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Shrinking electric demand growth: How will
By Matthew Rose, Enerdynamics Instructor
A review of current energy industry reports and commentaries suggests that the utility landscape is undergoing major challenges that could forever change the way companies do business. It is not exactly a “sky is falling” mentality, but there is a lot of concern and discussion about the pressures facing electric utilities and the viability of the traditional utility business model.
Under the traditional cost-of-service model, utilities make money based on their approved investments in facilities. As utility demand increases, utilities have reason to build more power plants and lines to keep earnings growing while recovering their costs from ratepayers.
The industry has long been blessed with electricity demand growth. Starting back in the 1950s, the industry benefited from the growing penetration of electric technologies such as air conditioning and various appliances. The commercial market for electricity also grew due to the increased number of shopping centers and malls that required air-conditioned space and lighting. The electric utilities had their mandate: make sure there was enough power to keep up with demand.
Some 50 years later, the question is “what happens now?” Demand is barely growing with some companies even seeing a forecasted loss in their demand requirements. How do utilities remain viable, competitive businesses attracting investors with demand shrinking? The end result is a needed examination of the way the industry is regulated and compensated while allowing companies the ability to map out a sustainable and meaningful future.
Evidence of the Situation
There are a number of possible explanations for the notable drop in electricity demand. While the factors behind the trend seem varied, demand requirements across the country have steadily declined over recent decades. Although there are exceptions with some utilities still experiencing notable demand growth, the overall trend shows a stark reality for most electric utilities:
Source: Energy Information Administration as presented in paper by F. Sioshansi. Why the Time has come to Rethink the Electric Business Model. The Electricity Journal, August/September 2012.
Reasons behind this decline are varied, inter-related, and wide-ranging. For some companies, customer growth has simply stagnated, and loss of a large industrial customer load has impacted demand. For others there are notable, longer-term drivers directly impacting customer demand.
Key Drivers Impacting Demand Requirements
Key factors driving the decline in customer demand include the impact of emerging technology advancements and policy directives at both the federal and state levels. Although these are not the sole contributors, these considerations result in notable changes in the utility-customer relationship. The key considerations include:
- growth in distributed generation and renewable assets
- expanded state directives advancing energy efficiency
- the impact of federal and state building codes and equipment standards
- robust demand response markets
These drivers differ from other issues that traditionally impacted utility operations such as extended weather and temperature patterns, uncertain energy usage patterns of large customers, or the overall health of the economy – issues that tend to be of shorter duration and offer opportunities for risk management. In contrast, the above-noted drivers reflect fundamental changes over the long term, including shifting the production and management of electricity to consumers. A more detailed discussion of the various key drivers follows:
Growth in distributed generation and renewable assets
The electric utility industry faces the emergence of technological advancements that allow consumers to take advantage of a more distributed system of generation and renewable energy assets. These include customer-located systems such as small-scale generators, distributed solar systems, and combined heat and power (CHP) projects. The growth of these technologies results in reduced system demand as customers take greater control over their energy use. As evidence, according to recent findings by Navigant Research, costs for distributed solar systems have dropped by more than 50 percent over the past three years and are trending to levels supporting grid parity by 2017-18. Distributed solar projects in North America are expected to increase from 2,475 MW in 2013 to 3,919 MW in 2018.
Expanded state directives advancing energy efficiency
Many states have advanced policies mandating utility investment in energy efficiency using financial penalties as a tool to ensure compliance. Such initiatives often have a separate carve-out for demand reductions. The target savings goals range across the relevant states but typically require annual energy savings of 1-1.5 percent (a savings rate that tends to be greater than some utility annual sales forecasts). A recent Lawrence Berkeley Lab study forecast of total U.S. spending on electric and gas efficiency programs projects growth with a mid-range projection of $9.5 billion. This compares to total spending of $4.8 billion in 2010. These efforts result in mandating utilities to incentivize customers to use less of their product, directly challenging utility revenue and margin forecasts.
The impact of federal and state building codes and equipment standards
The impact from building codes and equipment standards is expected to increase based on current rules already in place over the next few years. According to a study prepared by EnerNOC Utility Solutions Consulting, the impact of codes and standards is forecast to reduce energy consumption between 6-12 percent by 2025 (as compared to the Energy Information Administration’s 2012 Annual Energy Outlook forecast). Although the research did not include specific forecasts for demand impacts, many of the assumed codes and standards affect end uses directly contributing to utility system demand requirements such as air conditioning, lighting, pumps, motors, and electronics.
Robust demand response markets
As a result of FERC policies, there are active wholesale markets offering consumers the ability to manage demand in response to price and reliability. According to a recent FERC survey report, the potential demand response resource contribution from all U.S. demand response programs is estimated to be nearly 66,351 MW, or about 9.2 percent of U.S. peak demand. This is an increase of about 24 percent as compared to the 2010 FERC Survey. The FERC continues to encourage demand response at the wholesale level as new program offerings emerge across the country.
Implications and Future Directions
The decline in demand poses numerous implications to utilities. The biggest challenge is determining how the business model may need to be changed. From the utility standpoint, the lack of demand growth poses difficulties for sustaining the traditional business model of investing to meet demand and recovering costs through ratepayers. Additionally, the promise of more consumers relying on distributed generation or renewables serves to decrease the number of ratepayers to defray utility investments, potentially causing higher rates for the shrinking pool of ratepayers. This may ultimately resemble the “death spiral” concept: utilities have fewer customers to pay the same fixed costs, which raises rates, which causes more customers to leave.
In California for example, it is estimated that 85,000 PG&E customers have installed distributed solar systems causing approximately $200 million in lost sales to the utility. The utilities are questioning whether it is fair that customers without solar bear these costs.
The situation also directly impacts the central tenet for investor-owned utilities — attracting utility investors through a return on their investment by increasing the value of these investments through growth in earnings (and dividends). This premise is challenged when customers have the ability to reduce their electricity use or find another provider. Left unchanged, this may impact the attractiveness of utility investment.
The reality of the changing landscape is causing some companies to change the way they conduct business and take advantage of “grid edge” opportunities. Looking to the future, there are some utilities seeking new ways to transact and maintain their relationships with customers. The following provide some illustrative examples:
- PG&E in California has developed a solar offering for customers through the state’s California Solar Initiative (CSI) and remains an important participant in customer transactions. Other utilities including American Electric Power and Southern Company also are looking at distributed solar as a utility opportunity. Stated Nick Akins, CEO of American Electric Power: “On its face you would look at it and say distributed generation is a threat. But on the other hand we see it as an opportunity because our business is changing. There’s no getting around it."
- Exelon Corporation has established numerous businesses to facilitate energy management for customers including serving as a curtailment service provider for large businesses in bidding demand response resources in wholesale markets across the country.
- The California utilities (as well as others across the country) have successfully negotiated with regulators for risk/reward performance incentives. These incentives provide the opportunity for companies to earn profits from investments in energy efficiency.
- Electric utilities such as NStar are proactively positioning their roles in supporting electric vehicles as consumer options including examining alternative rates and charging station infrastructure requirements.
The future risks and challenges to utilities are substantial. The end result will likely evolve over time and may be varied in accordance with the fragmented nature of the industry with different markets, regulation, corporate culture, and views of relevant stakeholders. The need to manage this transition is also critical to ensure the end result is fair and effective. It’s clear these challenges seem to be more structural, affecting longer-term positions of electric utilities and requiring a focused, transformative response unlike the traditional approach of making smaller incremental changes to the existing legacy system.
1. Navigant Research, Distributed Solar Energy Generation. April 2013.
2. American Council for Energy Efficient Economy, Three Decades and Counting: A Historical Review and Current Assessment of Electric Utility Energy Efficiency Activity in the States. June 27, 2012.
3. Lawrence Berkeley Laboratory, The Future of Utility Customer-Funded Energy Efficiency Programs in the United States: Projected Spending and Savings to 2025. January 2013.
4. EnerNOC Utility Solutions Consulting, Factors Affecting Electricity Consumption in the U.S. (2010-2035). March 2013.
5. FERC, 2012 Demand Response and Advanced Metering Survey. December 2012.
6. Lauren Sommer, KQED Science, Could Rooftop Solar Kill Utilities? California Grapples with Solar’s Success. May 17, 2013.
7. The terms “grid edge” and “distribution edge” are used by various authors to reflect the boundary space surrounding the electric utility supply and delivery transaction process.
8. Ryan Tracy, Utilities Weigh a Turn to the Sun. Wall Street Journal. May 28, 2013.
9. Massachusetts Electric Vehicle Roundtable, Plug-in Electric Vehicle presentation from Watson Collins, Manager of Emerging Technologies, Northeast Utilities. March 2013.