The Quiet Unraveling of the Power Grid Monopoly
- Distributed energy, solar, and battery storage are making electricity demand more elastic.
- As consumers self-generate and defect from the grid, traditional cost-of-service regulation accelerates a “death spiral,” where rising prices push even more customers away.
- Electricity distribution may need to be treated as a public good, implying greater government ownership or municipal-style models.
Will the electric utility distribution monopolies (”discos”) remain financially viable over the longer term? That is the question, and not an idle one. When the government broke up the Bell Systemm (some of you may remember that formerly ubiquitous entity) in the 1980s, it assumed (as did most investors) that the local exchange (the telephone equivalent of the disco) had an unassailable regulated monopoly. Technology (the internet and cell phones) changed that picture, and today only 30% of the population utilizes local exchange land lines. Could that loss of market happen to the electric disco, too?
First, consider that the other two key components of the utility business, generation and transmission, have already been deregulated with radical changes in their economics. Do we think utility distribution assets will be exempt from this process forever? No. And the reason is simple: the consumer’s elasticity of electricity demand is increasing, due to the increased penetration of renewables and distributed energy systems into the marketplace. And this undermines one of the bedrock principles of utility economics since the time of Samuel Insull 100 years ago— inelastic consumer demand. Consumers wanted products, such as heating and lighting, and they had no viable alternatives. Now, consumers can produce and store energy during the day, reducing daily demand peaks, and rely on battery discharge for off peak hours. All of this increasing commercial activity will have an adverse effect on the profitability of monopoly utilities.
Let’s take a step back. Three interrelated concepts underpin modern utility economics: inelastic demand, natural monopoly, and the attendant cost-based regulatory paradigm. Think of these as components of a three-legged stool. Take away one of the legs, and it falls. And right now, the emergence of new renewable technologies (hardware and software) threatens utility profitability by undermining inelastic demand when utility profitability levels should be highest. However, this also erodes the utility’s natural financial monopoly, which presupposes that one firm can provide service far more cheaply than multiple, competing firms. We view distributed energy like the ocean waves undermining beachfront homes with wildly exposed foundations. The end result is inevitable: the house collapses, but the process can take a long time. Same here. But there’s one more thing. If the natural monopoly erodes, which we believe it will, the state and federal regulatory structures also lapse into irrelevance. Why? Because they are designed to set rates so as to permit utilities to recover all their costs from captive consumers. What happens when companies can’t recover all their costs because their monopoly is slipping away? All the regulators can do is facilitate price increases that hasten the legacy monopoly’s demise. This is the logic of the so-called “death spiral”. Consumer migration leads to higher prices, which encourages even more consumer migration away from the legacy utility. What’s interesting to us is that these core utility regulatory concepts that have basically existed undisturbed for almost a century are now being undermined by new, distributed and renewable technologies.
Going forward, start with three related ideas: 1) the utility distribution network still provides considerable consumer value 2) its natural monopoly status and hence its economics are being eroded by new technologies and thus 3) the existing regulatory paradigm, which presupposes a natural monopoly, is also becoming irrelevant and obsolete. The simplest conceptual solution is to change the way we as a society regard electricity and to think of it as a public good. A public good for us is simply something that everyone in society wants and needs, like cheap electricity, but for whatever reason, the full cost recovery via market-based prices is no longer possible, Public goods also imply government ownership and price setting—the way municipally owned utilities operate today.
The electric distribution utility, to operate as a prosperous for-profit business that can attract capital requires two things: continuous growth in assets ( rate base) and a consistent and predictable growth in earnings. A “good” utility should be a declining cost business (via technology) while spreading its expenses over an increasing number of customers. Thanks to the proliferation of distributed, renewable technologies this growth dynamic is beginning to run in reverse due to competition from renewables, which is eroding the natural monopoly. Government ownership of utilities (even in the guise of share ownership in ostensibly commercial ventures) is the norm in much of the world. Whether the US remains wedded to private ownership in the future remains to be seen.
By Leonard Hyman and William Tilles for Oilprice.com
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