In a two-part post, I’ll look first on what makes encouraging distributed energy such a conundrum, and then at the steps the WUTC is proposing to take. For part two, please click here.

The Early 20th Century Bargain With Investor-Owned Utilities

Electrical companies are natural monopolies within their service areas. It would make no sense at all for competing companies to build a distribution network in the same location as an existing network, creating competition. And if market forces determined where electrical networks were built, rural areas or areas where demand was limited or users could not pay the costs would go without service. In the early 20th Century, as government sought to rein in the power of monopolies in general, states across the country brought investor owned electrical utilities (IOUs) under the control of state utilities and transportation commissions such as the WUTC.

In doing so they struck a bargain of sorts. The utilities and transportation commissions would set the rates IOUs could charge and the terms of service that the utilities would have to meet. The utilities would be expected to build systems that could provide for the needs of their service area – not just on a daily basis, but to meet the peak demands of those customers. In exchange, the utilities commissions would set rates that were “fair, just, reasonable and sufficient.” “Sufficient” was a key word – because it meant sufficient to provide the investors in the IOUs with a reasonable profit on their operations and a reasonable return on their investment in the generating plants, transmission lines and distribution systems that were essential to providing service. In short, in exchange for giving up the ability to make monopoly profits, utility investors were assured that they would be able to charge high enough rates to generate a reasonable return on their investments, essentially protecting them from the vagaries of capitalism. Utilities commissions set rates to achieve the lowest rates possible for consumers – consistent with the obligation to the IOUs. They also set rates to insure that one class of customers were not able to pass off the costs that they caused the IOUs to incur onto other classes of customers.

Distributed Energy as “Disruptive Technology”

Most electricity is generated at enormous power plants – hydroelectric dams, coal or gas-fired power plants – from which electricity is transmitted in very high voltage transmission lines from the power plant to the customers. As the electricity nears the customers, the voltage needs to be reduced, so that it can be utilized by appliances and is not unreasonably dangerous. That happens through substations, where the voltage from the transmission system is reduced to the point where it can be sent out onto the local distribution network. The lines on the distribution side of the substation carry far less energy then the line from the transmission side of the substation.

As the search for renewable energy has begun, there have been, and will be, efforts to build massive wind farms, or massive arrays of solar panels – projects that would replace an existing power plant or a fraction of an existing power plant. Beyond the challenges of new technology, such proposals tend to have two fundamental challenges, however. The first is that their massive size and often considerable impact requires literally years of permitting. The second is that since reliable wind or solar power are seldom co-located with existing transmission lines, they usually require construction of high voltage transmission lines from the project site to where the energy can be used or connected onto the regional grid. Condemning right of way and building high voltage transmission lines is its own multi-year, contentious process.

Distributed energy takes advantage of much smaller sources of power generation capability – from solar panels on a shopping center roof, to dairy digesters handling the dairy waste of a dozen dairies in a valley, to co-generation plants using waste heat from existing manufacturing facilities. The concept behind distributed energy is that it is delivered to the grid on the downstream side of the substation, in low enough voltage so that the existing distribution system can handle it, and so that the power may serve other customers on the same side of the substation – but never go onto the transmission grid. With enough distributed energy, the demand on the central power plant would shrink, requiring less of the power produced on a massive scale, or making existing power plants cover the needs of expanding users without construction of new power plants.

The problem with that is that distributed energy is potentially a disruptive technology – doing for the existing transmission and generation systems what the personal computer did for typewriters or digital cameras did for film manufacturers. Our electrical utility system has been premised on IOUs being obligated to build enough generation capacity to supply the peak demand needs of electricity users, and then keeping rates as low as possible by selling as much power from their generation capacity as possible. But what if over a fairly short period, the demand began to shrink? Worse yet, what if the demand began to shrink most of the time – but not necessarily the peak demand, so that the IOUs still had to have as much generation capacity, but could sell fewer kilowatts of power over the year. The dollars that must be generated from rates to provide the guaranteed return to the IOU doesn’t go down just because the demand goes down. So if the IOU can sell fewer kilowatts of electricity because distributed energy is reducing demand, the only way to provide that return is by increasing the rates for the kilowatts actually sold. And if that raises the rates required of all power users, how do we make that fair when a few customers happen to be lucky enough to have the ability to produce power, while most customers simply have to pay the higher costs?

In the technology revolutions of the 1990s and 2000s, market forces mostly sorted those questions out. Because there were fortunes to be made, there was plenty of incentive for inventors and entrepreneurs to innovate to produce better products at lower costs. Gaining the benefits of the improved technology required investment by millions of people and businesses, but those investments eventually paid off in lower costs and greater productivity for everyone. In the case of electricity generation, however, we have a regulated market. It is as if when Microsoft developed Office, it had to sell it to the typewriter market in which the government had agreed that in exchange for typewriter manufacturers selling their goods at just above cost, all businesses would need to pay a return on the investment in typewriter plants. The incentive for Microsoft to invest in research and development would have been much reduced.

Various Parts of the Conundrum

All new technology gets cheaper as it expands its market. But the first prototype is expensive. With the various forms of distributed energy, a key question is, who pays for that prototype? And how does an entrepreneur have any assurance that it can take the technology to scale when it has to sell to a regulated utility? Will there be enough potential for profit to incent entrepreneurs to put their energies and money into developing the technology?

Utilities have various sources of power, some that are extremely low cost (much of our hydropower) and some that is much higher cost. If IOUs are required to buy power from distributed producers, what price should they have to pay – the price they would sell power to the producer at, the price they can generate power from their existing portfolio at, or the price it would cost them to get additional power for their portfolio elsewhere?

How long should an IOU have to be committed to buying power from a distributed generator? What if it doesn’t need the power? What if two years from now someone can produce an equivalent amount of power at a fraction the cost?

If a customer wants to generate its own power, and sell any excess to the utility, does the utility still have to have generation capacity available to serve that customer if the distributed generation isn’t working? With wind or solar power one of the critical challenges is that they may not be generating any power during the period of peak demand – thus requiring IOUs to maintain generation plants to meet peak demand – and causing the IOUs to expect to continue to receive a return on their investment in that peak capacity, even if the customers they are holding it for may not use it.

That final issue is one of the trickiest parts of the distributed energy conundrum. As few as ten years ago, most people thought that our demand for additional electricity was endless. Any new sources of energy were considered desirable, because they could meet future demands at least in part without construction of new power plants. But today, many Northwest IOUs are facing a future where their demand may not expand, or may shrink. Recent estimates are that 85% or more of future increased demand could be met through conservation. The greatest need is for sources to meet peak demand. And unfortunately many distributed sources of electricity are not reliably available to meet demand peaks.

These are some of the challenges that the WUTC and the Washington Legislature face when attempting to increase distributed energy in Washington State as a way to reduce the use of fossil fuels. If it seems that these are intractable problems, under our existing system of utility regulation, that is to a large extent true. It is possible to make progress around the edges. In the next post I will look at the WUTC’s proposals for doing that. But their proposals are only for progress around the edges. Very fundamental changes – very unlikely to happen – would be required to move quickly to achieve the level of renewable electricity that has occurred in Germany.