When competitors have a head start, how can US utilities innovate to overtake?

By

Dana Hanson

EY Americas Advisory Power & Utilities Sector Leader

Helping clients transform their businesses during this time of change and convergence.

5 minute read 7 Jun 2018

Show resources

Compared to counterparts in other markets, US utilities have longer to prepare for disruption from lower cost distributed energy resources (DERs). But how they use their time will determine their fate in the new energy world.

Around the world, energy markets are transforming. And most are changing much faster than previously expected. Together with a global analyst house, we’ve determined three critical tipping points that mark the utility sector’s progression on a journey to fundamental change.

The first of these tipping points — when going off-grid becomes as affordable and accessible as staying on it — will hit Oceania in 2021 and Europe in 2022. Two further tipping points will follow shortly afterward. The countdown for utilities in these markets is on.

But our modeling of the US market reveals a very different story. We’ve determined the tipping points for five US markets and found that they will hit much later than in other parts of the world.

  • The energy industry is at the start of a period of unprecedented change, one that will fundamentally change the market place (presenting new challenges as well as new opportunities). Three tipping points will mark the emergence of a new energy system.

    Tipping point one is when self-generation reaches cost parity with grid-delivered electricity. To determine this date, we calculated the projected demand for electricity, future generation mix and cost of delivering electricity via a central grid between 2015 and 2050, and then compared it to the predicted cost of self-generating electricity using solar PV and battery storage.

    To help determine when these costs would reach parity, we worked with a leading global analyst house to model the expected adoption and interactive impacts on electricity demands and costs of 10 core distributed energy and information technologies: solar PV; battery storage; electric vehicles; microgrids; home and building energy management systems; P2P electricity exchange; smart meters; artificial intelligence; grid-edge technology; and cloud.

    The study also identified two further tipping points for the energy industry:

    • Tipping point 2: when the price of battery electric vehicles reaches cost and performance parity with traditional cars with internal combustion engines
    • Tipping point 3: when the mere cost of delivering electricity (i.e., the unit-cost of electricity transmission and distribution) exceeds the cost of self-generated electricity

    Because drivers vary across markets, the tipping points will hit different regions at different times. The American energy sector is complex and highly regionalized, making it difficult to get one clear picture of what is driving change. To provide clarity we’ve determined the tipping points for five US markets – ERCOT, Westcoast, Midwest, Northeast and Southeast, with a focus case study on California.

Why will disruption hit American markets much later?

The American energy sector is complex and highly regionalized, making it difficult to get one clear picture of what is driving change. But several common factors can help explain why the rise of DERs will impact US utilities at a slower pace than elsewhere:

Low coal, gas generation and utility-scale renewable costs

Wholesale power prices have fallen across all of the major US trading hubs, mostly because of sustained low costs of natural gas — the fuel that often determines the marginal generation cost in most power markets. Natural gas costs in the US are almost half that paid in Europe (US$2.5/MMBtu compared to $4.9/MMBtu), while coal in the US is just US$12 a ton compared to US$64 a ton in Europe. Such low fuel costs combined with the low-marginal cost of utility-scale renewables drive electricity prices lower. At these low prices, consumer pressure for change will come more slowly and grid price parity for distributed generation (DG) plus storage will take much longer to achieve.

Low taxes

One of the biggest factors behind lower energy prices in the US is a much lower rate of taxation compared to other regions.

  • Taxes contribute only 5% of US retail electricity prices — compared to making up one-third of prices in Europe.
  • In the US, generation costs make up 50%-60% of electricity retail prices compared to only 38% in Europe.
Lower transmission and distribution (T&D) costs

Over recent decades, US utilities have generally invested less (as a percentage of total capital spend) in the electricity grid compared to utilities in other developed regions of the world. This, along with a tendency to deploy overground poles and wires rather than the underground infrastructure used in much of Europe, has led to lower costs. But while years of lower T&D investment may have helped keep consumer energy bills lower in the past, this has changed in recent years. Several utilities have announced multibillion-dollar programs to modernize the grid and upgrade aging infrastructure over the next 5–10 years.

Accelerating technology and consumer demands could bring tipping points forward

But while grid parity for PV plus storage is expected to occur more slowly in the US compared to other countries, this first tipping point is only 13 years away for the US Northeast region. For an industry used to investment timelines that span 40 or 50 years, this is a compressed time frame in which to make big changes. And most US regions will experience all three tipping points in quick succession, leaving little room for adaptation once these changes come thick and fast.

Across the country, two factors could also bring tipping points forward:

  • Accelerating technology: Advances in digital technology are increasing exponentially, creating new products and services that may transform energy use in a way we cannot even imagine today. At the same time, technology is continually improving the performance and reducing the cost of existing services and products such as solar PV generation and batteries.
  • Consumer demand: While residential solar PV currently sits at just 1%, changing consumer attitudes toward renewable energy and the technology that supports it could see this figure rise quickly. Meanwhile, corporate consumers, including some of the world’s most influential companies are investing heavily in DG to take charge of energy bills and boost their “clean and green” reputations.

State-based initiatives will make the difference

The highly localized nature of the US energy market means that real change will be driven at a state or regional level. So while the federal government has withdrawn some support for renewables, increased clean energy initiatives at a state level may speed up progress toward tipping points in some areas.

For example, while California sits within the West Coast region — where tipping point 1 is expected in 2034 — we’ve modeled that the state will reach this milestone in just a decade. If other states are inspired to adopt some of California’s world-leading policies and programs around DER and electric vehicles, we may see more US “hotspots” of energy transformation emerge.

  • How the Golden state is leading the way to a new US energy system

    California is highlighting how a different approach to energy can help build a better future for consumers, utilities and government

    California’s energy turnaround is remarkable for both its speed and scope. While natural gas still dominates the energy mix, falling costs are quickly increasing the deployment of solar PV, which is expected to rise from installed capacity of 17GW today to 48GW in just a decade. By 2050, it’s expected that 62% of the state’s energy mix will be made up of renewables and 65% of cars will be electric.

    Our modeling suggests these trends will see California hit tipping point 1 — grid parity — in 2028, three years before the next region — the Northeast — will get there. If the state government succeeds in plans to roll out a target of achieving 100% renewables by 2045, we may see this milestone achieved even earlier.

    A policy of Californian collaboration

    California’s energy transformation has not been hindered by the recent withdrawal of support for renewables at a federal level. Its shifting energy mix highlights how state-based policy and initiatives can drive change within the very localized US energy markets. California’s cap-and-trade program may be one of the world’s strongest, and revenues raised through the sale of permits to large polluters is funding innovative policy and programs. A collaborative approach between state government, utilities, industry and consumers is also a key factor behind rising rates of renewables and electric vehicles (EVs).

    • For example, EV uptake is supported by policy requiring automakers to derive 15% of their sales from zero-emission vehicles by 2025, incentives of up to US$7,000 on purchases of EVs and an ambitious rollout of charging stations by utilities.
    • We also see examples of utilities helping corporate consumers meet clean energy targets. San Francisco’s public electricity utility worked with cloud computing giant Salesforce.com, Inc. to source 100% renewable power for two office buildings.
    • At a community level, local government in West Hollywood, where many people live in apartments or condos, has partnered with utility EnergySage to make it easier for all residents, regardless of their type of dwelling, to access energy generated by rooftop solar panels. And several Los Angeles city councils have joined community choice aggregation programs, which allow them to purchase their own power from several sources, bypassing the local public utility.

    California’s rapid adoption of distributed energy resources and EVs will raise challenges around grid capabilities and infrastructure upgrades. And just as the uptake of these technologies was enabled by state-based initiatives, it will be up to California to manage their successful integration. Meanwhile, many other US states are looking west for inspiration for their own energy transformation.

Time to prepare for a new energy world

It’s clear that DERs will play a critical role in shaping the future US energy market, with generation becoming more diverse, decentralized and enabled by a digital grid powered by automation and data-led intelligence.

To find out about how the generation mix is changing across the US, see the video below:

Those that stand the best chance of success in this new US energy sector are those taking action now to prepare. Now is the time for utilities to:

  • Rethink investment priorities as the energy mix shifts. More renewables and natural gas generation will require appropriate grid upgrades and new capabilities, including digital technologies. Several major US utilities have announced investments in solar, smart meters, grid modernization and batteries.
  • Leverage the potential of EVs: Modeling predicts that there will be 7m EVs in the US by 2025 — and 88m by 2050. With each EV holding up to 30KWh of battery storage, utilities should consider how this can be used to benefit consumers while strengthening and enhancing the grid.
  • Learn lessons from other regions: US utilities could benefit from taking a more outward view to learn from energy companies in other regions that have already had to adapt to much higher market penetration rates of distributed generation, especially rooftop solar.
  • Accelerate diversification to mitigate risk: Diversifying into natural gas, renewable generation and advanced energy storage now will position utilities to take advantage of a changing energy mix.
  • Explore connections with corporate consumers with sustainability agendas: Opportunities to help corporate clients build and manage self-generation and storage facilities could be lucrative. Brokering power purchase agreements of off-site, large-scale wind and solar energy is another strong growth area.
  • Consider collaborations with innovators in other industries: US utilities are already forming partnerships with companies in adjacent industries, such as battery manufacturers and technology firms, to enhance their capabilities in new energy services and develop innovative products and services.
  • Get closer to regulators to shape new regulatory frameworks: Energy regulations lag the transformation of the sector. Different models of rewarding sector investment could help incentivize innovative new business models. In addition to New York’s REV, Illinois’s recent energy reforms that reward utilities for investing in distributed generation are expected to help shape new solar-based business models.

US utilities should seize opportunities of change

The US is a patchwork of regional differences in market structures, retail prices and resource availability. Each region is on its own path to transformation and now we’ve modeled the date on which US energy markets will change forever.

Now is the time to rethink investment strategies, innovate new business models, learn lessons from other regions and industries, and take a proactive role in the transformation of the utility sector.

Summary

As the countdown to increasingly feasible grid defection by customers accelerates and a new distributed model emerges, American utilities can seize the opportunities that extra lead time allows them. 

About this article

By

Dana Hanson

EY Americas Advisory Power & Utilities Sector Leader

Helping clients transform their businesses during this time of change and convergence.