Did Energy Efficiency Break Utilities' Business Model?

Guest blog by Shakeb Afsah, Nicola Limodio, and Kendyl Salcito

We have reached a tipping point in America’s power sector. An industry that has sustained itself on Americans’ growing power demands has suddenly seen demand drop. This is making it difficult for U.S. power utilities, under their current model, to turn a profit.

What’s more, this is not a new trend. Using a time-series filter, an analysis of forty years of monthly end-use electricity data exposes a twenty-five year trend during which energy efficiency has steadily chipped away at the total electricity use in the U.S. This would signal a pending contraction of the power generation sector, but seasonal, cyclical fluctuations are making it impossible for power providers to scale back. Increasingly warm summers in the U.S., combined with a demographic shift towards warmer states, have caused demand for electricity to actually increase during peak seasons.

The two diverging long-term patterns—falling electricity use and the increasing peak load—create a perfect storm for the finances of utility companies. While warmer summers require utilities to maintain generation capacity, warmer winters and energy efficiency starkly reduce demand the rest of the year, cutting into utility companies’ cash flow and bottom line.

This may be good news for consumers who watch their electricity bills drop, but it’s a real problem for power companies. If trends persist, they will be forced to increase the price of electricity to cover costs. But increased price will only strengthen the incentives for more electricity conservation and boost the demand for rooftop solar with net metering.

We see this action-and-reaction as a disruptive force that could trigger radical reform of the power sector’s obsolete business model.

The combined realities of rising peak demand during summers and declining demand for everyday needs means the electricity sector will soon face tough decisions. The New York Independent System Operator (NYISO), which operates New York’s 11,000 miles of high-voltage transmission, sees implications for “system planning, grid operations, wholesale electricity markets, and demand-side management programs.”

Dr. Amory Lovins of the Rocky Mountain Institute has stated the problem succinctly: “Higher peak loads require investment (under the old business model) not only in generation but also in distribution, which typically costs even more nowadays.” That is only half the challenge: “meanwhile, many utilities face a lot of catch up investment for deferred maintenance, environmental cleanup, and grid security fixes.”

With the worsening warming trend, peak load will continue to outpace the growth in the overall consumption of electricity. At the same time energy efficiency will only gather more steam as old commercial buildings and residential units are replaced by new units. New policies will have a similar effect—most notably the EPA’s Clean Power Plan, which relies heavily on energy efficiency measures to cut electricity use.

This has major financial implications for electricity companies, because significant investments are needed to maintain peak generation capacity. Most of the industry’s operating costs must be covered by billing day-to-day usage, since peak flow periods are so brief. As day-to-day usage declines, electricity companies will likely need to boost tariffs. Such price hikes are likely to trigger demand declines. This dynamics is a financial nightmare for power utilities. The Columbus, Ohio-based American Electric Power Company CEO told the Wall Street Journal, “It’s a new world for us.”

Shakeb Afsah and Kendyl Salcito are with the CO2 Scorecard Group. Nicola Limodio is a doctoral candidate at the Department of Economics at the London School of Economics; he is a former Junior Professional Associate at the World Bank.

 

Excerpted from Did Energy Efficiency Break the Electric Utilities Business Model? from the CO2 Scorecard Group. Read the full report here.