PG&E and the future of U.S. utilities

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Pacific Gas & Electric Company (PG&E) is in trouble. The Northern California utility filed for bankruptcy in January, citing potential liabilities for more than $30 billion in damages from wildfires in the summer of 2018, including its role in the Camp Fire in Northern California, which claimed 86 lives.

This is far from the first hot water that PG&E has gotten itself into, and the utility is still on probation for its role in the 2010 San Bruno gas explosion. Even before the company announced that it would file for bankruptcy, California regulators had opened a docket to explore an alternative future for PG&E, including the option of public ownership. This docket opened the door for a group of seven community choice aggregators (CCAs) to propose in February that regulators kick PG&E out of the retail power business altogether.

To exclude PG&E from selling retail electricity would be a huge move, and not only for California, as there have been no municipalizations anywhere near this large in the USA in recent memory.

 

Wildfires and other disasters

The inquiry launched by the California Public Utilities Commission (CPUC) into changes at PG&E is driven by the utility’s safety record. There are a number of lawsuits alleging that PG&E did not de-energize power lines when it should have during high winds, and that these power lines played a role in multiple catastrophic wildfires. The allegation of serious safety problems at PG&E is further underscored by its conviction for both violating safety laws and obstruction of justice for its role in the 2010 San Bruno Gas explosion. Connecting the two, a federal judge has accused PG&E of killing people by causing wildfires, thus violating the terms of its probation.

Even PG&E admits that there is a real safety problem, however it is not the only utility that is in trouble over wildfires. Southern California Edison and San Diego Gas & Electric Company (SDG&E) have also faced lawsuits over their roles in fires in California, with SDG&E paying a massive $2.4 billion to settle 2,000 lawsuits. It is clear that these utilities have argued that their equipment is not the only cause of these fires. California has been getting hotter and drier, leading to longer, more intense, and damaging wildfires, which scientists say is likely driven at least in part by climate change.

Nor is California the only state seeing an increase in natural disasters due to climate change. Hurricanes are getting stronger, and so are snowstorms in the U.S. Northeast. In general, this is leading to more disruption of electricity supply, and as climate change progresses this will only get worse.

 

DG and reliability

In the case of wildfires as well as power outages during hurricanes and “Nor’easters,” the problem is the same: power lines. The United States typically does not bury its power lines, but strings them overhead on poles, even at the distribution level, and the large majority of power outages are the result of power line failures.

PG&E has published a plan to address this, including proactively de-energizing its power lines. But besides one lonely pilot microgrid project, the utility has failed to look at reducing its reliance on power lines in the first place.

Craig Lewis has been articulating the potential reliability benefits of distributed generation (DG) in his work as executive director of Clean Coalition for years. “Central generation requires a highly vulnerable transmission line and when you eliminate that, you inherently increase your reliability and resilience,” he explains.

In addition to localizing generation, the ability to disconnect portions of grids can provide a key advantage. Microgrids have been deployed for decades for essential infrastructure including at military bases, and in the aftermath of Hurricane Sandy the City of New York has deployed microgrids not only at critical facilities like hospitals, but also at housing projects.

Lewis notes that the advantages of microgrids are magnified when paired with renewable energy. “If you want to talk about the resilience of a diesel generator, that is typically two days,” notes Lewis. “If you have a really big disaster and you can’t supply the liquid diesel, you are going to be out after two days. In a community microgrid, renewables are designed for indefinite operation.”

And yet despite the fact that rooftop solar, batteries, and other distributed energy resources (DER) are already reducing the extent of transmission and distribution (T&D) system assets that are needed in California – leaving fewer transmission lines to cause fires in the first place – PG&E has been a consistent opponent to policies that would enable the expansion of rooftop solar.

Nor is PG&E alone. With a few small exceptions, such as Green Mountain Power’s rollout of Tesla Powerwalls at the homes of its customers, in docket after docket, bill after bill, and rate case after rate case, utilities are fighting distributed generation tooth and nail.

 

Cost of Service Regulation

So, why aren’t U.S. utilities deploying DER and microgrids as fast as they can? The answer may lie in the utility business model, and specifically Cost of Service Regulation, which has been the dominant model for investor-owned utilities in the United States for generations.

Under Cost of Service Regulation utilities can’t mark up the electricity or fuel they purchase, but earn a rate of return on capital to deploy infrastructure, typically in the 8-10% range. “If you look at the incentives and the model, it explains the behavior,” says Mike O’Boyle, Director of Electricity Policy at Energy Innovation.

Regulators are supposed to make sure that proposed infrastructure is needed, but O’Boyle describes, “a big information asymmetry issue. You can’t expect a regulator, on their own, to be able to determine whether every little bit of infrastructure is necessary,” says O’Boyle. “You have an explicit incentive to gold-plate the system.” And he says that as long as customer rates are not beyond what is acceptable, this will usually go unchallenged.

There have been many moves to change the utility business model over the years. However, as aptly illustrated when visionary former CEO David Crane tried to take NRG into distributed solar, utilities, and more specifically their shareholders, often don’t want to change.

“It’s a very conservative, cautious industry,” O’Boyle explains. One reason for this is that the Cost of Service Regulation brings shareholders predictable revenues.

However, many options for reforming the investor-owned utility business model have been proposed, and they fall largely into three main camps.

 

Municipalization

Canadian activist and author Naomi Klein championed one option for reforming utilities in her 2014 book, This Changes Everything. According to Klein, if utilities become public companies, then the public as owners can force them to move away from fossil fuels and accept rooftop solar and other forms of renewable energy.

This has worked in some places, but not in others. Arizona cooperative Salt River Project has not only killed rooftop solar in its service area, but also donated substantial sums to stop an initiative to set a stronger renewable energy mandate, even though it would not be subject to the mandate. Another example is the Tennessee Valley Authority (TVA), which is technically owned by the federal government. TVA has been strongly resistant to renewable energy, and has stifled rooftop solar.

Even the nation’s largest municipal utility, the Los Angeles Department of Water and Power (LADWP), is no haven for renewable energy. LADWP is not ahead of California’s three large investor-owned utilities in terms of renewable energy procurement, and Los Angeles has less rooftop PV than other cities, which advocates say is due to bureaucratic barriers at the interconnection level.

 

Performance-based regulation

While public ownership is not guaranteed to work, the most straightforward method to reform the utility business model is to change the incentive structure. This is commonly done through what is called performance-based regulation (PBR), under which utilities get paid for meeting agreed upon objectives as measured by standardized metrics, not for deploying capital. Examples of PBR metrics include increasing reliability, controlling costs, increasing energy efficiency, and integrating higher levels of renewable energy.

A number of regulators have set forth on paths to change the model for the utilities they regulate by integrating PBR, including the Reforming the Energy Vision (REV) process in New York, and the Power Sector Transformation (PST) process in Rhode Island. Additionally, Hawaii has begun the process of moving its utilities to PBR.

Notably, the reforms underway do not entirely replace Cost of Service Regulation with PBR, but rather are a hybrid of the two.

 

Separate powers, DG markets

Perhaps the most significant change to utility business models that has been attempted is the separation of utilities into parts. During the deregulation of the U.S. energy sector in the 1990s, vertical monopolies were split so that the same company could not both own generation and sell electricity to end-customers, which also created wholesale marketplaces and third-party grid operators.

Further changes have been contemplated, as there is no reason why the same company that operates and maintains transmission and distribution assets has to be the one that retails that power.

The first tentative steps towards this have been taken. Many states have retail choice of electricity providers, but typically allow utilities to remain as the default option. Some have argued this needs to go further, such as proposals to create Distribution System Operators (DSOs) that only maintain lines and wires, and are forbidden from either operating assets or selling power.

 

New models

Community choice aggregators (CCAs) can be seen as a form of separation of powers and a partial step towards municipalization. Under CCAs, communities form companies that procure power and sell it to end customers, while utilities still operate and maintain the distribution and system. CCAs in California have been a powerful mechanism for deploying renewable energy more quickly, and also have set up programs to aid distributed generation and install microgrids. In fact, CCAs in California are pushing for a more complete separation of powers for PG&E.

Meanwhile, the U.K. shows a model of how both a move to performance-based regulation and separation of powers is working, achieved through multiple waves of changes. After moving to PBR, and separating the retail and grid operations, the U.K. is now contemplating further reform towards a distribution system operator (DSO) model. Mark Sprawson, the Head of Network Technology at EA Technology, says that the move to PBR, specifically under the Revenue = Incentives + Innovation + Outputs (RIIO) model in 2015, definitely changed the way that utilities operated in the U.K.

“I think one of the things that we have seen in the RIIO framework is to get away from the value of deploying capital,” Sprawson tells pv magazine. “The capex versus opex bias has been removed.” Sprawson adds that this has encouraged a move to demand-side solutions. “Before we had that there was absolutely no incentive for businesses to engage with the sort of flexible solutions offered by third-party providers.”

 

Many paths

It is not clear what exactly will replace PG&E, or any utility in the United States. In their February filing, California’s CCAs say that they and potentially municipal utilities could take over the procurement and retail sale of power, and that this will allow PG&E to focus on making its T&D business safe. While the CCAs have shown more interest in DG and microgrids than PG&E, there is nothing in the filing about changing the financial incentives that drive the utility’s investments in T&D.

Other parties have alternative ideas about how to transform PG&E. The Clean Coalition’s Craig Lewis says that this is an opportunity to strip PG&E not of its retail business, but of its transmission assets, and move the utility to a DSO model. “Divestment of those transmission investments would force PG&E to become 100% laser-focused on the DG grid, which means local renewables, and local storage, and local services become PG&E’s only game,” states Clean Coalition’s Craig Lewis.

Whatever ends up happening to PG&E, there is growing consensus that change is needed. In the end, it is not clear what model, or combination of models is needed or will be implemented. What is clear is that the utility model in the USA is in crisis, and that business as usual is no longer working.

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