Ivanpah solar electric generating system, California
Ivanpah solar electric generating system in the Mojave desert, which opened last year to provide power to California © Getty

At 255-257 Pearl Street in lower Manhattan, there is only a discreet bronze plaque to honour one of the world’s most historic sites: the first commercial centralised power station. Thomas Edison opened his first plant here in 1882 to serve New York’s financial district, and the global spread of electrification, with all the enormous changes that has brought, has mostly followed his model. Until now.

Spurred by falling costs and government incentives, US homes and businesses are producing more of their own power, a trend that threatens the business model of centralised generation that has dominated the industry, in the US and the world, for 130 years.

A paper for the Edison Electric Institute, the US industry association, has warned that electricity utilities were facing “disruptive challenges” comparable to the way the fixed-line telephone industry was shaken up by mobile. The utilities worry that as more businesses and households use solar, wind and other sources to generate their own power, they will lose customers and revenues, while still bearing the costs of running the grid. The utilities would then have to charge higher rates, losing more customers, worsening their position further. In the industry, they call it the “death spiral”.

So far, investors have generally shrugged off the threat from people producing their own power, which is known as distributed generation. The S&P 500 US utilities index has risen by a third since that EEI paper was published in 2013. The market share taken by distributed generation is small. But utility executives increasingly see it as a threat to the industry’s future.

“Up until recently, the industry thought there was no way it could happen to us,” says Leo Denault, chief executive of New Orleans-based utility Entergy. “The utility business model is still the cheapest, most reliable way to supply power. But now other things are being required of the system, and we don’t control those.”

It may not be a death spiral, says Lyndon Rive, chief executive of SolarCity, a solar company, but it is a “change spiral”. He adds: “When you’ve had a monopoly for a hundred years, and you’ve never seen change, change may seem like death to you.”

European utilities have already been battered by weak demand and the EU’s support for renewable energy, and they have lost hundreds of billions of euros in market capitalisation. US utilities are likely to have to make radical changes if they are to avoid a similar fate.

To understand the revolution sweeping through the US electricity industry, look at the Brooklyn branch of Whole Foods, the upmarket grocery chain. The lighting in its car park is powered by renewable energy, from solar panels on the roofs of the carports and wind turbines on the lampposts, with batteries to store enough power for five days of still, overcast weather. The store is the acme of trendy retailing, with vinyl albums next to the whetstone for sharpening knives, but brand image is not the main rationale for the investment, says Nick Blitterswyk, chief executive of Urban Green Energy, the company that provided the system. Whole Foods has saved about 20 per cent of the cost of connecting the lights up to the local grid, he says, and is getting what every customer wants: “Cheaper electricity without any sacrifice.”

Across the US, about 45,300 businesses and 596,000 homes have solar panels, according to GTM Research. Over the past four years, the numbers have risen threefold for businesses and fourfold for homes, as the cost of solar power has plunged thanks to efficiency improvements and huge overcapacity in panel manufacturing in China.

In past decades, US electricity consumption has closely followed economic growth, but in the past few years that link has been broken. The US Energy Information Administration expects the country’s large-scale generators to produce less power in 2015 than in 2007, despite years of economic recovery. The rise of distributed generation, along with improvements in energy efficiency, is one of the reasons why.

For utility executives who have been reluctant to accept that their businesses are at risk, the sharp slowdown in demand growth is forcing them to face up to the reality. “There is a consensus that these social and technological trends are here, and they are going to grow,” says Casey Herman of PwC, the consultancy.

The economics of distributed generation vary by region — solar power is more competitive in sunny states such as California and Nevada, for example — but it is often fundamentally a higher-cost option than centralised power. However, it is also heavily subsidised by federal, state and local governments. Michael Hidary, managing director of Samba Energy, a New York-based solar company, says a residential system with a gross cost of $25,000 can cost a home-owner just $6,975 once all the various tax allowances are taken into account. At that cost, the system will pay for itself in utility bill savings by the fourth year.

There is also an implicit subsidy provided by the existence of the grid. Electricity storage is expensive, and even when customers have solar panels with a battery back-up, they are nervous they might not be able to get power when they need it — so most of them stay connected to the grid. “People misinterpret what we are trying to achieve [and think] that there isn’t going to be any grid,” says SolarCity’s Mr Rive. “It is important that there is a grid.”

The problem is if solar customers use less power, they will pay less towards the operation, maintenance and development of that grid: not just the wires and transformers, but also the centralised generation capacity needed when the sun goes down. If customers have “net metering”, which allows them to sell any excess power they generate to the grid at the same price they pay for their own supplies, the problem is exacerbated.

Utilities are becoming more vocal in their protests. “We are saying: pay your fair share,” says David Owens of the EEI. If customers choose to go off the grid and “live in the dark”, he says, that is up to them, but “if you rely on the grid, then you’ve got to make a payment for those services.”

It is particularly unfair, utilities say, because better-off customers can afford to fit solar panels and benefit from the savings, leaving the poor to bear more of the burden of paying for the grid. Lobbying by utilities has led to political and regulatory battles across the US over attempts to force homeowners with solar panels to pay more. In 2013, Arizona agreed a fee paid to utilities typically worth about $5 per month for solar-powered homes, after rejecting a proposal for a much larger charge.

Oklahoma last year passed a law requiring utilities to agree with regulators how to cover the infrastructure costs of distributed generation, which could mean additional charges. In Utah, a push for a fee such as Arizona’s was rebuffed by the state’s regulators last August, but there are similar proposals emerging in many other states.

The American Legislative Exchange Council, a free-market lobby group, has been campaigning for restrictions on net metering, and a year ago published a resolution for state policy makers calling on them to impose fixed charges or similar fees on users of distributed generation.

The distributed energy companies are scathing about those moves. “The idea that the world is not going to change if you bang your fist on the table is just wrong,” says John Berger, chief executive of Sunnova, a residential solar company in Houston, Texas. “If utilities are allowed to do some anti-competitive things, then I think it will backfire on them.”

If the cost of a grid connection becomes too expensive, customers will eventually leave it behind altogether. In November, Microsoft opened a power-hungry data centre in Wyoming that has no grid connection, but generates its own electricity with fuel cells using biogas from a nearby sewage works. As the cost of electricity storage, fuel cells and other technologies falls, going off-grid will become more viable.

Many utilities accept that distributed energy is not going away. “We can argue about it, but we’ve got to figure out a way to manage it,” Mr Denault says.

Michael Britt of the consultancy Oliver Wyman argues that “utilities could be fine,” if they respond to the changing market in the right way. “There are a lot of opportunities for them to provide a better service,” he says. “There may be a different model, focusing on their core activities. They may become smaller, more nimble and more focused.”

Some are making their own moves into distributed generation. Arizona Public Service, the state’s largest utility, last year launched a residential solar programme for about 1,500 homes.

David Crane, chief executive of New Jersey based utility NRG Energy, announced plans last year to offer small-scale gas-fuelled power generation, allowing businesses and homes with gas supplies to go off the grid. “As soon as you can convert natural gas into electric power without using a big power plant, it’s a game changer,” he said. As for concerns about competing with NRG’s existing business: “If we don’t do it, someone else will.”

Similar reasoning is encouraging the utilities Pacific Gas & Electric and Southern California Edison to work with FirstFuel, a start-up that analyses consumption data, to offer energy efficiency services to customers.

“What do utilities have that their competitors don’t? Our answer is: it’s data and customer relationships,” says Swap Shah, FirstFuel’s chief executive. “ The question is: how do they leverage that? Energy efficiency is the killer app.”

All of those strategies have their drawbacks. State regulators often object to utilities investing in distributed energy, because it benefits the customers who have it, not bill-payers in general. The collection and use of customer data has become more competitive after Google’s $3.2bn acquisition a year ago of thermostat company Nest Labs.

Jon Wellinghoff, a former chairman of the Federal Energy Regulatory Commission, says US utilities may need a more radical solution: splitting off control of the grid.

The power grid is a very important asset, he says, saying it is more efficient and reliable than everyone generating their own power. To make that clear, the local distribution system should be operated separately as a platform that competing generators large and small can use.

“If people love the grid, they will have to find a way to cover the cost of it,” he says.

Others in the industry are reluctant to embrace such radical reform. It seems clear, though, that if utilities carry on as they have done in the past, it could be fatal.

“If we’re not thoughtful, then in five or 10 years’ time, the death spiral is going to hit us,” Mr Denault says. “And we won’t be able to say we didn’t see it coming.”


Electric cars give hope to the utilities

Utility executives wanting a break from the angst in their industry
should have gone to the North American International Auto Show in Detroit, where electricity was one of the hot trends.

General Motors unveiled the Bolt, a proposed new electric car that it says offers significant improvements in performance on earlier models, including a 200-mile range.

Electric car sales have been slow in the US, falling short of manufacturers’ hopes. If oil prices stay below $50 per barrel, they are likely to remain a tough sell. But if they do take off, they will have a transformative impact on electricity demand.

“The future for utilities is actually not a bad future; it’s pretty good,” says Elon Musk, the tech entrepreneur. “As we transition to electric transport, we’re going to see a significant increase in the demand for electricity.”

Mr Musk is an equivocal figure for utilities: he is a rival in his capacity as chairman of SolarCity, the residential solar power company, but he is also a pioneer of demand creation as chief executive of Tesla, the electric car company.

“Long-term, I think demand approximately doubles, and if half of that is [met] from solar, and half from existing utilities, to a first approximation the utilities’ business remains about the same,” he says.

Advocates for renewable energy argue that electric cars and distributed energy are ideally suited for one another. Electric vehicles are essentially batteries on wheels, which can be charged up when the house is producing more power than it needs.

However, no one will want to be forced to choose between having a hot shower and being able to drive to work. “Are you really going to use the battery in your car to power your home?” asks Julien Dumoulin-Smith, a UBS analyst.


Letters in response to this article:

The US grid utilities’ problems are largely self-inflicted / From Leonard S Hyman

All hands on deck for an electricity local generation / From Alistair Buchanan

UK electricity producers are heading towards a ‘death spiral’ of their own / From RJ Barry Jones

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