The Smart Grid Business Case

1. The Smart Grid Business Case John Caldwell Edison Electric Institute

2. A Potential Roadblock to Smart Grid:Regulatory Ambivalence Approved • Portland General Electric AMI (5/2008) • Duke Energy Ohio Infrastructure Modernization (5/2010) • Oklahoma Gas and Electric Smart Meters (7/2009) • Texas – New Mexico Power AMI (7/2011) • Conditional • Idaho Power AMI (2/2009) • Pacific Gas and Electric (3/2009) • American Electric Power Smart Grid Pilot (3/2009) • New York – Smart Grid Initiatives of 6 Utilities (7/2009) • Baltimore Gas and Electric AMI (8/2010) • Rejected • Hawaiian Electric Company Inc. Smart Meter Pilot (7/2010) • Duke Energy Indiana Smart Meters (11/2009) • Commonwealth Edison Alternative Rate Plan for Smart Grid Funding (5/2011)

3. The Regulator’s PerspectiveThree Questions That Will (Probably) Be Asked • Sounds wonderful – but will it “put bread on the table”? (Will it produce tangible, monetary benefits or savings to the ratepayer?) • Are we “shooting craps”? • How probable is it that the benefits stream will occur? • Are the benefits contingent on some other activities (e.g., demand response)? • Will the “check be in the mail”? (How will the benefits be realized by the ratepayer?) • Will they be passed through automatically in a rate tracker? • Will they not be passed through until the next rate case?

4. The Business Case Challenge Broad and Inclusive Rigorous and Defensible • All Benefits • Ratepayer • Societal • Platform • Must Take “Long View” • Potential Transformational Impacts Considered • Costs are Specific • Benefits are: • Trackable, • Measurable • Verifiable • Projections are Reasonable • Risks are Accounted For

5. Preparing the Business CaseGeneral Principles • For each smart grid application, create “long list” of benefits • Characterize benefits • By recipient (e.g., shareholder, customer, societal) • By contingency (what else must occur for these benefits to be realized?) • By measurability • By verifiability • The value chain in each business case must be oriented to its relevant beneficiary • For the utility: shareholder benefits • For the regulator: ratepayer benefits • For the taxpayer: societal benefits

6. Smart Grid Benefits (and Costs) Not the Same for Everyone!

7. Benefits Peak/Off-Peak Pricing Change in Consumer Surplus (Not Savings!) Deferred Generation Capacity Reduced O&M Meter Reading Call and Billing Centers Outage Response Energy Theft / Meter Errors Enhanced Receivables Recovery Costs Peak/Off-Peak Pricing Change in Producer Surplus? (No!) Marketing / Administrative Costs Capital Costs for New Meters O&M for New Meters Billing / Customer Information Systems Upgrade AMI: The Complete Business CaseConsumer Perspective Incremental expenditures and savings are tracked by year, and converted into net present value. Length of study period should correspond with service life of principal assets.

8. A Good Deal??? Suppose Starbuck’s sells a medium cup of coffee for $2.00 and you buy two cups a day, five days a week. . . . . . but then they raise the price to $3.00, so now you only buy one cup a day, five days a week. CONGRATULATIONS!!! Starbuck’s has saved you 25% on your coffee costs!

9. Savings ≠ Benefits!An Example Assumptions: • Flat rate energy price of 4.1 cents/kWh • Two consumption behaviors • Peak (2:00 PM – 7:00 PM Weekdays): 1.33 kW/hour • Off-Peak (All Other Hours): 0.85 kW/hour • Introduce peak / off-peak rate • Peak: 4.9 cents/kWh • Off-Peak: 3.7 cents/kWh • Price elasticity • Peak: -0.6 • Off-Peak: -0.1

10. Peak Pricing Example On-Peak Demand Curve Flat Rate Supply Curve Off-Peak Demand Curve

11. Peak Pricing ExampleConsumer Loss Calculation for On-Peak Period On-Peak Demand Curve On-Peak Price Lost value of reduced electricity consumption. Loss from purchasing electricity at new, higher price. Original Flat Rate New Usage Old Usage

12. Peak Pricing ExampleConsumer Benefits Calculation for Off-Peak Period Off-Peak Demand Curve Benefit of additional usage at new, lower price. Original Flat Rate Savings from old usage level at new, lower price. Old Usage Off-Peak Price New Usage

13. Consumer Benefits Calculation Summary Off-Peak Benefits Savings from original usage at lower price (Old Price – New Price) x (Original Hourly Consumption) x (# of Off-Peak Hours) Benefit from additional usage ½ x (Old Price – New Price) x (New Hourly Consumption – Old Hourly Consumption) x (# of Off-Peak Hours) On-Peak (Negative) Benefits Losses from new usage level at higher price (Old Price – New Price) x (New Hourly Consumption) x (# of On-Peak Hours) Lost benefit from curtailed usage ½ x (Old Price – New Price) x (Old Hourly Consumption – New Hourly Consumption) x (# of On-Peak Hours)

14. Consumer Surplus Calculation Results Savings = $ 328.90 – 309.90 = $19.00 Consumer Surplus = [($0.041-$0.037) x (0.85 + 0.5 x (0.86-0.85)) x 7,456] – [($0.049-$0.041) x (1.16 + 0.5 x (1.33-1.16)) x 1304] = $11.41 Conclusion: Savings calculation overstates consumer benefits estimate by 66%!

15. A Note on Producer Surplus • Consumer Savings = Lost (Producer) Revenue • But Loss in Producer Surplus is Less Than Loss in Revenue • The Benefits Stream Parallels that for Consumers (i.e., Gain During Off-Peak Hours, Loss During On-Peak Hours) • Off-Peak Benefits • Serve original load - at higher price! • Serve additional load (at higher price) • On-Peak (Negative) Benefits • Serve reduced load – at lower price! • Lost benefit of curtailed usage

16. Peak Pricing ExampleProducer Loss Calculation for On-Peak Period Supplier Price When Customer Billed on Flat Rate Lost margin from reduced electricity sales. Supply Curve Loss from selling electricity at new, lower price. Supplier Price When Customer Billed on Peak Rate Peak Rate Usage Flat Rate Usage

17. Peak Pricing ExampleProducer Benefits Calculation for Off-Peak Period Supply Curve Supplier Price When Customer Billed on Off-Peak Rate Margin from additional sales at new, higher price. Increased margin from selling electricity at new, higher price. Supplier Price When Customer Billed on Flat Rate Flat Rate Usage Off-Peak Rate Usage

18. Supplier Benefits Calculation Summary Off-Peak Benefits Increased margin from original usage at higher price (New Price – Old Price) x (Original Hourly Consumption) x (# of Off-Peak Hours) Increased margin from additional usage ½ x (New Price – Old Price) x (New Hourly Consumption – Old Hourly Consumption) x (# of Off-Peak Hours) On-Peak (Negative) Benefits Margin losses from new usage level at lower price (New Price – Old Price) x (New Hourly Consumption) x (# of On-Peak Hours) Lost margin from curtailed usage ½ x (New Price – Old Price) x (Old Hourly Consumption – New Hourly Consumption) x (# of On-Peak Hours)

19. Producer Surplus Calculation Results Lost Revenue = $ 328.90 – 309.90 = $19.00 Producer Surplus = [($0.037-$0.036) x (0.85 + 0.5 x (0.86-0.85)) x 7,456] – [($0.057-$0.049) x (1.16 + 0.5 x (1.33-1.16)) x 1304] = - $9.50 Conclusion: Margin loss (negative producer surplus) is half of revenue loss.

20. Why Energy Savings is a Bad Metric • It ignores the value of energy consumed • It ignores collateral costs that may be incurred by consumers if energy use is shifted • It ignores the corresponding losses incurred by producers from lower sales (however, these can be ignored if business case is from consumer perspective only) Consumer Surplus is the appropriate metric for measuring the direct impact of changes in energy consumption behavior.

21. But Does This Mean that Real-Time Pricing is a Bad Thing?Not Necessarily!!! • Consumer surplus could (and usually does) increase • Future rate increases (and perhaps even current rates) will be reduced due to deferred capacity expansion and/or lower capacity charges • Traditional non-TOU pricing is a form of hedging (i.e., energy provider pays for energy in real time, while customer does not), which may result in a “hedge premium” that can be removed or reduced with TOU pricing

22. . . . And What About that Starbuck’s Deal?Here’s the Real Impact of the Price Increase Lost value of reduced coffee consumption New Price Demand Curve Loss from purchasing coffee at new, higher price Original Price $2.10 $2.70 $2.50 $2.30 $2.90 New Quantity Old Quantity Loss from Purchasing Coffee at Higher Price 5 cups x $1.00/cup = $5.00 Lost Value of Reduced Coffee Consumption Cup 6: $2.90 - $2.00 = $0.90 Cup 7: $2.70 - $2.00 = $0.70 Cup 8: $2.50 - $2.00 = $0.50 Cup 9: $2.30 - $2.00 = $0.30 Cup 10: $2.10 - $2.00 = $0.10 Total Loss: $7.50

23. Sample AMI Business CaseRatepayer’s Perspective Assumptions: 20-year meter life, 8% discount rate, 20% residential customer enrollment in peak / off-peak rate.

24. Some Final Lessons • Don’t oversell the case! (It’s only as strong as it’s weakest link.) • Different stakeholders will have different business cases. Don’t ignorethe distinctions! • Multipliers multiply confusion (and grief!). Smart grid investments may create positive job multipliers, but reductions in staff due to automation may produce negative job multipliers • Phantom benefits will only haunt the case: best if they are measurable and trackable! • There’s no such thing as a risk-free investment. Acknowledge it in the case, and be willing to share it!

25. Who Bears the Risk? Rate Case for Cost Recovery / Guaranteed Reduction in Revenue Requirements Over Time High Risk Rate Case for Cost Recovery / Rate Tracker for Savings and Benefits Rate Case for Cost Recovery / Rate Case for Savings and Benefits Performance- Based Ratemaking? Rate Tracker for Cost Recovery / Guaranteed Reduction in Revenue Requirements Over Time Utility Rate Tracker for Cost Recovery / Rate Tracker for Savings and Benefits Rate Tracker for Cost Recovery / Rate Case for Savings and Benefits Low Risk Customer High Risk

26. Thank You! Questions? John Caldwell 202-508-5175 jcaldwell@eei.org