February 12, 2010
Building a business case for smart grid investments is a difficult, if not an impossible, task in the current regulatory and economic environment.
Despite that, many utilities have made the reasonable presumption that efficiencies do exist, though in uncertain amounts, and have forged ahead. Similarly, the federal government, in the form of stimulus grants, has recognized the difficulty and provided funding to jump-start smart grid investments. Future progress, however, will depend on a more clearly defined business case and predictable levels of operational and financial risk associated with smart grid investments.
There are at least two significant hurdles to building a reliable business case for smart grid investments. First, a large portion of the smart grid landscape depends upon assumptions about how the technology involved will work and how utilities and consumers will change behaviors as a result of the new technology. We simply cannot predict how consumers will respond to something that they have never had before. Second, many jurisdictions have not yet resolved important issues related to cost recovery and rate making.
These are not new concerns. The National Association of Regulatory Utility Commissioners has been following these issues for quite some time. NARUC is acutely aware of the benefits of the smart grid, but cautious about endorsing investments before a proper course is charted.
In fact, Frederick F. Butler, past-president of NARUC, cautioned smart grid enthusiasts about putting the cart before the horse in his March testimony before the U.S. Senate: "The benefits of the smart grid are obvious, and we must be sure that we move deliberately and in stages so that the costs of rolling out the necessary infrastructure are borne by those who will benefit."
Additionally, NARUC's July resolution stated that state regulators, rather than federal agencies, should evaluate requests for smart grid cost recovery.
A proper business case has many elements, including the potential savings achieved and the return on investment. The potential savings achieved will depend largely upon how utilities change operational practices and upon how consumers change behaviors. Additionally, NARUC has made it clear that the return-on-investment portion of the business case falls directly within the jurisdiction of state regulators. With these two significant elements unknown and uncertain, the development of a proper business case is very difficult.
The U.S. Department of Energy has recognized this shortcoming in the development of a business-case justification. The DOE in a July "Smart Grid Systems Report" noted the collective reluctance of the industry to make smart grid investments when the "expected cost recovery timelines are only theoretical and have no precedent." Clearly, the issue of cost recovery and return on investment is important and weighs heavily on the minds of regulators.
Business Case
Despite the difficulties associated with developing those portions of the business case for the smart grid, we should not lose sight of the obvious benefits associated with it. Investors and regulators like risk frameworks that are predictable, as do most consumers.
As the technology and experience level with the smart grid evolves, the industry will get better at identifying true costs, behavior patterns, true benefits and, ultimately, reasonably accurate risk patterns. The early adopters, including those utilities and regulators from California and Texas, have been very helpful to the industry in capturing information about the technology, as well as consumer and utility company benefits. This information can be helpful to others in making assumptions and calculations for their business cases.
NARUC's and DOE's comments and efforts seem to support the concept of a meaningful business case that balances the needs of utilities, the grid system and consumers, which is good. The experiences of the early adopters will be helpful to those yet to follow, but even that help will be of limited value if the regulatory framework for cost recovery and return on investment is not resolved.
In short, the time is ripe to resolve questions related to cost recovery and return on investments. Without resolving those questions, it will be difficult to generate a meaningful business case and attract additional smart grid investments.
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Bart Thielbar - Senior Research Analyst
Sierra Energy Group
