Smart Grid Policy Primer

Smart Grid: The Devil Is In the Details

Policy Wrinkles to Watch Out For
  • By Gerald Richman, Special Advisor, Energy Policy Advisory Council
February 23, 2010 |

1) We Don't All Agree on What a “Smart Grid” is – or What it will Accomplish.

Rather than a physical entity, the “Smart Grid” is really a concept. The term refers to a host of digital technologies, in various stages of development, intended to enable real-time coordination along the Nation’s electric grid. The goal is nothing less than instantaneous communications between the various stakeholders involved in the generation and delivery of electric power: generating plants, power marketers, transmission systems, local power companies, and end-use customers (businesses and homes). Smart Grid proponents believe that such real-time coordination will lead to enhanced operational efficiency, increased reliability, and the ability of consumers to more cost-effectively manage their electricity purchases.

For example, so-called “smart” appliances that directly communicate with the electric grid potentially may give consumers information, control, and options that enable them to vary their electric usage based upon when electric power is least expensive. Ultimately, consumers —armed with a new generation of smart appliances -- may be able to “shop” for cheaper power and put greener power, such as wind that's primarily available in the nighttime, to effective use. Conversely, grid operators effectively can use those consumers who can vary their requirements as resources in day-to-day grid operations.

Increased coordination can lead to other operational and reliability benefits. The Smart Grid can make the grid more reliable by improving load factors (basically, the ratio of average and peak power usage), lowering system losses (various forms of energy loss that occur during transmission), and making it easier for operators to manage outages (e.g., power disruptions caused by storms, circuit problems, etc). The availability of additional grid intelligence can give planners and engineers the knowledge to build what is needed, when it is needed. The information can be used to extend the life of assets, prevent equipment failures, and more effectively manage the work force. In the process, operational, maintenance, and capital costs can be reduced, which in turn can lead to downward pressure on prices.

However, as always, the devil is in the details. All these benefits remain potential and are dependent on how the components and incentives actually are implemented in a so-called “Smart Grid.”

2) The Feds and the States are Both Players

A truly operational Smart Grid will be expensive, and ultimately this money will have to come from private investment sources. At the same time, much of this investment will be made by utility companies subject to State and federal regulation that imposes limits on utilities’ ability to pass through Smart Grid costs to consumers. Moreover, the federal government is playing a direct role in Smart Grid development – with the federal tax payer defraying a significant portion of initial investment costs.

In 2007, Congress enacted the Energy Independence and Security Act (the EIS Act), which directs the National Institute of Standards to coordinate activities by both the government and the private sector to achieve interoperability of Smart Grid devices and systems. The EIS Act also directs the Federal Energy Regulatory Commission (FERC) – the agency with core federal responsibility over wholesale electric markets and electric transmission – to develop standards and protocols necessary to insure interstate Smart Grid functionality. Moreover, the economic stimulus package Congress passed in early 2009 – the American Recovery and Reinvestment Act (ARRA) – authorized the Department of Energy (DOE) to award up to $4.5 billion in matching grants to stimulate Smart Grid development.

Along with these federal efforts, the States retain their traditional role as the primary regulators over the retail distribution and sale of electric power. The various State public utility commissions (PUCs) employ differing regulatory schemes, but each PUC ultimately exercises control, or at least strong influence, over the investment decisions of local power companies. There is considerable variation in the regulation and incentives from one State to another, as can be seen in the varying rates of deregulation across State lines.Basically, PUCs allow utilities to pass along the cost of prudent investments in facilities required to serve their retail customers. Conversely, recovery of utility investment that is not deemed prudently incurred and/or not deemed to have resulted in “used and useful” infrastructure can be disallowed. Thus, by determining the degree to which utilities ultimately can recover Smart Grid investment costs, the PUCs will play an obvious role in encouraging – or discouraging – such investment. The question is whether the FERC and the local utilities will be in agreement about which Smart Grid features are most important.

3) It's Not Clear Who's Picking Up the Check

California’s investor-owned utilities alone are reported to be spending about $4.5 billion on deploying smart meters over the next few years (see discussion below on smart meters). That implies that nationwide implementation of smart meters could cost around $50 billion. While estimates of the total Smart Grid implementation costs are hard to come by, clearly that total figure will prove to be in the multi-billion dollar range – and far in excess of the $4.5 billion provided under the ARRA.

Moreover, the preceding paragraph focuses on “smart” technologies. However, there appears little question that beyond the question of “smart” technologies, and even in the face of the severe economic downturn from which we hopefully are escaping, the nation’s electric grid will require massive investment simply to meet expected future demand. There is universal agreement that the United States power grid has not kept up with the growth in demand for power and, as a result, some parts of the system have become increasingly congested.

It has been estimated that transmission congestion currently costs consumers in the eastern U.S. an estimated $16.5 billion annually in higher electricity prices. Further, the Electric Power Research Institute estimates that power interruptions and fluctuations cost the economy more than $100 billion each year in damages and lost business. Current estimates of the investment required to meet future grid demand range from $100 billion to $2 trillion. For example, the Department of Energy’s Pacific Northwest National Laboratory (PNNL) estimates that $450 billion would have to be poured into conventional grid infrastructure to meet America’s expected growth over the next decade, even apart from Smart Grid development.

At the same time, PNNL also estimates that modernization of US electric power grids can save anywhere from 46 to 117 billion dollars over the next 20 years – flowing from benefits such as reduction in congestion and transmission and distribution outages and the ability to customer to engage in more flexible response to price changes. As the saying goes, you (often) have to spend money to make money. But the question remains – will those picking up the bulk of the tab be those who have procured the most benefits?

Despite federal stimulus funding under the ARRA, the vast majority of grid modernization investment, including Smart Grid investment, will come from private-sector sources. Private investors, of course, will be seeking the maximum possible return on investment and, historically, much utility investment gets passed through to electric consumers. It is estimated that a $100 billion investment in the grid could add from $4.00 to $5.00 a month to the average electric bill. That is not necessarily unreasonable, because grid investment, by lowering the cost of energy itself (through improved reliability, efficiency and access to energy sources) can lower overall consumer energy costs. But clearly there is a natural tension between the interests of utility investors and utility customers – that essentially is why both the State PUCs and the FERC exist.

4) Paradoxically, the Stimulus May Not Fully Stimulate the Smart Grid

By authorizing 50 percent matching funds for “DOE-approved” Smart Grid projects, Congress (through the ARRA) clearly intended to stimulate Smart Grid development. But an argument can be made that the existence of the ARRA itself actually slowed down Smart Grid spending in 2009. There have been reports, not necessarily substantiated, that many utilities with applications for Smart Grid stimulus funding put projects on hold while waiting to find out whether the federal government would pay 50 percent of the cost.

DOE made its Smart Grid disbursement decisions by the end of 2009, so the list of approved and disapproved grants – the list of Smart Grid “losers” and “winners” – is now known. But questions remain about the ARRA’s long-term impact. To begin with, there remains the question of how those utilities that received Smart Grid grants will now proceed. Will those grants stimulate future new projects by those companies, or will those projects prove to be one-time affairs? A related question is whether those utilities that received Smart Grid grants – and the PUCs that oversee their investment decisions – will become so focused on the need for federal taxpayer matching fund that they will deem future, non-subsidized Smart Grid investments to be too expensive or imprudent.

Conversely, there is uncertainty about those utilities whose applications for Smart Grid funding were rejected by DOE. One issue is whether these companies will be prepared to move ahead with their proposed projects on their own – perhaps on a smaller scale projects. DOE rejections could become an excuse to cease significant Smart Grid investment. Further, there is the concern that, from a political standpoint, the PUCs of “losing” utilities may have a tough time authorizing the pass through investment for Smart Grid projects that the public may view as not “good enough” for DOE.

At this stage, there probably is enough overall Smart Grid momentum – or, more properly, belief that the Smart Grid will be a paying proposition – to encourage private investment even by utilities that were not successful in securing stimulus grants. For example, the Utilities Telecom Council, a utilities trade association, recently released a report finding that a typical electric utility can expect smart grid technology to generate at least $110 million per year in system benefits. So, even without taxpayer subsidization, utilities clearly retain incentives to make Smart Grid investments.

Conversely, at a time when a possible “Stimulus II” is under debate, it will be necessary to carefully examine the impact “Stimulus I” on Smart Grid development prior to any determination that the taxpayer should be called on for additional Smart Grid investments. This is not to say that that some additional direct governmental subsidization may not be necessary. But we must be careful neither to push money at projects companies were going to undertake anyway nor create a situation where the failure to win stimulus awards itself becomes an excuse for companies to walk away from the Smart Grid.

5) Are the PUCs Really Ready to Facilitate Smart Grid Development?

Even with the DOE Smart Grid grants made under the ARRA, the vast majority of funding must come from private-sector investment. Utilities will seek to pass through as much of this cost as possible to consumers, subject to approval by their regulators. The application of both federal and State regulation inevitably will impact utility investment decisions. But are State regulators ready?

a) The State PUCs Don't Yet Know What Smart Grid Costs Should Be “Passed Along” to Consumers.
As discussed above, retail electric rates historically are regulated by State PUCs. While regulatory regimes vary, the basic scheme is a determination of whether particular classes of consumer are “captive” to a particular utility (i.e., the consumers lack effective access to alternative suppliers) and, if so, whether the utility’s costs in providing the service were prudently incurred. Basically, PUC's decide whether a utility spent money wisely on investments, and then allow the utility to pass the cost on to customers.

With few exceptions, the State PUCs have yet to develop clear policies for Smart Grid rate recovery. Of course, a decision about who should pay for multi-billion dollars of investment is not one that can be made quickly, or easily – especially in difficult economic times.

But with continued regulatory uncertainty, utilities may be unwilling or unable to move forward. Indeed, DOE’s July 2009 Smart Grid System Report expressly notes:

Since the technology and value propositions are emerging, utility companies may be reluctant to expend the significant amount of capital required to move toward a smart grid, especially because the expected cost-recovery timelines are only theoretical and have no precedent. Currently, regulated utilities and their flat-rate customers have no risk or reward signal. Regulation makes it difficult for them to raise rates and recover costs, and makes them reluctant to change.

The DOE Report emphasizes that “new products and services depend on regulatory recovery for smart grid investments.”

b) The FERC Versus the States
Under the Federal Power Act (FPA), the FERC has jurisdiction over (a) transmission of electric energy in interstate commerce, (b) wholesale power sales, and (c) reliable operation of the U.S. bulk-power system. At the same time, the FPA explicitly left to the States their traditional regulatory authority over the distribution and sale of retail electric power.

FERC’s 2009 Smart Grid Policy Statement provides that while the previously-discussed EIS Act gives FERC new responsibilities for the adoption of standards needed to insure Smart Grid functionality and interoperability, that statute does not alter the FPA’s jurisdictional boundaries between federal and State regulation. FERC recognizes that the EIS Act does not allow FERC to direct States to implement any particular retail customer policies or programs.

But FERC asserts that the EIS Act does provide FERC with authority to adopt Smart Grid standards that will be applicable to all electric power facilities and devices with Smart Grid features. This presumably includes electric power facilities and devices at the local distribution level and those used directly by retail customers, provided FERC can establish that the standard is necessary to ensure functionality and interoperability in interstate transmission of electric power and regional and wholesale electricity markets.

As interpreted by FERC, the EIS Act thus creates an obvious tension. Individual States (and their PUCs) may not want all Smart Grid functionalities deployed in the same manner, and may push for final FERC standards that accommodate different State-imposed retail rate structures and policies. Conversely, other entities – such as independent power producers, suppliers of distributed generation, energy brokers and traders, commodities exchanges, or manufacturers of communications technologies – likely will press for national standardization.

As FERC’s Smart Grid rulemakings move forward, this tension is likely to routinely bubble to the top. State PUCs can be expected to show sensitivity to FERC standards that impinge on the States’ regulatory flexibility. Given the deference our federal system traditionally accords the States in the area of electric distribution – deference explicitly reflected in the FPA – FERC can be expected to show sensitivity to State concerns. But an overly-sensitive approach to State PUC turf concerns could impede the creation of a truly effective and integrated Smart Grid. If, for example, State pressure caused the FERC to issue interoperability protocols and standards that do effectively (or efficiently) allow “real time pricing” of electricity at the distribution end of the chain (at least in certain States), much of the impetus for consumers to more actively use the smart grid through new or specialized appliances could be lost..

On the other hand, much of the direct consumer benefit from the Smart Grid is predicated on smart meters (see next section). The meter, of course, is the primary real interface between the PUC-regulated local utilities and their retail customers. The States (and the PUCs) will have to live with whatever smart meter communications protocols or standards FERC develops. At the same time, the PUCs, and not the FERC, will determine how much of the cost of smart metering will be passed through to consumers. FERC/State coordination in this area will be particularly crucial.

6) Just How “Smart” Do You Want Your Smart Meter To Be?

Most people have little idea how much electricity they are using until they are presented with a bill. This could change with the installation of smart meters, which track customer electric use in real time and can transmit that information back to the power company, also in real time. More than 50 million smart meters are expected to be deployed by U.S. electric utilities by 2015, according to a list of publicly announced projects kept by The Edison Foundation. More than 8 million have already been deployed.

Smart meters establish a two-way data connection between the customer and the power company by sending information over a communications network that may include power-line, radio or cellular-network connections. Once smart meters are installed, power companies can determine the location of outages more easily, and no longer need to send staff to read meters, or to turn the power on or off at a particular location.

Further, smart meters eventually may be able to communicate with “smart” thermostats, appliances and other devices, giving people a much clearer view of how much electricity they are consuming. Customers will be able to access that information via read-outs in their homes or web-based portals, through which they will be able to set temperature preferences for their thermostats, for example, or opt in or out of programs that let them use cleaner energy sources, such as solar or wind power.

As well as giving utilities more control, smart meters also give them more flexibility. In particular, they can vary the price of electricity throughout the day in response to demand. Telling people that electricity is more expensive when demand is high can encourage them to do their laundry when demand has fallen and electricity is cheaper. And eventually it should be possible to do it automatically, so that the dishwasher waits for the price to fall below a certain level before switching on, for example, or air-conditioners that turn themselves down when the price goes up.

However, some consumers argue that the meters are logging far more kilowatt hours than they believe they are using. Many find it unfair that they will begin to pay immediately for the new meters through higher rates, when the promised savings could be years away. Further, there is a question of whether it is really cost-effective utilities to scrap well-functioning technology and programs designed to reduce consumer demand during peak periods with untested and costly new technology

Smart meters certainly have the potential to help consumers lower their bills by giving them more flexibility in how their homes use power. For instance, people could set appliances in their homes to scale down power consumption in peak times, when electricity is more expensive. But, again, there is a real question of how feasible it will be for consumers to only utilize appliances at non-peak hours. For example, can someone on a normal work and commuting schedule realistically be expected to organize thing so that laundry appliances and ovens only function during the middle of the night?

7) Grid Hackers – The Smart Grid Comes With Serious Cybersecurity Concerns

The long-term practical and theoretical benefits to developing a truly Smart Grid are obvious. But security experts are becoming seriously concerned by the dangers of equipping homes and businesses with new meters that enable two-way communication with utilities. The risks are similar to what happens when computers are linked over the Internet. By exploiting weaknesses in the way computers talk to each other, hackers can seize control of innocent people’s machines. Similarly, in the case of the power grid, better communication between utilities and the meters at individual homes and businesses raises the possibility that someone could control the power supply for a single building, an entire neighborhood, or worse.

For example, a computer “worm” – a self-replicating computer program – could hop between the meters at homes and businesses in a Smart Grid network. The worm could give unauthorized third parties remote control of the meters, which would let them take advantage of a utility’s ability to, for example, disconnect someone’s power for not paying his bill. From that scenario, it is not hard to think of more serious potential occurrences, ranging from power theft to sabotage and terrorism.

Indeed, government officials revealed this spring that spies have broken into parts of the U.S. electric grid and left behind programs that would allow them to disrupt service. The intrusions were discovered only after some electric companies opened their doors to audits. The full scope of the attacks is unknown, though, because the government doesn’t have blanket authority to examine other electric systems.

Unfortunately, the older systems – designed decades ago – lack modern security features. So as they extend their networks, energy companies need to take steps to make sure their networks are not open to any of these possible intrusions.

There is a lot of variety in the kind of communication enabled by smart meters and how secure that communication will be. Right now, much of the work on standards is evolving quickly and out of the public eye, so it remains untested politically. As this technology comes into people’s homes, it will be tested in real world situations for its reliability, security, economic viability, and political implications. Poor or problematic implementation could put billions of dollars of investments at risk.

8) So Where do We Go From Here?

This paper was not intended to provide an complete list of Smart Grid issues or an exhaustive examination of the subject. But it was intended to highlight some important issues at the intersection of economics – the question of who pays – and regulation – the question of how the State and federal government oversee the economic question. What does this intersection suggest?

Clearly, there is an ongoing need for coordination between the States and the FERC. To a degree, this has been achieved through participation by the PUCs and other State agencies in FERC Smart Grid rulemakings and FERC stakeholder conferences. But, while FERC is required to make decisions on a open record through rulemaking proceedings, Smart Grid development could well be facilitated by more formalized arrangements between FERC and the PUCs – possibly, a memorandum of understanding between the FERC and the PUCs (acting through the National Association of Regulatory Utility Commissioners (NARUC) on agreed regulatory goal across the Federal/State divide. Such agreement, in turn, could be published in the Federal Register to insure that the public has the opportunity to review and comment upon the document.

There also appears to be a need for increased consumer involvement in Smart Grid development – particularly, at the regulatory end. Major stakeholders – utilities, transmission companies, software developers, appliance companies, etc., – have been extremely active (and properly so) at DOE, NIST, the FERC, the PUCs, and other public forums. Consumer groups certainly have been present, but it’s extremely unclear whether the average consumer is really aware of the potential benefits and pitfalls of the Smart Grid. The average consumer, of course, does not have the time to attend forums, draft rulemaking comments, or keep abreast of all develops. Consumer groups will have to carry that burden, but of that effort can include consumer forums (perhaps in the evening or on weekends) where interested consumers can be better brought into the process.

And while consumer benefit may be an important Smart Grid goal, that benefit can only be achieved if utility companies build the Smart Grid and install the necessary components. Utilities will do so if it’s in their economic self-interest. While regulators must ensure that consumers are not subsidizing utility shareholders, regulators must equally ensure that utilities can profit from investments that promote public policy. For example, if utilities are going to bear the risk of moving quickly on Smart Grid development, it will be necessary to provide them with clear incentives to justify the risk. Which, of course, is easier said than done. Again, the devil is in the details. But that’s what regulators are for.

For the past 19 years, Gerald Richman has been an energy regulatory attorney in Washington, D.C. For much of that time, he was in the enforcement office at the Federal Energy Regulatory Commission. Since his time at the FERC, he has been active in private practice on behalf of electric utilities, natural gas pipelines, and energy marketers. Richman currently serves as a special advisor to New America's Energy Policy Advisory Council.

More concept than physical entity, the "Smart Grid" could reduce power outages, reduce costs and pollution, enable the installation of more "green" technologies, and bring the US electrical system into the 21st Century. But the devil is in the details--and regulators have many pitfalls to avoid.

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