more than likely that they will grow in building complexes with diverse thermal and electric loads such as campuses, hospitals, shopping centers or office complexes. The case for micro-grids as a contribution to a distributed power system and as a measure to enhance resilience seems to have become well established, especially after recent environmental events such as Hurricane Sandy. Micro-grids will most likely be connected to the larger grid due to economic opportunities to sell any surplus power, because they are potential system resources in terms of reliability and restart and because the economics of balancing thermal and electric loads tends to benefit from the scale economies of large interconnection areas.

Even if the potential exists to do away with those nasty utilities it is not obvious that it will happen very soon, especially not for small scale commercial and residential customers. In some recent articles in the industry press, advocates of distributed power have extolled the virtues of consumer choice and autonomy along with the enhanced value proposition entailed in being greener. Greenness aside, the model here is of course telecoms.

But let’s take a step back and ask whether the analogy to telecoms is really apt.

First, the potential new value proposition is more limited – for the consumer the end result is essentially the same things: lights and a warm house (although distributed vehicle fueling is something else). It is hard to see how a transformed energy system makes calls to grandmother or posting selfies on your Facebook page any easier or cheaper.

Second, for all the liberation implied in the telecoms model, it seems doubtful that there has been a great increase in warmth of feeling toward service providers. Customers have a choice but they still have the service providers’ systems in their houses. When the irritation level gets too high they can switch but the transaction costs entailed in doing so are substantial.

Third, based on years of experience with energy consumers, most observers have seen little evidence of interest in choice. Retail deregulation in gas and electricity has not generated the predicted change. Gas customers have tended to either stick with the incumbent utility or in some cases migrate back to it after a brief dalliance with a third party energy provider. Environmental attributes matter of course but experience shows that a very small share of customers are willing to pay more for green attributes. What is clear is that most of all, customers just want peace of mind (a system that always works); that has low intrusiveness (they don’t have to think about it); and low cost.

And yes the younger generation are more environmentally aware but they will all grow older and acquire the attributes of householders with multiple responsibilities and constrained budgets. It seems imprudent to factor changes in basic human nature into any prediction of transformational change in energy systems.

In short, if one were trying to predict the future of energy the best bet would be on customers continuing to look to safety, reliability, out of sight out of mind, and low cost. When they act politically of course, citizens will demand environmental attributes but that takes us out of the realm of the private transaction and into that of public policy.

The Challenge for Public Policy

It is possible that we may someday leave the era of energy grids but not soon. In fact we may well be going the other way – with three grids increasingly the norm – power, gas and thermal along with a vehicle fueling system depending increasingly on the electric and the gas grids. Most important they will all be interconnected with one affording resources to the other.

And that is where the need arises for a more strategic conversation about both the policy and regulatory implications of that sort of change.

First, this article has argued that there are several potential policy benefits to be found in the world of multiple interconnected grids based on diverse (both centralized and decentralized) resources. Governments, in short should increasingly see it as in the public interest to encourage the sort of change implied in all of this – provided that it is cost-effective over a plausible time horizon (no rate shock), that it lives up to its promise in terms of reliability and resiliency and that it delivers environmental benefits.

Governments should look first to what competitive markets can deliver and if a big priority is to deliver less carbon then they should price it. But with or without carbon pricing it is not clear that competitive markets alone will deliver the best outcome for public policy.

First of all consumers have notoriously short time horizons for payback. Information acquisition and transaction costs can easily swamp any putative value proposition. Markets, in other words, don’t always work.

Second, more rapid investment in technology is required – especially in the application of technology in integrated systems – each of which will pose its own technical and management challenges. Some of that investment is arguably a public good since a substantial part of the benefit cannot easily be internalized by investors – especially in utility systems themselves.

Almost any investment in this sort of system will have a long time horizon. Individual consumers – even larger commercial or industrial consumers – will not invest where paybacks are much more than a (very) few years and they will not take on management complexities that distract them from their core business. Finally, competitive investors in supply technologies faced with investment returns that are uncertain as well as long in coming may choose to invest elsewhere.

And if it all remains tied to grids then we still have natural monopolies that entail complex management challenges. Gas and electric grids will still be regulated. Thermal utilities will largely become regulated – even if light-handedly – because of the inherent market power in the hands of the provider once the customer is signed up. And the systems will become more and more untidy compared to the unbundled world of standalone wires and pipes that has been the governing paradigm for over twenty years.

A thermal system is not just pipes but also the thermal resources that supply the pipes. If it involves combined heat and power assets then it becomes part of the system of electric power resources. A power system dependent on radically distributed resources such as CHP, solar and storage might work with all of those resources supplied from independent entities. Or it might require much tighter integration than is afforded by an entirely unbundled model. Fueling systems requiring high upfront investment and facing slow market growth might or might not get built at all. A vehicle stock which becomes part of the electric storage system brings its own management challenges. Other behind-the-meter investments including garden variety energy efficiency investments are unlikely – as in the past – to be made at a level consistent with public policy objectives or be as effective in terms of power system balancing without integration one way or another into the management of the larger energy delivery system.

How does all of this play out in the regulatory world?

We have seen and will see more tension between competitive suppliers and regulated utilities. Even utility affiliates are suspect because of perceptions that they will have an unfair advantage due to their affiliate relationships. On the other hand, competitive players have not exactly rushed into the game in the face of a weak consumer (private) value proposition and very long paybacks. Whether that will change in the face of technology change and declining costs remains to be seen.

Utilities themselves are of course inherently conservative although many have seen the writing on the wall – as did gas utilities in their support for QUEST. The utilities that do see the writing on the wall will look to reshape the business model by expanding their service offerings and they will fiercely protect their ability to maintain the integrity of their systems. They might or might not be positive change agents but, regardless, it seems unlikely that they will look fondly on the prospect of so-called death spirals and nor should policy makers or regulators.

The instinct of regulators seems to be to ensure that utilities not venture into activities beyond the pipes and wires. The unbundled model has served us well for two decades and allowing that to erode reintroduces a world of non-transparent cost allocation and possible barriers to the emergence of competitive suppliers. On the other hand the New York State Department of Public Service in a recent staff paper signalled that they see no inherent reason why electric utilities cannot invest in power resources alongside competitive players.

The instinct of policy makers ranges from “ignore it” to “just do it”. Almost none understand the regulatory system which for most is something of a mystery and, just like consumers, most of the time they prefer the whole thing to remain out of sight out of mind. When they do want change, policy makers see the regulatory system as slow and conservative which of course it is. Better to use directives or familiar tools such as mandates and subsidies regardless of whether they match well with regulated systems.

This combination of forces looks on balance as if it will inhibit innovation or at least make it even more disruptive (in a negative sense) than it need be.

I’m your local utility regulator and I’m here to help you innovate

This is not a line from a lame joke although it could be. It is possible that the future of energy delivery may be just as regulated as in the past – maybe even more but based on different models despite the risks to clarity and transparent cost allocation and the potential to inhibit competitive players.

The regulatory system may have its limitations but it also has attributes in a combination that neither competitive markets nor other policy instruments can replicate.

  • If we still live in a world of grids, the regulatory system will oversee the underlying networks on which innovative supply and demand technologies will have to be built.
  • The regulatory system supports a business model with long time horizons – a characteristic of most energy systems.
  • The regulatory system can explicitly build external (public interest) costs into the system through things like system benefits charges or demand side management expenditures.
  • It allocates costs to customers with strict attention to fairness; other policy approaches allocate costs to taxpayers – and fairness is optional.
  • It is close to customers with a deep understanding of habits and needs and the capacity to deliver most of the attributes that customers look for.
  • Regulatory processes are distinct from policy processes in important and desirable ways: expert, evidence based, transparent and subject to due process.

A Bigger Conversation

The clearest path toward more sustainable, less carbon intensive energy systems involves real prices for energy including a carbon price. But most governments are not yet prepared to price carbon especially at the small consumer level because consumers are not ready for it.

In the meantime, other forces including other policy measures have contributed to new solutions being developed and applied. It is arguably in the long term interests of society – and of customers – to experiment and to bring more of those solutions into play, some of which will come up short, others of which will be winners.

Where competitive markets work we should leave it to competitive markets. Where competitive markets don’t deliver and where innovative solutions stand on the platform of the regulated system there is a case to be made for regulatory systems to take an active role and experiment. Apart from anything else, one thing we know is that consumers will never be ready for carbon pricing unless there are lower carbon solutions ready to hand.

If that is to happen we need a different sort of discussion. The regulatory community – regulators, utilities, customers and competitive service providers – needs to stand back from day to day preoccupations and from the adversarial environment of the hearing room. Some years ago regulators and utilities in Canada initiated a series of regulator/industry dialogues. They were a good idea which helped advance mutual understanding. But they were limited in their goals and they did not attract policy makers or reach a broader audience.

In future discussions policy makers need to be active participants because much of what needs doing will require policy or legislative support. And to be seen as legitimate, such discussions need to be accessible to a broader range of participants and a broader audience.

The subject matter is vast in its scope and paralyzing in its complexity but it is also about the fundamental configuration of our energy systems for decades into the future. We are stumbling into the future right now whether anyone wants it or not. We will make mistakes; some ideas will come up short and there will no doubt be many black eyes.

If we could just acknowledge that last point it might be liberating. Better black eyes than black outs.

* Michael Cleland is a private consultant with extensive experience in energy and environment policy. He is currently Nexen Executive in Residence at the Canada West Foundation. He was formerly President and CEO of the Canadian Gas Association, Senior Vice President Government Affairs for the Canadian Electricity Association (CEA) and Assistant Deputy Minister (ADM) for the Energy Sector in the Department of Natural Resources Canada (NRCan).

  1. Quality Urban Energy Systems of Tomorrow, online: QUEST <>.

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