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The New Infrastructure

Illustration 73420832 © Monicaodo - Dreamstime

In 2004, as a not-quite-graduate from Stanford, Matt Rodgers started working at Apple on its new portable music player, the iPod Mini. The sleek user-friendly device would go on to become one of the most successful consumer products ever launched by a company that is world-renowned for consumer-oriented design. Rodgers would stay at Apple for several years, playing a role in the company’s development of other insanely popular consumer products (e.g. the iPhone) and generally internalizing the design-focused corporate culture that Steve Jobs was famous for creating.

In 2011, now an independent entrepreneur, Rodgers partnered with another Apple veteran to launch a new consumer product. The device was a smart thermostat called Nest, and it embodied all the tropes of successful Apple products: sleek design, user-friendly interface, and a level of functionality that put it at the head of the pack in the (at the time) relatively uncrowded “smart home” product space. The product was a hit, and 3 years later, the company was acquired by Google for a whopping $3.2 billion.

However, the Nest thermostat was different than any of the consumer tech products that Rodgers had worked on at Google. As a smart thermostat, the device used complex algorithms to understand and automatically fit indoor temperatures to its owner’s particular preferences, making it an appealing product for people who wanted to reduce the hassle of fiddling with esoteric temperature controls to achieve their desired comfort level. But because it was internet-connected and could be controlled remotely, the Nest thermostat could be more than just a consumer product, a fact that electric utilities began to take notice of.

Utilities had been running demand response (DR) programs for decades. However, most of these programs were with large industrial energy users, and many were often fairly low-tech, sometimes as simple as utilities physically calling energy managers at industrial facilities asking them to turn down energy-intensive equipment for a few hours. The uptake of smart thermostats in residential buildings offered a new dimension to these programs, one in which the energy use of thousands of residential customers could be incrementally adjusted to reduce load on the grid when generation resources were stressed.

The result is a collision of two worlds that have traditionally been separate: consumer products and infrastructure. As consumers autonomously purchase “smart” interconnected devices for use in their homes, they are simultaneously creating a network of advanced equipment that can be tapped to optimize operations on the electrical grid. The results will have significant implications for how infrastructure is deployed and operated, how it’s payed for, and perhaps most importantly, how companies that provide that infrastructure approach their business.

The Blurring Line Between Product and Infrastructure

Smart thermostats are the first major entrant to this new hybrid consumer product/infrastructure classification, and they’re likely to be the primary one for the immediate future. The number of smart thermostats and other internet-connected devices deployed in homes almost tripled between 2015 and 2018, from 600 million to 1.5 billion devices. This number is expected to more than double again over the next three years, with 3.3 million smart thermostats forecast to be deployed by 2021. This represents a sizeable amount of adjustable load that can be optimized according to conditions on the grid, allowing the electrical system to be balanced at a lower cost than was previously possible.

But smart thermostats are just one of the many distributed energy resources (DERs) being installed in customers’ houses, and the amount of consumer load they can influence, while significant, is not transformative. A more impactful trend is the adoption of rooftop solar and, increasingly, residential batteries. Rooftop solar sales have been growing for a while, but since solar panels really only export power, they didn’t necessarily provide a “resource” that utilities could call on to respond to grid stress. They also didn’t fit an Apple-esque idea of a consumer product because they didn’t actually do anything better than their closest “competitor” – grid-supplied electricity. Their appeal mainly came from savings on energy costs (largely supported by subsidies) and an assurance that at least part of the household’s power consumption was carbon-free.

Residential batteries change this equation. The addition of battery storage to a rooftop solar system switches it from a simple cost-saving measure to a back-up power installation. Suddenly, the product plays in a new market, one in which it has a number of advantages over the portable diesel generators that currently dominate the residential back-up power space. Solar-plus-storage systems are quieter than diesel generators, significantly easier to use (many will turn on automatically when there’s an outage), and don’t require refueling. Although the widespread appeal of residential batteries has faced skepticism, growth in sales for this product have been surprisingly strong over the past few years. Residential diesel generators are a $2 billion dollar market in the US alone, and as battery prices continue to drop, the portion of this market they capture will only grow.

But the largest product-turned-infrastructure candidate will undoubtedly be electric vehicles (EVs). Growth in this product category have been consistently strong year-on-year, a result of subsidies and cost reductions but also the fact that in many ways, EVs are just a superior product. Compared to traditional cars, EVs have faster acceleration, lower maintenance costs, and the option to conveniently refuel at home with a low-cost fuel that doesn’t fluctuate in price the way that gasoline does. As continued cost reductions and the build-out in charging infrastructure eliminates some of the advantages gasoline-powered cars still hold, consumer purchases of EVs should accelerate even further.

As this happens, the amount of energy demand that utilities can tap to provide grid services will grow exponentially. The energy demand of a single EV is enormous, providing an incredible resource for utilities that can take advantage of it. Smart charging infrastructure will allow EVs plugged in overnight to absorb excess wind energy produced during off-peak hours, while fleets of EVs charging at workspaces during the day can be programed to soak up excess solar power or even discharge back to the grid in response to high demand events. As consumer interest in EVs grows, utilities will suddenly find themselves with a network of useful load-management tools without lifting a finger.

The New Infrastructure in Action

 The rise of technologies that blur the lines between consumer product and infrastructure will create a shift in how electric infrastructure is managed and paid for. In the past, when a utility had to meet a future capacity need or transmission constraint, the process was relatively straightforward. The utility would run demand forecasts to demonstrate the need to its regulators, who would approve expenditure for a new peaker plant or transmission line upgrade. The utility would build the plant/upgrade the line, assuming that the demand at the end of the construction period (which could often take several years) would align with its forecasts. The resulting capital costs would be socialized across its customers through the electricity rates they paid.

The new infrastructure model upends this by allowing the utility to take advantage of exogenous consumer demand for products that can be leveraged to provide the same services as traditional grid investments. In other words, certain customers, by purchasing the newest in household consumer tech, are paying the capital costs for the grid infrastructure that utilities would usually cover (and then recover through their rates). The utility can now pay customers for the services these devices provide incrementally as they are needed. This allows utilities to meet capacity and balancing needs on the grid more cheaply and precisely, creating cost efficiencies that ultimately flow through to customers as lower rates.

This sounds great in theory, but how would it look in practice? The simplest examples of this model are the “Bring Your Own Device” DR programs that many utilities are already exploring. These programs allow utility customers to register load-management devices that they own with their utility, which can then call on these devices to reduce load when the grid is stressed. Customers are compensated for making their device available, and utilities are able to defer or sometimes obviate the need for more costly grid investments. When the midwestern utility Xcel launched one of these programs, offering customers just $25 a year to give it access to their thermostats during peak demand events, it found that customer interest was 50% higher than initially expected, with costs coming in at one-third to one-quarter of Xcel’s other direct-install DR initiatives.

But as the value of this model becomes more apparent, utilities can become more proactive in the role they play in allowing customers to get their hands on these products. This could be as simple as helping customers with their shopping, as utilities like Con Edison and National Grid are doing. Both of these utilities have online marketplaces that allow customers to compare and purchase different energy efficiency and load management products, often making the shopping process simpler by rolling available rebates into the price that customers pay. This not only provides customer with guidance by a (hopefully) trusted energy company, but it also gives the utility insight into where on its network these devices are being deployed, improving its ability to maximize the value they can offer to the grid.

Finally, the utility itself can play the product supplier, as Green Mountain Power (GMP) has done in Vermont. Through a partnership with Tesla, GMP allows customers to lease residential battery systems from them for $15 a month. GMP maintains the right to call on this network of batteries to reduce system demand when needed, but the rest of the time each battery is available to provide back-up power to the customer’s home. Although only a certain number of customers will install batteries, all of GMP’s customers benefit from lower network costs, savings that GMP estimates will exceed $2 million over a 10-year period.

These are just a couple of ways that utilities can engage with this new class of technologies, but there are myriad other examples and approaches that could be employed. The key similarity is that all programs allow customers to share in the value created by their new consumer tech products, either through direct payments or reduced costs of the product itself. This effectively lowers the price of purchasing these the products, incenting more customers to buy them, which in turn provides a larger network of devices the utility can leverage for more services, which means more money will be available to customers who decide to purchase these products. Taking note of this virtuous cycle, some analysts have estimated that the available capacity from household load management technologies could be as high as 30% of peak load by the mid-2020s, an absolutely massive resources if utilities are able to harness it effectively

Adjusting to the New

In the HBO sitcom Silicon Valley, would-be tech baron Richard Hendricks attempts to create a “decentralized internet” by downloading a specialized app onto thousands of cell phones at a tech conference. The effort fails, but Hendricks’ overall project ends up succeeding when the company’s proprietary algorithm is installed on hundreds of thousands of smart fridges instead, creating the foundation for a new decentralized digital infrastructure. The events in this episode are (I assume) restricted to the world of comedic science fiction, but in the electricity sector it feels very close to home. The ability for household products to play the same role as traditional infrastructure is rapidly becoming a reality; the question now is how the electricity industry will adjust.

Some of these adjustments are structural in nature. In deregulated electricity markets, the market rules governing the provision of capacity and grid services must be updated so that the new decentralized infrastructure products will be able to compete against conventional electricity equipment on fair terms. More importantly, regulatory frameworks will need to change so that utilities are not incentivized to spend money on capital investments rather than payments for grid services from the existing equipment housed in their customers’ homes. This will require a re-thinking of classic cost-of-service regulation to ensure that utilities are able to make money by directing their energies to the most effective solutions.

However, some of the most important adjustments will be to the utility business model. Companies that, in the past, were exclusively focused on maintaining massive machinery to provide consistent and reliable service will now need to develop new skills and competencies. The successful electricity companies of the 21st century will be able to understand and respond to customer preferences and needs, predicting how quickly customers will purchase new distributed energy products, where they’ll be deployed, and how they can be used to benefit the system. The end result will be a more efficient power grid, lower rates for customers, and a utility well-positioned to navigate the new shape of its business.               

Collin Smith's picture

Thank Collin for the Post!

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Matt Chester's picture
Matt Chester on Aug 28, 2019 2:25 pm GMT

In the HBO sitcom Silicon Valley, would-be tech baron Richard Hendricks attempts to create a “decentralized internet” by downloading an app designed by his company on thousands of cell phones at a tech conference. The effort fails, but Hendricks’ overall project ends up succeeding when the company’s proprietary algorithm is installed on hundreds of thousands of smart fridges instead, creating the foundation for a new decentralized digital infrastructure. The events in this episode are (I assume) restricted to the world of comedic science fiction, but in the electricity sector, the ability for household products to play the same role traditional infrastructure normally would is rapidly becoming a reality. The question now is how the electricity industry will adjust.

Sometimes reality can't help but follow fiction (or more likely the writers of Silicon Valley are pretty smart and knew the democratization of network infrastructure as at a turning point). Either way, it's a fun way to point out the direct energy infrastructure looks to be going. 

Collin-- I found it interesting you brought up the needs for adjustments in deregulated markets, but are there unique aspects that are needed in states with regulated power still?

Collin Smith's picture
Collin Smith on Sep 6, 2019 5:01 pm GMT

I'd say in vertically integrated territories, the most important changes will be to the regulatory structure and the way that utilities are compensated. Since vertically integrated utilities can directly own and rate-base peaker plants, the ability for load management technologies to reduce peak load will have a more significant impact on their revenue stream. 

This can be addressed by switching out traditional cost-of-service regulation with performance-based alternatives. Revenue cap regulation that covers both capex and opex has great potential to align utility and customer incentives in situations where there are large cost-saving opportunities from non-utility owned assets - such as BYOD demand response programs. Performance incentive mechanisms targeting specific goals like peak demand reduction or environmental goals can also help move utilities towards more socially beneficial solutions.

The switch will probably be gradual at first, but as the correct incentives are established and utilties become more comfortable with these non-traditonal infrastructure solutions, it's likely that vertically integrated utilities will be able to scale these programs in their service territories more quickly than in unbundled markets.

Matt Chester's picture
Matt Chester on Sep 6, 2019 9:56 pm GMT

Appreciate the thoughtful reply, thanks!

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