The Smart Grid Business Case

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The Smart Grid Business Case

• John Caldwell
• Edison Electric Institute

2
A Potential Roadblock to Smart GridRegulatory
Ambivalence

• Approved
• Portland General Electric AMI (5/2008)
• Duke Energy Ohio Infrastructure Modernization
  (5/2010)
• Oklahoma Gas and Electric Smart Meters (7/2009)
• Texas New Mexico Power AMI (7/2011)

• Conditional
• Idaho Power AMI (2/2009)
• Pacific Gas and Electric (3/2009)
• American Electric Power Smart Grid Pilot (3/2009)
• New York Smart Grid Initiatives of 6 Utilities
  (7/2009)
• Baltimore Gas and Electric AMI (8/2010)

• Rejected
• Hawaiian Electric Company Inc. Smart Meter Pilot
  (7/2010)
• Duke Energy Indiana Smart Meters (11/2009)
• Commonwealth Edison Alternative Rate Plan for
  Smart Grid Funding (5/2011)

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The Regulators PerspectiveThree Questions That
Will (Probably) Be Asked

• Sounds wonderful but will it put bread on the
  table? (Will it produce tangible, monetary
  benefits or savings to the ratepayer?)
• Are we shooting craps?
• How probable is it that the benefits stream will
  occur?
• Are the benefits contingent on some other
  activities (e.g., demand response)?
• Will the check be in the mail? (How will the
  benefits be realized by the ratepayer?)
• Will they be passed through automatically in a
  rate tracker?
• Will they not be passed through until the next
  rate case?

4
The Business Case Challenge
Broad and Inclusive
Rigorous and Defensible

• All Benefits
• Ratepayer
• Societal
• Platform
• Must Take Long View
• Potential Transformational Impacts Considered

• Costs are Specific
• Benefits are
• Trackable,
• Measurable
• Verifiable
• Projections are Reasonable
• Risks are Accounted For

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Preparing the Business CaseGeneral Principles

• For each smart grid application, create long
  list of benefits
• Characterize benefits
• By recipient (e.g., shareholder, customer,
  societal)
• By contingency (what else must occur for these
  benefits to be realized?)
• By measurability
• By verifiability
• The value chain in each business case must be
  oriented to its relevant beneficiary
• For the utility shareholder benefits
• For the regulator ratepayer benefits
• For the taxpayer societal benefits

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Smart Grid Benefits (and Costs) Not the Same for
Everyone!
Consumer Utility (Shareholder) Society
Deferred Generation / Transmission Capacity Gain (from avoided rate increases) Loss (from return on deferred investments)
OM Savings Gain (but only after savings passed through in rates) Gain (before savings passed through in rates)
Outage Reductions Gain Gain Gain
Demand Response Savings Gain (in consumer surplus) Loss (in producer surplus)
CO2 Emissions Reductions No Monetary Benefit (without CO2 tax) General societal benefit
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AMI The Complete Business CaseConsumer
Perspective

• Benefits
• Peak/Off-Peak Pricing
• Change in Consumer Surplus (Not Savings!)
• Deferred Generation Capacity
• Reduced OM
• Meter Reading
• Call and Billing Centers
• Outage Response
• Energy Theft / Meter Errors
• Enhanced Receivables Recovery

• Costs
• Peak/Off-Peak Pricing
• Change in Producer Surplus? (No!)
• Marketing / Administrative Costs
• Capital Costs for New Meters
• OM for New Meters
• Billing / Customer Information Systems Upgrade

Incremental expenditures and savings are tracked
by year, and converted into net present value.
Length of study period should correspond with
service life of principal assets.
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A Good Deal???
Suppose Starbucks sells a medium cup of coffee
for 2.00 and you buy two cups a day, five days a
week. . .
. . . but then they raise the price to 3.00, so
now you only buy one cup a day, five days a week.
CONGRATULATIONS!!! Starbucks has saved you 25
on your coffee costs!
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Savings ? Benefits!An Example

• Assumptions
• Flat rate energy price of 4.1 cents/kWh
• Two consumption behaviors
• Peak (200 PM 700 PM Weekdays) 1.33 kW/hour
• Off-Peak (All Other Hours) 0.85 kW/hour
• Introduce peak / off-peak rate
• Peak 4.9 cents/kWh
• Off-Peak 3.7 cents/kWh
• Price elasticity
• Peak -0.6
• Off-Peak -0.1

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Peak Pricing Example
On-Peak Demand Curve
Flat Rate
Supply Curve
Off-Peak Demand Curve
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Peak Pricing ExampleConsumer Loss Calculation
for On-Peak Period
On-Peak Demand Curve
On-Peak Price
Lost value of reduced electricity consumption.
Loss from purchasing electricity at new, higher
price.
Original Flat Rate
Old Usage
New Usage
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Peak Pricing ExampleConsumer Benefits
Calculation for Off-Peak Period
Off-Peak Demand Curve
Benefit of additional usage at new, lower price.
Original Flat Rate
Savings from old usage level at new, lower price.
Old Usage
Off-Peak Price
New Usage
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Consumer Benefits Calculation Summary

• Off-Peak Benefits
• Savings from original usage at lower price
• (Old Price New Price) x (Original Hourly
  Consumption) x ( of Off-Peak Hours)
• Benefit from additional usage
• ½ x (Old Price New Price) x (New Hourly
  Consumption Old Hourly Consumption)
• x ( of Off-Peak Hours)
• On-Peak (Negative) Benefits
• Losses from new usage level at higher price
• (Old Price New Price) x (New Hourly
  Consumption) x ( of On-Peak Hours)
• Lost benefit from curtailed usage
• ½ x (Old Price New Price) x (Old Hourly
  Consumption New Hourly Consumption)
• x ( of On-Peak Hours)

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Consumer Surplus Calculation Results
Flat Pricing Demand Price Hours kWh Total Cost
Off-Peak 0.85 kW 0.041/kWh 7,456 6,344 258.43
On-Peak 1.33 kW 0.041/kWh 1,304 1,730 70.47
Total 8,760 8,075 328.90
Peak Pricing Demand Price Hours kWh Total Cost
Off-Peak 0.86 kW 0.037/kWh 7,456 6,407 235.33
On-Peak 1.16 kW 0.049/kWh 1,304 1,508 74.57
Total 8,760 7,971 309.90
Savings 328.90 309.90 19.00
Consumer Surplus (0.041-0.037) x (0.85 0.5
x (0.86-0.85)) x 7,456 (0.049-0.041) x
(1.16 0.5 x (1.33-1.16)) x 1304 11.41
Conclusion Savings calculation overstates
consumer benefits estimate by 66!
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A Note on Producer Surplus

• Consumer Savings Lost (Producer) Revenue
• But Loss in Producer Surplus is Less Than Loss in
  Revenue
• The Benefits Stream Parallels that for Consumers
  (i.e., Gain During Off-Peak Hours, Loss During
  On-Peak Hours)
• Off-Peak Benefits
• Serve original load - at higher price!
• Serve additional load (at higher price)
• On-Peak (Negative) Benefits
• Serve reduced load at lower price!
• Lost benefit of curtailed usage

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Peak Pricing ExampleProducer Loss Calculation
for On-Peak Period
Supplier Price When Customer Billed on Flat Rate
Lost margin from reduced electricity sales.
Supply Curve
Loss from selling electricity at new, lower price.
Supplier Price When Customer Billed on Peak Rate
Flat Rate Usage
Peak Rate Usage
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Peak Pricing ExampleProducer Benefits
Calculation for Off-Peak Period
Supply Curve
Supplier Price When Customer Billed on Off-Peak
Rate
Margin from additional sales at new, higher price.
Increased margin from selling electricity at new,
higher price.
Supplier Price When Customer Billed on Flat Rate
Flat Rate Usage
Off-Peak Rate Usage
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Supplier Benefits Calculation Summary

• Off-Peak Benefits
• Increased margin from original usage at higher
  price
• (New Price Old Price) x (Original Hourly
  Consumption) x ( of Off-Peak Hours)
• Increased margin from additional usage
• ½ x (New Price Old Price) x (New Hourly
  Consumption Old Hourly Consumption)
• x ( of Off-Peak Hours)
• On-Peak (Negative) Benefits
• Margin losses from new usage level at lower price
• (New Price Old Price) x (New Hourly
  Consumption) x ( of On-Peak Hours)
• Lost margin from curtailed usage
• ½ x (New Price Old Price) x (Old Hourly
  Consumption New Hourly Consumption)
• x ( of On-Peak Hours)

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Producer Surplus Calculation Results
Flat Pricing Demand Price Hours kWh Total Revenue
Off-Peak 0.85 kW 0.036/kWh 7,456 6,344 230.78
On-Peak 1.33 kW 0.057/kWh 1,304 1,730 98.12
Total 8,760 8,075 328.90
Peak Pricing Demand Price Hours kWh Total Revenue
Off-Peak 0.86 kW 0.037/kWh 7,456 6,407 235.33
On-Peak 1.16 kW 0.049/kWh 1,304 1,508 74.57
Total 8,760 7,971 309.90
Lost Revenue 328.90 309.90 19.00
Producer Surplus (0.037-0.036) x (0.85 0.5
x (0.86-0.85)) x 7,456 (0.057-0.049) x
(1.16 0.5 x (1.33-1.16)) x 1304 - 9.50
Conclusion Margin loss (negative producer
surplus) is half of revenue loss.
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Why Energy Savings is a Bad Metric

• It ignores the value of energy consumed
• It ignores collateral costs that may be incurred
  by consumers if energy use is shifted
• It ignores the corresponding losses incurred by
  producers from lower sales (however, these can be
  ignored if business case is from consumer
  perspective only)

Consumer Surplus is the appropriate metric for
measuring the direct impact of changes in energy
consumption behavior.
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But Does This Mean that Real-Time Pricing is a
Bad Thing?Not Necessarily!!!

• Consumer surplus could (and usually does)
  increase
• Future rate increases (and perhaps even current
  rates) will be reduced due to deferred capacity
  expansion and/or lower capacity charges
• Traditional non-TOU pricing is a form of hedging
  (i.e., energy provider pays for energy in real
  time, while customer does not), which may result
  in a hedge premium that can be removed or
  reduced with TOU pricing

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. . . And What About that Starbucks Deal? Heres
the Real Impact of the Price Increase
New Price
Lost value of reduced coffee consumption
Demand Curve
Loss from purchasing coffee at new, higher price
Original Price
2.10
2.70
2.50
2.30
2.90
New Quantity
Old Quantity
Loss from Purchasing Coffee at Higher Price 5
cups x 1.00/cup 5.00
Lost Value of Reduced Coffee Consumption
Cup 6 2.90 - 2.00 0.90
Cup 7 2.70 - 2.00 0.70 Cup
8 2.50 - 2.00 0.50 Cup 9
2.30 - 2.00 0.30 Cup 10 2.10
- 2.00 0.10
Total Loss 7.50
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Sample AMI Business CaseRatepayers Perspective
Costs Costs Benefits Benefits
Meters 60,100,000 Reduced Meter Reading Costs 123,070,000
Remote Disconnect Collars 101,820,000 Billing / Call Center Savings 8,730,000
AMI Operating Costs 10,160,000 Reduced Energy Theft / Meter Error 30,440,000
Information Systems Upgrade 5,720,000 Enhanced Receivables Recovery 10,810,000
Marketing / Administration 20,000 Salvage 1,660,000
Deferred Generation Capacity 17,800,000
Gain in Consumer Surplus 16,800,000
Total 177,820,000 Total 209,310,000
Assumptions 20-year meter life, 8 discount
rate, 20 residential customer enrollment in peak
/ off-peak rate.
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Some Final Lessons

• Dont oversell the case! (Its only as strong as
  its weakest link.)
• Different stakeholders will have different
  business cases. Dont ignore the distinctions!
• Multipliers multiply confusion (and grief!).
  Smart grid investments may create positive job
  multipliers, but reductions in staff due to
  automation may produce negative job multipliers
• Phantom benefits will only haunt the case best
  if they are measurable and trackable!
• Theres no such thing as a risk-free investment.
  Acknowledge it in the case, and be willing to
  share it!

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Who Bears the Risk?
Rate Case for Cost Recovery / Guaranteed
Reduction in Revenue Requirements Over Time
High Risk
Rate Case for Cost Recovery / Rate Tracker for
Savings and Benefits
Rate Case for Cost Recovery / Rate Case for
Savings and Benefits
Performance- Based Ratemaking?
Rate Tracker for Cost Recovery / Guaranteed
Reduction in Revenue Requirements Over Time
Utility
Rate Tracker for Cost Recovery / Rate Tracker for
Savings and Benefits
Rate Tracker for Cost Recovery / Rate Case for
Savings and Benefits
Low Risk
Customer
High Risk
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Thank You!
Questions? John Caldwell 202-508-5175 jcaldwell_at_e
ei.org