Creating the Modern Electric Utility: The David Energy Roadmap

A distributed future with retail electricity markets means offering the electric consumer something previously thought unimaginable — individual empowerment. When we think of a retail electric service provider or utility on a distributed grid, we should think of the customer experience at the point of usage. For this individual empowerment will require a new type of business that analyzes how the customer can respond to retail price signals with myriad assets of their own. This entity that stands between the customer and the electric grid, if any, is what we can call the modern utility. In order to discuss what this may look like, let’s first recap what we know about retail markets. So far, we have established:

  1. Retail markets should be segmented, at the very least as wholesale markets are, in order to fairly and efficiently provide the information (via price signals) that will drive more distribution-level projects. That means that different entities own or operate the following: poles and wires (TDSPs), wholesale power procurement (the utility), market settlement and reliability (ISO/DSO/DSP). As of yet, we have not discussed onsite asset management, except to say that NYREV pledges to only let third party developers own distributed assets, and never the utility.
  2. Peak demand is the most serious problem the grid currently faces. Collocation is one powerful solution, and as franchise rights stand in the way of that, should be unilaterally abolished.

This leaves a few questions to answer: what, then, does the modern utility look like? How do we leverage distributed assets into the bulk grid? With talks of ISO-like DSO’s, what even would be the line between retail and wholesale markets anymore?

Electricity markets are bound to become increasingly complex, especially at the distribution level, and it is improbable that the customer wades through this complexity on their own. It makes sense to have those that are managing nodes at the retail level also interacting at the wholesale level. Furthermore, if a firm manages more than one node, they can coordinate the action of those nodes in response to network events, benefiting a collective of users by acting in unison. Thus, aggregation will result in the most efficient integration of distributed resources into the bulk grid.

What I’m referencing here, more broadly, are the future network node custodians: some sort of fusion of aggregators and ESCOs (Energy Services Companies). ESCOs provide financing and consulting for energy efficiency and onsite energy projects, while still being able to procure wholesale power. So, in competitive retail areas, ESCOs can provide bulk power purchasing to customers instead of the local distribution utility, which still provides delivery. And now, ESCOs are starting to act behind-the-utility meter too.

Thus, instead of “giving” third parties asset ownership and letting the utility keep control of reliability, poles and wires, and payment settlement, regulators should do the opposite. Utilities should lose outright control of poles and wires, reliability, and payment settlement (they have in competitive retail areas, but not everywhere), and be given access to behind-the-meter assets. At the very least, utilities must either become competitive TDSP’s or competitive power providers, but not both in order to maintain marget segmentation. This may sound very strange, so this article aims to break that idea down.

Aggregators and ESCOs, by providing energy services directly to the consumer and their loads, point to a vital idea as we restructure energy markets. With a properly structured DSO — one that is not set up by the utility — the concept of “behind-the-utility-meter” loses significance. There will only be energy markets, and the customer’s gateway into them. Whether or not they possess energy generating assets of their own is irrelevant. What this boils down to is that, simply, a single entity should provide wholesale power procurement, onsite energy asset management, and node aggregation.


NYREV Has It All Backwards

In a previous article, I wrote that NY utilities will be creating retail energy markets in the form of the NYREV DSP. Under this structure, utilities run the platform that establishes market prices (the DSP or DSO), can procure customer’s wholesale power, and own the poles and wires the energy is traded on. The one thing NYREV regulators offer the consumer that makes it a “market” is that behind-the-meter assets cannot be owned by the utilities. Solar, cogen, storage, fuel cells, and any other distributed assets are to be owned by third parties or the building owners themselves. Regulators feel like they gave consumers a win with this rule. The only problem is that it’s completely backwards compared with how retail markets should be developing.

The difference with wholesale markets compared to retail markets is that wholesale markets, for the most part, don’t have “prosumers” — costumers who also produce power for (sell into) the grid. Wholesale markets consist predominately of one-way nodes. When they are two-way, they are large enough to interact with markets directly, both buying and selling. At the retail level, with the emergence of the prosumer, there is no reasonable justification for segmenting the buying and selling process. With the NYREV DSP, whoever runs a building’s asset (the owners themselves or a third party manager) can make money by selling into the grid or to the tenant directly. And while they can choose different retail electricity providers or ESCOs (those who procure wholesale power), the utility can still provide that service. Consumers also have no direct access to other nodes.

In a segmented market, the selling of power into the grid and the buying of wholesale power should be done by the same entity, whether it’s the utility or otherwise. This should be self-evident, but the next sections argue why. For now, consider this. The final step of a retail market is the restructuring of the utility itself, leaving us with the following:

  1. Market settlement and reliability should be handled by the third-party DSO/DSP, like the ISO — not the utility. In NY REV, this is run by the utility (exclusively).
  2. Poles and wires should be run by private Distribution Service Providers, not the utility. With NYREV, this is still the utility (exclusively).
  3. Onsite assets should be managed by the entity that is procuring wholesale power, or the modern utility. In NYREV, the utility cannot do both of these things at the same time.

Thus, the utility should become exclusively a TDSP or exclusively a retail electricity provider. If it is the latter, they should have access to behind-the-meter asset deployment. The incongruity of current NYREV policy should not stop this evolution from occurring over time.

In every step of what the market should look like, we’re completely backwards. This is bound to happen when applying top-down (centralized) grid thinking to the creation of a bottom-up (decentralized) one. What is, then, the proper mode of thinking towards a decentralized grid?

Network Nodes and The Modern Grid: Coase’s Theory of Firm

Organizing two-way nodes to effectively communicate with the bulk grid is a unique problem that we have not faced in energy markets before. On the current grid, nodes either buy or sell, for the most part (NEM and DR programs are very small in comparison), and buying and selling nodes are treated differently. In a proper distributed network, however, each node should be treated the same, whether they produce power or consume it or both.

That is, the future grid is a network involving active, two-way nodes. With the internet, we don’t find it strange that single nodes both send data and receive it. It goes without saying that internet service provides handle both adequately. While comparing the internet and the grid is an imperfect analogy, the point is that we should think of the grid less having centralized, one way assets, and more as a distributed network of interacting nodes.

With all the talk of technical sophistication creating the possibility of p2p trading, one might ask why there needs to be a utility at all. However, in a system as vital and sophisticated as the grid, there will be efficiencies gained by individuals consolidating into firms. Even with one of the most distributed (it’s global) systems ever devised, Bitcoin, there will be firms consolidating on top of a distributed layer: centralized exchanges, banks protecting assets, trading funds, even lightning network nodes to enable transactions. What’s important is that the user has agency in choosing these layers. So, what “natural laws” mandate, or will drive, the reorganization of the modern electric utility? And what is the end result?

Coase’s Theory of Firm

In his famous essay, “The Nature of the Firm”, Ronald Coase argued that the reason individuals consolidate into firms — as opposed to acting independently — is due to transaction costs to using the market, which come in various forms. Because I cannot say it better myself, I will quote Cameron McClain’s description of the firm:

“Firms exist, partly, to manage operational complexity and coordinate actions between individuals. Though it’s far from a perfect correlation, as a general rule, adding people to a process means increasing the costs of coordination. Firms help to minimize these costs by creating structures and contracts that are less transaction focused.”

What’s important to understand when assessing the idea of decentralization is why, and to what degree, firms form. In a sense, the utility became the sole firm on the distribution grid out of necessity due to technological constraints. When electric infrastructure was indeed a natural monopoly, this made sense. But at this point, in an era where that’s no longer true due to collocation, the utility stands between costumers and markets by divine right. In many markets, consumers can choose between utilities or ESCOs, but it is a false choice dictated by the archaic architecture of a centralized grid. Now, as those technological constraints are removed via onsite power generation and digitization, the “firm” (utility), will change shape.

It is important to note that decentralized does not mean distributed, and all transactions need not be p2p. Decentralization is a spectrum, and the aggregation of distributed nodes is not the same as having one centralized node (the utility, in this case).

A decentralized network, with potentially varying degrees of centralization, can be built on top of an underlying distributed grid architecture, but a truly decentralized grid cannot be born from a centralized architecture.

Image (A) in the figure above is our current distribution grid. Nodes, even if they are both using and producing power, can only communicate with other nodes and the wholesale market through the centrally controlling utility. This is the “false choice” I mentioned earlier — they can’t communicate with others directly even if they wanted to. In competitive retail areas, they can only choose between slightly different central rulers. A distributed architecture (C), with centralizing firms acting on top of it to create a scenario like (B), will lead to a more empowered consumer and a more efficient market. Consumers even having the ability to communicate with other nodes without an intermediary exerts competitive pressure on firms. It is not just franchise rights that lead to market inefficiencies, but the structure of the markets themselves.

This is to say that in the current model, the utility business model and centralized nature of the utility’s power has become a clear impediment to a more decentralized system, even if the consumer can choose between different wholesale power providers. They are the only means to access not only wholesale networks, but other customers (if my neighbor’s solar power electrons end up in my toaster, who do you think charges me?). This is still true in the NYREV DSP model, so the essential question becomes: do we need the utility standing between me and my neighbor’s toaster? Maybe, but also likely not. At least not in its current form.

Having an underlying network with p2p capabilities doesn’t mean that firms coordinating and managing assets on top of this distributed architecture will not provide value. Aside from reliability and maintaining the poles and wires, the utility acts as a financial hedging mechanism for the consumer. The utility offers a fixed rate to its consumers while procuring power with variable power prices on the wholesale market. While this is not an article about transaction costs on the grid, it suffices to say that they are large enough to justify aggregation. With individuals signing onto firms as they see fit to collectively hedge their exposure to markets, they can gain efficiencies by coordinating action. Thus, the removal of the arbitrary constraints applied to the grid by current outdated market mechanisms will lead to a more efficient deployment of resources overall.

In brief, the modern utility could help design and finance onsite generation assets, while also providing the software solutions (DERMs, IoT, yada yada) to handle them. Note how decidedly different this is than the current utility model: instead of making money solely on a markup from wholesale energy sales, the modern utility will rather share in the upside of effectively trading users’ generating assets for them in energy markets. In the future, the utility’s and the customer’s incentives are actually aligned, and could be what helps lead to the proliferation of renewables.

Aggregators and ESCOs

The emergence of aggregators and the long-time existence of ESCOs point to an entire new realm of interesting possibilities in the retail energy space. Over time, it is likely that these two ideas combine to some degree in the formation of the modern utility.

Aggregators

Aggregators have become the talk of the town in the storage space, with buzzwords like “virtual power plant” being thrown around gleefully. Since storage is most valuable when “stacking benefits” and demand response is one of the most lucrative value streams, individual units not large enough to respond to wholesale market signals alone are coordinated virtually into an aggregated asset large enough to do so. Put simply, aggregators make an agreement with battery owners so that when a wholesale market like ERCOT or a utility like ConEd calls on them for load reduction, the aggregator can ensure that all the battery banks under management respond in unison to the signal. Then, the profits from providing the grid service are divided up proportionally.

If markets were granular enough, this may not be necessary. In fact, FERC has ordered ISOs to figure out new ways to include distributed storage (and other assets) into their wholesale markets. However, I wouldn’t count on aggregators going anywhere. As we saw in the previous section, there is a benefit to certain levels of centralization and consolidation — but only if the individual has choice in doing so.

ESCOs

ESCOs provide onsite energy efficiency and generation retrofits, guaranteeing energy savings through something called an Energy Savings Performance Contract (ESPC). In NY, ESCOs are interesting in that they can provide financing for energy efficiency upgrades and onsite energy assets like cogen while offering the same customer wholesale power procurement like a utility.

It is difficult to say why an ESCO can do this and a utility cannot, and demonstrates a certain lack of coherence in NYREV policy-making. Maybe it is simply an oversight. ESCOs are thus important to point out in that they are an entity that operates both in front of and behind-the-meter; they provide financing for energy upgrades to a building while also buying wholesale power for them. An ESCO can provide cogen, solar, or storage to a building they are servicing, meaning they can bill tenants directly for power produced onsite. It is obvious that from a market perspective, there is no difference to the bulk grid between a kwh generated to be used onsite and a kwh not used (efficiency).

But as NYREV starts introducing VDER tariffs, this means that an ESCO will be able to provide onsite energy services to be sold into the grid, while also providing wholesale power procurement. This is a monumental idea: it may be that ESCOs will even be able to use onsite assets to hedge wholesale power procurement, in effect integrating distributed resources into wholesale and retail markets, and superseding the distribution-level utility.

ESCOs are thus one piece of the puzzle, and aggregators the other. By combining the services of an ESCO and an aggregator, you get a picture of the modern utility: an entity that procures wholesale power, offers (or brokers) financing for energy efficiency and generating assets within the building, and can provide services to the bulk grid by organizing small, distributed nodes into unified action. This would be the firm that services individual nodes while empowering them to communicate efficiently with other nodes.

The Roadmap

For those thinking, “well this sounds great, but, how are we going to get there? Regulation?” The process will be long and frustrating, but it will happen as a natural progression. As such, David Energy, the company I have helped found, has a three step plan towards this distributed future:

  1. To develop projects on the distribution grid that either charge tenants directly for power (cogen) or interact directly with wholesale markets (aggregation). That is, any project that does not require the utility acting as an intermediary. This means no Net Energy Metering projects. This begins the process of applying competitive retail pressure on the utility by selling kwh’s directly to consumers or markets.
  2. As regulations (such as with VDER in NYREV) evolve, to develop projects on the distribution grid that interact directly with retail markets or newly structured tariffs and demand response programs. While the utility is still an intermediary in the VDR structure, retail projects still provide further competitive pressure on the incumbent utility.
  3. To leverage distributed assets on the retail grid into the wholesale, taking over the entire billing process — including wholesale power procurement — for customers in lieu of the legacy utility by becoming an ESCO. This makes an aggregating ESCO (David Energy) the definitive link between customers generating assets and energy markets. This will lead to the most effective and efficient use of distributed resources for the bulk power grid. This step is about creating the Coasian firm that a distributed grid architecture will call for, one that charges the customer as a service for managing assets, not one that seeks rent solely for marking up wholesale prices as a mandated intermediary. Most importantly, signing on with this firm will be a choice for the user. This is outright competition with the utility.

A sister company will offer to finance the generating assets, while David Energy designs and installs them based on the state of regional energy markets and different technologies that can interact with them, whether it be solar, storage, wind, cogen, fuel cells, etc. We are calling this Energy Architecture for buildings. Any of the three steps is a viable business model, with each step building on the last and a likely overlap of phases.

In the NYREV proceedings, those in charge (such as Richard Kaufman) have repeatedly stated that distribution grid projects will not be owned by the utility. This makes sense: owning the poles and wires, running the market, procuring the wholesale power, and owning behind-the-meter assets would be a return to vertically integrated monopolies.

Thus, the current distribution utility should end up as either a wholesale power procurer/asset manager, Distribution Service Provider, or non-profit DSO, as these modern firms may increasingly rob them of their retail electric sales business over time. ESCO aggregators will manage behind-the-meter assets in NY interacting with retail markets and potentially wholesale (NYISO) Demand Response programs while procuring wholesale power. For example, ConEd may increasingly lose business to ESCOs, and focus solely on their poles and wires business while running the DSO. Eventually, regulators may step in and realize that separating the DSO from distribution infrastructure makes sense. Finally, as a distributed architecture takes shape, franchise rights may be abolished altogether.

As I’ve pointed out before, there is historical precedence to point to an answer to this progression. This process of segmentation already occurred at the transmission level over a 20 year period. Wholesale markets eventually became liberalized around the new millennium through the gradual competitive pressure of non-utility generators on vertically integrated utilities that was enabled by PURPA in 1978. It will be a slow process indeed, but one with an inevitable conclusion. Thus, it’s important to note that this future is not as far off as you think.

Conclusions

At the beginning of the article, I posed a question whether a distributed grid network removes the distinction between wholesale markets and retail markets altogether. I think not, but the lines will certainly be blurred. Currently, arbitrary limitations are put on who can and can’t participate in wholesale markets, due to grid technology and data handling mechanisms not being granular enough. These limitations make our markets less efficient. In ERCOT, for example, any power producer 1MW and up must sell into wholesale markets, but no smaller. Individual or aggregate (utility) users must consumer over 700 kW peak demand in order to be exposed to 4CP rates. So, one’s ability to participate in markets is dictated by arbitrary constraints, such as size. This all is changing, however, with FERC mandating that smaller or individual users be brought to the table.

We can see, then, that over time the difference between wholesale and retail markets will be determined by actual “Coasian” market forces where grid transaction costs dictate which users do and don’t self-organize into firms — which do and don’t interact directly with bulk or local markets. The distinction between wholesale and retail will remain in place — like any other market — but will cease being arbitrary.

That is, those power users and producers large enough will buy and sell directly with wholesale markets on transmission infrastructure. Large power producers don’t need to communicate with other individually producing or buying nodes, just the bulk grid. Small users will trade amongst each other on distribution grids and use firms to procure any wholesale power deficit they need on the buy side, as their bargaining power will be increased via aggregation. On the sell side, by aggregating their battery banks through a firm, they will be compensated fairly when wholesale markets need their services. And most importantly, individual users will have the choice to act independently, creating a check against monopolistic practices by firms that currently does not exist.