An outdated business model

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Across the country, electric utilities are charged with making sure families and businesses have access to safe and affordable electricity. But in many parts of the United States, the way utilities produce and sell this electricity is based on an old—and outdated—model. Why? Because it’s based on a core principle: selling more and more electricity.

ELECTRIC UTILITIES 1.0

The system of producing and selling electricity based on an assumption of ever-growing demand emerged during the last half of the 20th century. During that time, utilities needed to keep up with booming electricity demand and assumed abundant energy would always be needed. Due to economies of scale and the technology available at the time, we were forced to rely on large, centralized coal, nuclear, and hydroelectric power plants to supply cheap and reliable power to everyone.

The significant upfront costs of these large plants, and the necessary infrastructure that accompanies them—like power lines and electricity substations—were justified and mitigated by the country’s rapid and consistent growth in the demand for electricity. If a utility forecasted consistent increased demand in the coming years, they’d count on it when planning and financing new investments. This allowed utilities to pay for the construction of large, expensive power plants over several decades.

SETTING ELECTRICITY RATES

To earn their money back on these large investments—and to cover the ongoing cost of providing electricity to customers—utilities charge a rate based on how much electricity customers use. For investor-owned utilities, which are regulated monopolies in many states, these rates require approval by state regulators. Regulators examine in detail how much electricity a utility is forecasted to sell, determine how much revenue they will need to cover the costs to provide it, and set a rate. Once regulators approve a rate (an amount of money customers will pay per kilowatt-hour they use), it stays in place until the utility requests an increase. Electricity rates often remain the same for years.

With a rate in place, utilities earn money on every unit of energy sold. This creates a profit incentive for the utility to sell as much electricity as possible—even more than the amount originally allowed by regulators. This means customers pay more than they should for the electricity they receive, since power lines and substations are paid off once utilities sell the amount forecasted. Alternately, if customers use less electricity than utilities and regulators estimated, utilities struggle to cover the costs of providing service to customers and are likely to ask for a rate increase.

This scenario creates a strong incentive for permanent, increased customer energy use—the system is inherently weighted toward encouraging greater energy use so utilities make more money.

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The overall trend: electricity demand in the United States is dropping, due to increased efficiency, new technology, policy measures, and other factors. (Data source: Energy Information Administration, February 2013 Monthly Energy Review, Table 7.2b).

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the utilities’ dilemma

This model faces significant challenges today. The steady electricity demand growth of the past has stagnated and looks to remain relatively flat in coming

years. Additionally, technologies and policies that benefit the customer—such as  increased efficiency and more small-scale, local power production like solar—reduce the amount of electricity customers buy from the utility. Not only are these technologies becoming cheaper for customers to implement, but policy makers in many states are also calling on utilities to support or deploy them.

Let’s look at it from the utility’s perspective. Imagine you own a business that makes widgets. The more widgets your company sells, the more money you make and the happier your shareholders.

But now imagine that selling fewer widgets would have significant benefits to the economy, society, environment, and your customers. On top of that, policy makers are calling on you to sell less and less. All of these factors conflict with your business model of producing and selling as many widgets as possible.

This is the dilemma that utilities face today when it comes to providing electricity. A myriad of external forces are making the traditional utility business model—which is built largely around selling increasing amounts of electricity—ineffective and obsolete.

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