The Electricity Journal 29 (2016) 7–12

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The Electricity Journal

journal homepage: www.elsevier.com/locate/electr

Distributed renewable resources and the utility business model

Cliff Rochlin
Loyola Marymount University, Los Angeles, United States

A R T I C L E I N F O A B S T R A C T

Article history: The recent calls for a new utility business model, to avoid a DER-induced death spiral, fail to fully
Received 8 December 2015 understand the important role the utility business model has played in funding regulatory-driven social
Accepted 19 December 2015 programs. Over the past 30 years, as new regulatory demands have been placed on the utility, the utility
Available online 17 February 2016
business model has evolved. The new DER challenge to the utility business model is basically a new form
of uneconomic bypass that requires regulators to get utility pricing right, to reflect both the incremental
and full cost of utility service.
ã 2015 Elsevier Inc. All rights reserved.

1. Introduction Independence also implies that the utility service model,

Broadly speaking, distributed energy resources (DER) (any form
of distributed generation (DG), net metering energy sources,
demand-response programs, price-responsive electric vehicles,
energy efficiency, and distributed-level storage services) is
providing the impetus for developing a new utility business
model. Specifically, recent talk of the need for a new utility
business model across the country is predicated on the continued
technological innovations in metering, communications, and
distributed storage, coupled with the rapid growth of customer-
owned renewable energy self-generation at the distribution level.
Such advances allow for non-utility energy interactions at the
distribution level, and may ultimately provide for customer
independence from the grid. To the extent that customers leave
the grid and the utility’s costs do not decrease accordingly, rates to
remaining ratepayers will increase. Higher rates will provide
incentives for more of the remaining ratepayers to leave the grid.
Hence, without a new business model that is not based on the
growth in electricity sales, the regulated utility will find itself in a
“death spiral.”
While this narrative seems rational on the surface, it is based
upon three assumptions that are examined in this article. The first
assumption is that the 100-year-old vertically integrated utility
business model is inadequate to deal with the technology of the
21st century. The second assumption is that independence from
the grid is in the customers’ best interest, for both
reliability/resiliency and economic reasons. Independence would
allow for the continued availability of electricity during extreme
weather events, such as the polar vortex and Hurricane Sandy.
E-mail address: cliffrochlin@yahoo.com (C. Rochlin).
traditionally a natural monopoly, is no longer a “least-cost” option
to the customer any longer. A customer who is able to meet her/his
energy needs by self-generating may infer that the utility
transmission and distribution services are redundant and discon-
tinue contributing to utility fixed costs. The third assumption, an
implicit one, is that the utility business model no longer meets
regulators’ needs. Regulatory goals have moved beyond the safe-
and-reliable provision of energy. For the last 30 years, the utility
has proven to be both the laboratory and the provider/collector of
funds needed to meet the societal energy goals of increased energy
efficiency and reductions in greenhouse gas (GHG) emissions. To
the extent that the current utility business model can no longer
fund these societal goals, regulators will also have to find a new
business model.
2. The evolution of the utility business model
The assumptions that the vertically integrated business model
has remained static and is based on the continued growth in
energy sales lead to a strawman model that is easily discredited.
However, the utility business has been evolving with changes in
technology, business climate, and regulatory mandates for social
programs. One of the oldest and most established social programs
is energy efficiency: programs specifically designed to mitigate the
growth in electricity sales.
2.1. Energy efficiency and integrated resource planning
The current calls for a new utility business model are not new.
Previous warnings of the need for a new business model initially
surfaced in the 1970s and early 1980s to avoid an impending utility
death spiral. A slowdown in electric sales coupled with

http://dx.doi.org/10.1016/j.tej.2015.12.001
1040-6190/ ã 2015 Elsevier Inc. All rights reserved.
8 C. Rochlin / The Electricity Journal 29 (2016) 7–12
unanticipated, high rates of inflation, two oil embargoes, and
significant nuclear power plant cost overruns created economic
challenges to the vertically integrated electric utility business
model. As rate increases failed to keep pace with surging costs,
utility solvency became questionable. Regulatory responses such
as changes in the timing of rate cases, corrections for financial
attrition, and Allowance for Funds Used During Construction
(AFUDC), provided some relief to the utility business model based
on cost recovery through electricity sales.1 In addition to
regulatory relief, another response to high electric rates was
elicited.
Higher-than-expected costs eventually led to higher electric
rates. To mitigate the impact of higher electric rates, it became
reasonable to use electricity more efficiently. This behavioral
response is predicted by the basic economic theory that higher
prices are used to signal the increased scarcity of the resource and
provide an incentive to use less of the resource. Changes in electric
rate design supported this view as declining block per-kWh rate
structures were changed to increasing block rate structures.
However, this change in rate design was used to highlight that the
efficient use of electricity was somehow different for electricity
than for other resources. This uniqueness was embodied in a new
term, “negawatt”; the most cost-effective kWh is the one not used.
This interpretation led to a new way to plan the electric grid and
set the course for the current round of calls for a new business
model. Use of the term negawatt redefines the concept of energy
efficiency from an attribute describing how electricity is used, to a
resource in its own right, one that shifts the derived demand for
electricity inwards and can be added to the grid as an independent
resource. Energy efficiency was now viewed as a resource that
should be used in planning the electric grid.2 Electric grid planning
evolved into integrated resource planning (IRP), where energy
efficiency/demand response programs are considered to be an
equal building block, along with generation resources and
transmission facilities, in designing the electric grid. The idea
was to build a safe electric grid that would explicitly incorporate a
societal goal: slower growth in electricity usage. However, to reach
this goal, the utility needed to be compensated for its energy
efficiency efforts and meeting its revenue requirements led to
decoupling of revenues from electric sales.
2.2. Decoupling
Decoupling refers to the disassociation of a utility’s profits from
its sales of the energy commodity. Instead, a rate of return is
aligned with meeting a given revenue target. Rates are trued up or
down between rate cases to meet the revenue target. This makes
the utility indifferent to selling less electricity in the short run. That
is, decoupling improves the ability of energy efficiency programs,
demand response programs, and distributed generation to operate
within the utility environment and protects investors from lost
margins between rate cases.
1
Financial attrition can result from using historical test years in a rising unit cost
environment. Attrition can be mitigated by using forward test years in rate cases,
interim rate increases, cost trackers to quickly include new capital projects into
ratebase when they become used and useful, higher customer charges, and rate
cases for multiple years with escalation rates built in for interim years. When
utilities are not allowed to recover in current rates a return necessary to finance
construction projects during the construction period, they will generally be allowed
to capitalize the financing costs for future recovery from ratepayers. AFUDC
represents capitalized interest and equity costs, which will ultimately be included
in rate base as a component of plant in service, thereby earning a return and being
recovered through depreciation allowances. (Lowry et al., 2010, pp. 55–57)
2
Energy efficiency programs are administered by utilities, state agencies, and
other third parties and are paid for by utility ratepayers, typically through a non-
bypassable system benefits charge.
However, the operative phrase is short-run indifference. While
decoupling may be a method to compensate investors for lost
margins between rate cases associated with the promotion of DER,
it does not necessarily create a long-term, sustainable, investment
opportunity for the shareholder. Decoupling does not provide
utilities with the incentives to promote energy efficiency, demand
response, or the integration of DER at cost-based rates. Important-
ly, in the long run, decoupling does not provide a solution to the
anticipated, systematic, erosion of rate base resulting from DER-
induced declines in consumption and peak demand. While the
utility may be indifferent to lost sales in a decoupled environment,
theoretically no worse off for promoting DER, it does not solve the
potential death spiral related to long run DER.
2.3. PURPA and electric restructuring
In the late 1970s, the Public Utility Regulatory Policies Act of
1978 (PURPA) demonstrated that generation need not be built and
owned by the utility.3 Generation could, in fact, be provided by
third parties through the use of cogeneration. Efficient combined
heat and power was not new, but to become a viable source of
generation that could compete with the vertically integrated
utility’s generation assets, PURPA provided both a guaranteed
customer (the utility) for excess energy, which was priced at the
utility’s avoided cost, and nondiscriminatory access to the
transmission grid. The generation segment could be removed
from the vertically integrated utility business model. This would
eventually lead to a “new” utility business model where merchant
generation would compete in a competitive, wholesale energy
market with guaranteed nondiscriminatory access to the trans-
mission grid. The regulated utility would build and maintain the
network of wires, the decreasing cost transmission and distribu-
tion systems. This new business model was formally implemented
and extended through electric industry restructuring.
In the late 1990s through early 2000s, electric restructuring
dominated the electric utility business model in California, New
York, PJM, and New England. Restructuring focused on providing
incentives for the vertically integrated utility to sell its nonnuclear
generating assets, keeping the utilities financially viable by
ensuring stranded cost recovery, and providing open access to
the transmission grid through the creation of a FERC regulated
independent system operator (ISO) or regional transmission
organization (RTO). Electric restructuring unbundled generation
from utility transmission and distribution and created a competi-
tive, wholesale energy market. With the creation of a competitive,
wholesale generation market, the utility would remain the main
energy demand aggregator for its service territory ratepayers. The
aggregation of the utilities’ hourly demand would intersect with
the ISO supply curve to determine the market clearing energy
price.
Restructuring in California failed for many reasons culminating
in the well-known energy crisis of 2000 and 2001, but one of the
main reasons was that all the restructuring effort was placed on
ensuring competition on the supply side. Hourly energy market
3
The Public Utility Regulatory Policies Act of 1978 (PURPA) was implemented to
encourage, among other things, the conservation of electric energy, increased
efficiency in the use of facilities and resources by electric utilities, equitable retail
rates for electric consumers, expeditious development of hydroelectric potential at
existing small dams, and conservation of natural gas while ensuring that rates to
natural gas consumers are equitable. One of the ways PURPA set out to accomplish
its goals was through the establishment of a new class of generating facilities which
would receive special rate and regulatory treatment. Generating facilities in this
group are known as qualifying facilities (QFs), and fall into two categories:
qualifying small power production facilities and qualifying cogeneration facilities
(FERC).
 C. Rochlin / The Electricity Journal 29 (2016) 7–12
Table 1
Evolution of the Utility Business Model.
Social goal Regulations
1. Reduce pollution (through the decrease in Energy efficiency/demand response
electric usage)
2. Reduce electric rates (bills) Electric restructuring
3. Reduce GHG Renewable portfolio standard, cap &
trade
4. Engage utility customer Advanced metering infrastructure/Rate Advanced metering infrastructure
design
5. Reduce utility costs DER/EV/storage
prices were the result of matching generators’ offers with a vertical
demand curve for every hour of the day, since retail rates did not
increase to reflect the higher wholesale market energy prices.
Thus, the crisis emphasized the need for both long-term power
contracts and price responsiveness on the demand side. This was in
fact a common denominator in all existing ISOs.
2.4. AMI and new rate designs
It was not until the energy crisis that California state regulators
took a first step in facilitating active participation by ratepayers
and mandated advanced metering infrastructure (AMI) that allows
for the two-way communication between the utility and its
customers. The next steps of developing and implementing new
rate designs in California include higher customer charges
(minimum bills) and default time-of-use rates (TOU). California
will finally implement its new rate design to take advantage of AMI
with a default TOU rate design in 2019. The new TOU rate design
moves away from flat kWh charges and closer to prices that reflect
the actual cost of producing electricity throughout the day and
within a season. One stated purpose of the new rate design is to
“allow for more accurate allocation of costs and for energy rates to
more fairly reflect the cost of services” (CPUC, 2015, p. 1). This is
consistent with the usual interpretation of “just and reasonable”
rates as rates based on cost causation and provides more accurate
pricing signals and cost allocation. It is also based on sound
economy principles: “A consumer does not only have to decide
whether to consume additional units of a product; he has also to
decide whether it is worth his while to consume the product at all
rather than spend his money in some other direction. This can be
discovered if the consumer is asked to pay an amount equal to the
total costs of supplying him, that is, an amount equal to the total
value of the factors used in providing him the product” (Coase,
1946, p. 173).
Another aspect of creating a separate wholesale market was the
realization that many of the services provided by generation assets
within the vertically integrated utility were not priced. To
guarantee that the ISO would not become an active player in
the market, services like ramping, load following, regulation, and
resource adequacy had to be priced separately. In essence, separate
markets within the wholesale energy market had to be created that
were based on performance. These new markets are exceedingly
important for any “new” business model as they can provide an
alternative source of utility funding (performance-based regula-
tion) that is not based on capital expenditures and can also
potentially provide a source of revenue for DER.
2.5. GHG emissions reduction
A major change in the electric industry, as well as the utility
business model, has been the regulatory mandate to reduce GHG
9
Utility response
Decouple rates, balancing accounts, utility programs
Increase transmission and distribution infrastructure to support
merchant generation
Build transmission to renewable energy zones
Investments to facilitate two-way use of distribution system
emissions. Initially, renewable portfolio standards mandated that a
certain amount of new generation must be renewable. At the time,
these mandates required the utility to add renewable generation
that was significantly more costly than fossil fuel alternatives.
Eventually, the RPS mandates evolved into percentages of energy
generated by non-fossil fuel sources, excluding nuclear and large-
scale hydro projects. In California, the mandates have expanded to
include energy storage assets. However, since the most cost-
effective renewable resources tended to be located outside of load
centers, new, large, costly transmission projects were built. Since
most of these new transmission lines were not driven by the
traditional utility planning concerns of reliability and economic
cost savings, a new “policy driven” reason for transmission
construction was created.
The goal of GHG emissions reduction intensified the role of
policy direction in electric grid planning. IRP expanded from the
efficient use of energy to mandating the type of generation
resources the utility should purchase and the expansion of the
transmission grid to gain access to distant sources of renewable
generation. As more and more electric planning decisions were
removed from the utility’s discretion, energy costs increased and
the costs of meeting the GHG emissions reduction goal was paid for
by electric ratepayers.
Table 1 provides a concise summary of the evolutionary
transformation of the electric utility business model over the last
30 years. To achieve the regulator’s policy goals 2–4, utility rate
base has increased significantly. One can expect that, even though
goal 5 is to reduce utility costs, significant enhancements to the
distribution system will be required to accommodate the
anticipated large amounts of DER.4 For example, “rooftop solar
installations, which are characterized by relatively small size,
intermittent power production, widely dispersed deployment in
the grid, and the inability of grid operators to monitor and control
them. This creates a much more dynamic grid with respect to load,
voltage and other parameters, and drives the need to reinforce key
parts of the grid to better handle the new hardware and operating
characteristics.” (FierceEnergy, 2015)
Table 1 shows that, as the social goals of regulators crystallized
into policy, the utility was able to continue to build rate base and
have the opportunity to earn its authorized rate of return.
Simultaneously, the recognition for pricing to reflect full costs,
support flexibility, and reflect performance have been enhanced.
The flexibility of the utility model is impressive.
To summarize, the utility business model has been evolving for
over 30 years. The vertically integrated utility business model of
the 1970s is not the utility business model of today. Except for the
first changes to the business model in the 1970s, the evolution of
4
SCE’s expected distribution resource planning expenditures through 2017 are
between $347 million to $560 million. From 2018 to 2020, the projected cost grows
to between $1.4 billion and $2.6 billion (SCE, 2015).
10 C. Rochlin / The Electricity Journal 29 (2016) 7–12
the utility business model has been driven by regulatory goals of
increased energy efficiency, reduction in the use of fossil fuels,
increased customer participation, and energy industry transfor-
mation (use of markets and pricing of services). These social goals
have not come without increased costs. Notably, the funding for
these changes has come within the evolving utility business model
and was paid for by utility ratepayers. However, as utility costs
have increased and the growth in electricity sales have stagnated
by design, electric rates continue to increase. It is the potential to
avoid these rising electric costs that has now become the siren call
for customers to install DG or rooftop solar PV and leave the grid.
3. Active participation by customers
The regulatory pursuit of social goals has led to new
technologies, energy efficiency/demand response programs, stor-
age mandates, renewable distributed generation (rooftop solar),
electric vehicles, and AMI. All of which are the components that
make up the microgrid. The microgrid has the potential to
transform the electric industry from a centralized, vertically
integrated model paid for by ratepayers to a local distribution
centric market that works in real time at the edge of the grid with
customers that have options and can respond to price signals.
One potential outcome of a microgrid is that its customers are
expected to see increased reliability/resiliency and lower energy
costs, providing an incentive to leave the utility grid. If this is the
case, microgrid customers would no longer contribute to the
utility’s revenue requirements. If the associated cost reductions fail
to offset revenue losses, then it would lead to the utility death
spiral. Hence, the call for a new utility business model to secure
revenues to keep the utility financially whole.
Another potential outcome of a microgrid is the continued use
of a modernized, flexible utility distribution system. In this
scenario, the revenues associated with the ancillary services
separately priced provides an economic source of funding for the
microgrid. The utility distribution system provides a way to
connect, coordinate, and fund microgrids. The role of the utility as
an integrating force for the wholesale and retail market continues.
The microgrid will provide the utility with revenues based upon its
use of both the distribution and transmission networks and not on
the amount of energy used, mitigating the potential for a utility
death spiral.
Either scenario assumes active participation through the
pricing mechanism will transform the ratepayer into a customer,
where customers would have more choices, more control, and
foster two-way communication between the utility or energy
service provider and the energy user. This transformation is
actually a prerequisite for the new vision of the electric industry:
IRP through markets that operate at edge of the grid.5
Leveraging off the distribution network, a distribution system
platform (DSP) will create an intelligent network for delivering
safe, reliable energy by integrating diverse resources to meet
customer needs and social goals. It will foster broad market activity
that monetizes the electric system and social values. Expanded IRP
will continue to be the guiding principle with a major emphasis on
markets at the distribution level. DER will lead to greater customer
knowledge and actions as they form microgrids. The funding for
microgrids will come from the services provided by customers to
the utility distribution system. The utility will continue to remain
the interface with the wholesale markets. The utility will integrate
customer usage and social goals into markets for energy at the
wholesale, retail, operations, and planning levels.
5
New York’s Reforming the Energy Vision (REV) proposes this type of
distribution platform model.
A central assertion of the need for a new business model is that
customers want control, convenience, choices, and two-way
communication with utilities when it comes to energy usage.
This active role supplants the current passive role of the ratepayer
that wants reliability and low energy rates (bills). Numerous pilot
projects provide support for the basic assumption that customers
will respond to price differentials if they are educated in new rate
designs and it is relatively easy or transparent to respond to those
signals. That is, once their preferences can be transferred to a
computer, appliances and thermostats can be adjusted automati-
cally to respond to price signals. This may be a necessary
development in the reformed electric vision, but it is not sufficient.
Two additional issues must be determined.
First, do customers want to go beyond price responsiveness to
actually deal with the complexities of providing and selling energy
services to the utility? After all, electricity is a derived demand.
Electricity is an input, a requirement, needed to supply the power
to deliver services from appliances owned by the customer.
Electricity per se, is not the goal. To the extent that third parties can
make these complicated options and decisions, made possible by
customer investments, transparent at a lower cost than the utility,
is speculative at best.
Second, is the assumption that the growth in DER is being
accelerated because of “the increased financial viability compared
to traditional generation because of continuous lower price points
to produce and install DER” (Mackinnon et al., 2015 p. 1). This
statement seems to be at odds with the reality that even utility-
scale renewable generation is still dependent on federal subsides.6
4. Uneconomic bypass
Any speculation about customer DER participation at such an
involved level is moot until customers face energy prices that
reflect the real cost of energy assets (DER, storage, AMI) that are not
modified by tax credits, accelerated depreciation, feed-in tariffs, or
subsidies embodied in net energy metering. Regulatory capture by
the environmental movement to reduce energy usage and GHG
emissions through the reduction in the use of fossil fuels has totally
distorted energy prices. Mandated RPS created a market for
variable energy resources at power purchase energy prices that
remain above the cost of fossil fuel production, socialized the cost
of building new transmission facilities to fulfill the public policy
goals of increased renewable resources (not for reliability or
economic reasons), and mandated energy storage requirements
have all distorted and increased the cost of utility provided energy.
The utility has been used by regulatory agencies to be the financial
engine to fund the transformation of the U.S. energy industry. The
tendency of energy regulators is to ensure that the utility serves as
a vehicle for funding social goals by providing direct subsidies for
energy efficiency and rebates for installation of distributed clean
energy resources. With regard to subsidies and rebates, while they
encourage consumer investments, they prevent consumers from
seeing the true incremental cost/avoided cost associated with
incremental/decremental usage and distort customers’ ability to
value investment decisions according to their willingness to pay.
6
“The report found that power purchase agreements prices for wind costs would
need to increase 32–62% for wind developers to maintain profitability on projects. It
also found that removing the investment tax credit (ITC)—in a model with a
constant PPA price—could reduce a developer’s returns on wind by 68–109%, and on
solar by up to 76%.” . . . “In an AWEA statement, ‘After the expiration of the PTC at
the end of 2012, wind installations dropped 92% in comparison to the following
year,”’ GAO reports. “Collectively, the constraints faced by developers with reduced
or eliminated federal supports would likely lead to a reduction in the level of
investment in new renewable utility-scale electricity generation projects” (Brandt,
2015).
 C. Rochlin / The Electricity Journal 29 (2016) 7–12
Table 2
Comparable PV Costs.
PV components
PV module
Inverter & other hardware
Engineering & construction
Installation labor
Customer acquisition & PII
Sales tax
Margin, G & A
System cost ($/Watt)
If those costs were transparent and directly assigned to them,
meeting the intended policy goals would be achieved at a lower
social cost, since it would require fewer ex post mechanisms to
“fix” the implications of cross subsidies among customers.
To claim that a microgrid (conferring the ability to disconnect
from the utility grid) can avoid higher utility energy costs, while
increasing reliability and resilience, may facilitate uneconomic
bypass. That is, since utility energy rates are so distorted, microgrid
energy costs may be less than the utility’s energy rates but more
than the utility’s energy production costs. All of these additional
costs have been paid for by ratepayers. Customers seeking lower
energy bills may actually generate energy at a higher cost, but pay a
lower bill by avoiding these non-fossil fuel energy related costs.
4.1. Costs of residential PV (renewable DER)
The notion that residential PV is an example of uneconomic
bypass is supported by Table 2, which compares the cost of
installing utility-scale PV with the cost of installing residential PV
on a components cost basis.7 While the PV module costs are
identical, the balance of system (BOS) costs for the residential PV
are significantly higher. What is interesting to note is that, while
the utility-scale PV installation cost is very close to the utility cost
of PV, the residential cost is much lower than the reported average
market price charged for residential PV of about $4.90/Watt (MIT,
2015, p. 81). The differential is due to many factors: (1) at the utility
scale either the builder incorporates the solar subsidies into its
utility bid or the utility retains the subsidies and passes the cost
savings on its ratepayers, for residential lease PV installations
subsidies need not be fully passed on to customers because the
decision to install solar is based upon the solar lease payment
being less than the forecasted electric bills; (2) residential
installation costs vary depending on scale of installation, the
diversity of the housing stock, and the specifications of the PV
systems being installed; and (3) additional costs associated with
customer acquisition and marketing, permitting, interconnection,
and inspection (PII).
Even though BOS will fall with experience and innovation,
“some balance-of-system costs for residential systems will likely
remain high because of the structure of U.S. political jurisdictions
and the diversity of distribution of utilities” (MIT, 2015, p. 100). One
major finding of the report is that “Utility-scale PV is likely to
remain much less expensive than residential-scale PV, even in the
face of foreseeable reductions in the BOS costs associated with
residential-scale PV” (MIT, 2015, p. 111).
The addition of storage does not make the value proposition of
DER more palatable. “But as a number of commentators quickly
noted, even at Tesla’s relatively lower prices — $3,000 for a 7 kW
(kilowatt) battery and $3,500 for a 10 kW battery homeowners are
7 10
Table 2 combines the information contained in Figs. 4.7 and 4.8 found on pages
84–85 of the MIT report, “The Future of Solar Energy, an Interdisciplinary MIT
Study.”
11
Utility scale PV (>1 MW) Residential PV (< = 10 KW)
$0.65 $0.65
$0.40 $0.90
$0.40 –
– $0.35
– $0.56
$0.05 $0.05
$0.30 $0.74
$1.80 $3.25
unlikely to save money by shifting their power consumption from
the grid to a solar-plus-battery system. With the cost of solar plus
storage penciling out, in some cases, at more than twice as much as
power from the grid, the gap between the two is simply still too
wide” (Gibson, 2015).8
Also, the cost (cents/kWh) of utility-scale PV is significantly
higher than the cost of a natural gas-fired combined cycle plant.9
This is an example of the additional costs associated with
regulatory social programs that have led to the rising utility rates.
4.2. Net metering
Currently, most distributed solar generation enjoy the benefits
of net metering. “Net metering charges the homeowner for the net
quantity of electricity consumed—in other words, total consump-
tion less total generation. This means, in effect, the utility is paying
for electricity generated by the homeowner at the retail rate, in
contrast to utility-scale generation facilities, which receive the
wholesale price. Because the wholesale price includes charges for
the transmission and distribution systems (on top of a charge for
the power consumed), net metering pays distributed generators a
much higher price for power than gird-scale generators receive”
(MIT, 2015, p. 111). Another interesting fact related to net metering
is that with a steeply tiered rate structure, net metering can result
in an additional incentive to install solar that is equivalent to as
much as 30% of the federal tax credit.10
Even though utilities’ net metering schedules generally impose
system size restrictions so that DG facilities are smaller than the
customer’s typical maximum demand, customers’ solar systems
end up “over-generating” significantly at times of low demand, and
are compensated for the excess energy generated at more than
avoided costs. Thus, the utility is not fully compensated for
maintaining the distribution infrastructure for either the custom-
er’s purchase or sale of electricity. In addition, as solar generation
tails off in the late afternoon, a significantly steep ramp is created
for the early evening hours, which may increase the need for
utilities to increase their ramping capabilities.
The facts seem to contradict the claim that distributed solar PV
is cost effective; in essence, it represents uneconomic bypass. That
is, customers seeking lower energy bills may actually generate
energy at a higher cost, but pay a lower bill by avoiding these non-
fossil-fuel energy-related costs. From a social welfare perspective,
DER bypass may be inefficient unless energy tariffs are corrected.
8
See Helman (2015) for calculations.
9
“Adding a charge of $38 per metric ton of CO2, consistent with the ‘social cost of
carbon’ used in recent federal-level regulatory analyses, increases the levelized cost
of energy (LCOE) for the natural gas plant by 1.47 cent/kWh, bringing its LOCE to
8.08 cents/kWh—still well below the estimated LCOE for both the residential and
utility-scale solar projects. . . . In order for the LCOE for the utility-scale PV to be
equal to the natural gas-fired generation, the CO2 charge would have to rise to $104
per ton” (MIT, 2015, p. 109).
Severin Borenstein’s May 26, 2015, blog “What Put California at the Top of
Residential Solar?”, at https://energyathaas.wordpress.com/2015/05/26/what-put-
california-at-the-of-residential-solar/.
12 C. Rochlin / The Electricity Journal 29 (2016) 7–12
The success of DER today seems to be a classic example of
uneconomic bypass.
5. The Role of the Regulator
What may not be obvious in this new view of the interactive
electric world is that, as the new technologies transform passive
ratepayers into active customers, customers will have alternatives.
Once customers become aware of rate designs that reflect the cost
of providing energy and have the ability to respond to the pricing
signals, they will seek to reduce energy costs. Once the additional
costs related to tax investment incentives and cross subsides
needed to fund social programs embedded in utility rates become
explicitly known, customers will seek to bypass them. To the extent
these costs can be avoided, the creation of microgrids will provide
an incentive to leave the utility grid. This view of the new, active
customer posits a different reason to leave the grid: uneconomic
bypass. It is not the anticipated production cost savings associated
with the microgrid. Instead, it is taking advantage of the ability to
avoid the costs embedded in utility rates that are associated with
funding energy efficiency and GHG emissions reduction programs.
If this were to occur to a significant degree, it would not only be
that the utility is in need of a new business model, but so would
regulatory agencies need a new way to fund their social goals.
While not explicitly noted, this could be a motivating force for
regulators to acknowledge that the incentive for microgrid
customers to leave the grid is socially undesirable.
One option for regulators is to concentrate on making adjust-
ments to utility compensation models. The regulator can redefine
how utilities are compensated for providing services traditionally
provided to ratepayers. Another option is that regulators could
foster the development of the microgrid within the context of
developing a modernized, flexible distribution network. The
transformation of the radial distribution system into a distribution
network, one that is dependent on the two-way use of the
distribution local network, will need a source of revenue to survive
since the cost of self-generation (DER) is more than the cost of
utility-scale renewable generation. Revenues to support the
microgrid or the local market are expected to come from the
services provided to the local utility and the local utility will, in
turn, earn revenues by providing integrating services to microgrid
customers. With changes in utility rate design that are no longer
based solely on energy consumption, both the utility and micro-
grids can both be economically viable. The key to either option is
for regulators to get utility pricing right.
6. Conclusion
The utility business model has evolved over the last 30 years
and will continue to do so because it is in the regulator’s interest. It
is to all stakeholders’ benefit to ensure that the network of
transmission lines and distribution circuits remain reliable,
flexible, and safe. This implies a continued role for the utility in
providing integrating and operational services on both the
wholesale and retail levels. The incentive created by uneconomic
bypass to leave the grid, leading to the utility death spiral, is
neither an economically nor a socially viable alternative.
Customers leaving the grid do not only cause concern for
utilities. Current costs of microgrids seem cost-effective because
their costs are less than current utility rates. However, utility rates
include much more than the cost of energy production. As a result,
microgrids represent the latest form of uneconomic bypass that
not only undermines the economic viability of utilities, it raises the
cost to society of producing electricity. Undermining the economic
viability of the utility also calls into question the continued
viability of regulators to use the utility as a source of funding for its
social goals. Regulators are facing a dilemma: microgrid funding
will rely on selling ancillary services to the utility; however, the
microgrid may undermine the economic viability of the current
utility business model. The call for a new business model is not to
just avoid a utility death spiral, but to continue to provide
regulators with a funding mechanism to meet their social and
environmental goals. To the extent that microgrids make economic
sense in limited circumstances like hospitals, military bases,
airports, campus like environments, and isolated communities at
the end of a radial transmission line, remaining attached to a new,
vibrant distribution network still makes economic sense. The
utility business model can continue to evolve to meet the needs of
its customers and regulators. The first step in this evolution is to
address the uneconomic bypass incentive by getting utility pricing
right.
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Cliff Rochlin has over 35 years of experience in both the electric and gas industries.
He currently lectures in Economics at Loyola Marymount University in Los Angeles.
The author acknowledges the contribution to this article made by many hours of
discussion with Amparo Nieto, Vice President at NERA Economic Consulting. The
author remains solely responsible for any errors in the article.