creative destruction in the energy sector: from disruption to transformation

8/12/2019 Creative Destruction in the Energy Sector: From Disruption to Transformation

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CREATIVE DESTRUCTION IN THE ENERGY SECTOR PAPER SERIES 2014

CREATIVE DESTRUCTION IN THE ENERGY SECTOR

From Disruption to Transformation

GUILLAUME XAVIER-BENDER

IAN MUIR

ALBERT BRAVO BIOSCA

JOHN W. JIMISON

GERARD REID


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About the Creative Destruction in the Energy Sector Paper Series

Te Creative Destruction in the Energy Sector paper series presents timely policy analysis on emerging trends reshaping

traditional dynamics in the energy sector including how innovations outside the sector, such as telecommunications or

inormation technology, could transorm existing systems. Te paper series is conducted in close collaboration with GMFs

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C D E S

F D T

C E P P S

M

Guillaume Xavier-Bender,1Ian Muir,2Albert Bravo Biosca,3

John W. Jimison,4and Gerard Reid5

1 Guillaume Xavier-Bender is a program officer in the Brussels Office of the German Marshall Fund of the United States.

2 Ian Muir is a fellow for GMFs Energy & Society Program. He holds a bachelors in chemistry from Trinity College, Dublin,and is currently pursuing a masters in international relations from the Johns Hopkins School of Advanced InternationalStudies.

3 Albert Bravo Biosca is a senior economist at NESTA, which he joined in 2007. He holds a Ph.D. in economics at HarvardUniversity, a masters in economics from the London School of Economics, and a bachelors in economics from PompeuFabra University in Barcelona, Spain.

4 John W. Jimison is the managing director of the Energy Future Coalition. Prior to joining the Energy Future Coalition in2011, he served as senior counsel to the Energy and Commerce Committee of the U.S. House of Representatives. Jimisonpracticed energy and regulatory law from 1987 through 2006 in Federal and state forums.

5 Gerard Reid is the founder and managing director of Alexa Capital, a firm that provides advisory and financial solutions inenergy, energy infrastructure, and technology sectors. He holds a higher diploma in education and a masters in business &economics from Trinity College, Dublin.

Preliminary Findings and RecommendationsGuillaume Xavier-Bender . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Workshop on Creative Destruction in the Energy Sector: SummaryIan Muir . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Creative Destruction and Innovation: Views from Outside the Energy SectorAlbert Bravo-Biosca . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

A Changing Future for U.S. Electric UtilitiesJohn Jimison . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Appendix: Financing the Energy RevolutionGerard Reid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24


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C D E S 1

The German Marshall Fund of the UnitedStates is publishing the preliminary find-

ings of its project on Creative Destruction in

the Energy Sector. The project examines, through

convening and analysis, the disruptive effect of

innovation on the energy sector, particularly

focusing on the electricity sector.

In the fall of 2013, GMFs Brussels office hosted a

half-day workshop bringing together a group of

experts from the private sector, EU institutions,

member states, and non-governmental organiza-

tions from the United States and Europe. To informthe discussion, input papers were commissioned by

Albert Bravo-Biosca, senior economist at NESTA;

John W. Jimison, managing director of the Energy

Future Coalition; and Gerard Reid, head of Euro-

pean operations at Alexa Capital. Miriam Maes,

non-resident senior fellow at GMF, chaired the

meeting, which focused on the growing pressures

facing utilities as innovation disrupts their tradi-

tional business models, and the new opportunities

that could potentially emerge.

In his summary of the workshop, Ian Muir, non-

resident fellow at GMF, highlights the disruptions

of traditional utility business models by non-energy

players. Additional dialogue between all key actors

is required to ensure smooth transformation of

the power sector. John Jimison examines market

trends and technical innovations that are destined

to reshape the operations of the U.S. electric utility

sector and its institutions, anticipating major

change in a service integrated into every element

of modern life. In his paper, Albert Bravo-Biosca

explains why the process of creative destruction is

so important; particularities to the electric powersector and externalities such as technological

advances suggest it may be at the early stages of

transformation. Gerard Reid looks at the tech-

nology-driven ongoing energy revolution with a

particular emphasis on the impact of that revolu-

tion on investors and the power markets.

P F

R

G X-B

1

Complimentary discussions took place in Warsawin November 2013, on the official sidelines of the

United Nations Framework Convention on Climate

Changes (UNFCCC) 19thsession of the Conference

of the Parties (COP19). At this occasion, GMF and

Duke Universitys Nicholas Institute for Environ-

mental Policy Solutions organized a panel discus-

sion on innovation regarding decarbonization. It

shed light on transatlantic policies and technolog-

ical advancements changing the way we produce,

sell, and consume energy.

Paul Bledsoe, senior fellow at GMF; David King,special representative for climate change for the

British foreign secretary; Jonas Monast, climate and

energy program director at the Nicholas Institute;

Simone Mori, executive vice president for regula-

tion, environment, and innovation at Enel; and

Jonathan Pershing, deputy assistant secretary for

climate policy at the U.S. Department of Energy

took part in the discussion.

Implications

These activities and reports are part of GMFs

broader work on Energy & Society. As such, theycomplement existing initiatives conducted on

energy, economic, technological, and social transi-

tions. Disruptive technologies can have a deter-

mining impact on the future of utilities in Europe

and the United States. In turn, they also have the

potential of radically changing the way the power

sector is financed and organized. Much depends as

well on existing and future symbioses with other

economic sectors.

When it comes to the implications of creative

destruction in the power sector, they often dependon challenges and opportunities for the system as a

whole. As such, they can include:

for utilities and investors: the transformative

role of innovation in the power sector; lessons

learned from other network sectors such as the


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T G M F U S2

Internet industry; adapting business modelsto evolving technologies; and unlocking the

potential of energy storage

for policymakers: the governmental support

of technology champions; helping bridge the

Valley of Death (the financial gap between

the development of a technology and its

commercialization); promoting private-public

partnerships for technology; and the role of

renewables in energy efficiency

for consumers: understanding the power of

demand side management; enjoying affordable

clean electricity; and better living with smart

appliances

for non-traditional energy industries: the

impact of cross-sectoral innovation on the

power sector; taking stock of the implication

of ICTs in the grid; and not perceiving

incumbents as the blockers of change

Findings & Recommendations

From the discussions and analysis conducted

throughout the project, a number of preliminary

findings and recommendations can be drawn:

Change in the electric power sector is

happening, and it is happening much faster

than expected by many.

The process of creative destruction in the

power sector is transformative, and one that

affects all levels of the energy system.

For major transformations to take place in the

electric power sector, mindsets need to changeas well.

Common insights and understanding

are necessary in order to move toward an

affordable, low-carbon, and secure energy

economy.

Technology trends are driving the energyrevolution, and the intersection between these

technologies, policies, and consumers is a game

changer for the power sector.

New business models need to be determined in

order to create a sustainable utility of the future

built on smart investments.

Creating the utility of the future involves

having figured out where the value is created

in the power sector, where the benefits go, and

what power consumers have in the process.

Cross-sectoral innovation will be instrumental

in driving the transformation of the

power sector, as external technologies will

increasingly rely on a smarter network.

The way the Internet sector developed can

provide an insightful model for the grid of the

future both in terms of business developmen

and regulation.

The role of non-traditional actors in the power

sector, such as ICTs, will be instrumental inbringing utilities closer to the consumer with

the possibility of ICTs becoming larger energy

service providers themselves.

Incumbents are not blocking transformation,

and transition toward a more efficient electric

power system involves greater cooperation and

coordination among all stakeholders.


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C D E S 3

A major transforma

in the electricity se

is inevitable, but

outcomes that ens

energy affordability

security, and minim

climate impacts are

Background

On September 19, 2013, GMFs Brussels

Office hosted a half-day workshop on

Creative Destruction in the Energy Sector.

The workshop brought together two dozen partici-

pants with diverse backgrounds, representing a

range of private-sector, public-sector, and non-

governmental organizations from both the United

States and Europe. GMF Senior Fellow Miriam

Maes chaired the meeting and guided the ensuing

discussion, which centered on the growing pres-

sures facing utilities as innovation disrupts their

traditional business models, and the new opportu-nities that could potentially emerge.

The discussion was informed by input papers

commissioned by Gerard Reid, head of European

operations at Alexa Capital; Albert Bravo-Biosca,

senior economist at NESTA; and John W. Jimison,

managing director of the Energy Future Coalition.

Their insights fueled the discussion on the poten-

tial for innovation in the electricity sector as well

as the challenges that are likely to accompany such

innovation.

Seeding the Discussion: The Major

Transformation in the Power Sector

The worlds energy systems are undergoing a

period of rapid evolution. Many developed markets

are seeing demand stagnate just as alternative,

distributed power supplies are becoming increas-

ingly cost-competitive. In the electricity sector,

these trends are putting remarkable pressure on

utilities, calling into question the staying power of

traditional business models. At a minimum, these

models are expected to evolve considerably toaccommodate new realities.

However, a lack of innovation through coordi-

nation risks hampering the rollout of a smarter

system that both reduces uncertainty for utilities,

encourages good behavior, and fosters integration

of lower-carbon energy sources. The stability of theplanets climate hinges on both more rapid decar-

bonization and the more efficient use of energy.

A major transformation in the electricity sector is

inevitable, but outcomes that ensure energy afford-

ability, security, and minimize climate impacts are

not. Holistic discussions are required to comple-

ment specific innovations and to ensure the occur-

rence of the necessary knowledge transfer that will

benefit society as a whole.

Selected interrogations:

We see balance sheets going down and utility

business models under stress. How can we help

utilities given that we dont want them to disap-

pear?

Wouldnt new market-based mechanisms such

as a real-time consumer electricity price drive

energy efficiency at all levels? How can we

further encourage demand response?

How do we Finance the Energy Revolution?

The financial markets look at utilities in their ownway. Notably, they have identified the existing wave

of industry developments as an energy revolution

driven by shale gas, increasingly cheap renew-

ables, and information technology. Smart utilities

have reacted to this and gotten involved in these

burgeoning arenas; the rest have faltered. And

traditional investments have become riskier given

that renewables production earns priority dispatch.

EU power prices have fallen from 70 per mega-

watt-hour in 2008 to just 35 per megawatt-hour,

putting considerable pressure on generators thathave not hedged prices at higher levels. Moreover,

prices are now often defined by the weather, namely

if the wind is blowing or the sun is shining. These

uncertainties have stressed utilities to the point

that they are no longer considered safe financial

W C D

E S: S

I M2


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T G M F U S4

bets, thus requiring higher dividend payments, andeffectively driving up their cost of capital.

Fortunately, there are opportunities for Europe to

emerge from this so-called trough of disillusion-

ment. Utilities need to get into the renewable

energy game and to take advantage of the price

certainty offered by feed-in-tariffs (FITs). Such

investments have proven successful even at returns

under 5 percent.

The integration of the European electricity markets

will pose additional challenges but at the same

time promises considerable benefits in terms of

cost-efficiency and greenhouse gas emission reduc-

tions. And the faster that industry leaders act and

innovate, the greater the benefits to utilities and

consumers alike.

Selected commentary:

The utilities have already failed. Some are on the

verge of bankruptcy. But dont worry; I think its

a good thing if they go bankrupt. It helps bring

creative destruction into the world.

This is the issue that we [the utilities] need

to find business models and landscapes for,

otherwise were going to be dead We need [to

become involved in] the biggest game-changers,

namely small-scale renewables, which are

changing the game and making customers far

more involved.

The EU really needs to push for one market. Its

not that the grid needs to become bigger but that

it needs to become smarter. We need to change

the whole incentive structure so were pushing

more technology and not just more cables.

Europe is in the trough of disillusionment. In the

United States, its very different because there

is a focus on costs. The United States invested

more in wind last year than all other areas put

together. And there a lots of exciting new busi-nesses and business models emerging.

Storage needs to come at the local level. For PV

[photvoltaics], thats definitely going to happen.

If as a consumer, I can take electricity at a nega-

tive price, save it, and feed it back in or create

gas from it. An engineer will tell you its ineffi-

cient, but its not about efficiency, its about cost.

Utilities are not going to build nuclear, coal, etc.,

if their returns cant be guaranteed. So theyre

looking to new markets because the cost of

capital is too high.

The renewable movement has been all about

capacity and not enough about intelligence. No

one in Germany talks about demand manage-

ment, and I think thats a big mistake. Its a

significant contrast with the United States.

What are the Lessons on Creative Destruction

from Outside the Energy Sector?

Innovation is a product of both coordination and

competition. An electric car, for example, has

little value if there is no way to charge its batteries.

And innovation is a continuous process, often

initially involving many players competing vigor-

ously, followed by consolidation and a handful of

remaining winners.

With respect to creative destruction, there are

significant differences between the United States

and Europe. Companies in Europe tend to be older

and more static whereas in the United States, they

are younger and there is a greater distribution of

high- and low-growth firms. It should be little

surprise that static firms do not have a tendency to

drive innovation.

Comparing the internet and the electricity grid is a

useful exercise in that it can highlight key similari-

ties and differences. Moreover, could smart grid

nnovation is a product

of both coordination

and competition. An

ectric car, for example,

has little value if there

is no way to charge its

batteries.


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C D E S 5

Outstanding questi

remain in terms of

adapting business

models that reflect

the impact of new

technologies and o

creative destructionprocess.

technology bring the electricity system closer to the

internet model?

When it comes to the electricity sector, outstanding

questions remain in terms of adapting business

models that reflect the impact of new technologies

and of the creative destruction process: where will

value be created? Which bits of the value chain will

be completely commoditized and who will capture

the profits? What are the platforms and systemsthat will emerge?


Who is likely to dominate the industry? Startups

or incumbents? I cant think of any utilities that

sell solar panels to their customers.

[Incumbents do not] have a monopoly of ideas,

and companies are often not as good as they

should be about creating and adopting ideas.

They also have a fear of cannibalizing their own

products and assets. In the end, entrepreneurs

support radical innovation whereas incumbents

look to incremental innovation.

Were institutionally very rigid. And regula-

tory rigidity is not likely to change since thats

an element of the political power. And thatpreserves [utilities]. Were bringing this fast-

growing, fast-shrinking ethos into the industry

and the incumbents dont know how to deal with

it.

There are no policymakers against company

growth, but there are many against companies

failing. But you cant have one without the other.

You cant protect incumbents and expect to have

high growth companies.

The [electric] industry is decentralizing. With

solar, you can have an 8 kW system that is

almost the same cost as doing 5 MW. Thats the

game changer as size no longer seems to matter

so much. I look at Africa and India and see

that theyre going to decentralize. Think about

telephony in these parts of the world where they

skipped landlines completely.

I think we also need to acknowledge the limits

of decentralization. Take the U.K., which is

really trying to meet its decarbonization targets.

It needs to balance the intermittencies, which

is more difficult in an island system. You needsomeone to take that role. I think its important

to reflect that role. I still agree that it will be a

hybrid system.

What is the Future for Electric Utilities

in the United States?

Technology is driving this energy revolution,

and there are a number of market trends that are

affecting the way we think about the future of the

power system. The continued electrification of

energy services illustrates the value of electricityas a means of providing energy to consumers. And

this value is further evidenced by the increasing

cost of electrical downtime, which can now reach

millions of dollars per hour for single firms.

The Internet The Electricity Grid

Decentralized Centralized

Low capital intensity High capital intensity

Low cost of experimenta-tion

High cost of experimenta-tion

Low cost of deployment High cost of deployment

Easy market access Difficult market access

Difficult to block newentrants

Easy to block newentrants

Limited policy uncer-tainty

Considerable policyuncertainty

High creative destruction Low creative destruction


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T G M F U S6

IT and service

companies see

considerable

opportunities to profit

through the disruption

of traditional utility

business models, whileutilities themselves

ften get caught playing

catch-up.

To meet future demand and reliability expectations,the consensus is that massive capital investments

are required. The increasing competition in the

utility business ought to increase the efficiency of

these capital allocations, but uncertainties regarding

payback times are stifling investment. And while

clean energy has grown popular, existing policies

will likely need to be strengthened if the United

States is to play a proactive role in climate change

mitigation.

The emergence of the smart grid is expected to

revolutionize the operational system, allowingplayers to be able to react more efficiently as

demand comes and goes. Furthermore, a break-

through in low-cost electricity storage would be

a game changer, radically reducing the need for

backup and peaking generation. And lower-cost

renewables will only spur additional decentraliza-

tion of generating assets.

There are significant implications for U.S. utilities

going forward. By 2030, there will be a different

customer relationship whereby utilities are

rewarded for performance rather than kilowatt-

hours sold. The high-risk aspects of the business

will likely be spun off, competing with third-party

entrants, while a healthy balance of distributed and

centralized generation resources will emerge.


The hourly costs of outages are phenomenal.

For a brokerage, it averages $7 million per hour!

There is a tremendous reliability premium on

the market now.

I see financial markets forcing these changes by2020. The financial markets are what are really

driving changes.

Despite being the only country still having a

debate on climate change, the United States still

wants clean energy no matter what.

One point to pick on is what the investmentmarket would look like, namely the monopoly

nature of the sunk parts of the value chain.

Theres critical national infrastructure where the

government deems that its vital to go ahead

you might find if the market didnt do that, then

other players would need to step in.

Utilities fear this vicious cycle where lost

revenues require rate increases that further

incentivize distributed generation.

There is not going to be a guarantee of a return

like before, but there will be opportunities for

large returns. It will be a significant, difficult

migration.

Disruptive Innovation in Practice: Private-Sector

Experience

Private-sector players have been reporting a wide

range of experiences as the electricity sector under-

goes its transformation. IT and service companies

see considerable opportunities to profit through the

disruption of traditional utility business models,

while utilities themselves often get caught playingcatch-up. Greater proactivity on behalf of the

incumbents will be required if they are to achieve

new profit streams that can offset dwindling

revenues upstream.

While we are still only in the early days of the

electricity sector transformation, fast movers will

have the opportunity to capture a greater share of

new revenue streams. Moreover, innovative use of

IT can help ease supply and demand imbalances,

limiting further incidence of stranded generation

assets and reducing the need for costly new infra-structure.


The utility industry itself is going to have to

become the biggest consumer of telecommuni-


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C D E S 7

The uncertainty

regarding future

regulatory trajector

remains palpable a

is surely a significa

impediment to mor

rapid, widespreadinnovation in the po

sector.

cation services. To take all of the [data] fromthese smart meters, process them, and learn

from them. I see potential for major convergence

between the electricity and telecommunications

sectors.

Regarding telecoms, its true that utilities are

going to become big consumers of telecommuni-

cations services. Perhaps [their] past error was

trying to compete with the incumbents in this

area... We will probably see very interesting busi-

ness models in the near future.

The Market and Regulatory Framework

As traditional power sector business models

undergo a range of challenges, many are ques-

tioning how governments and regulatory agencies

might react to potential change. In certain coun-

tries, there is a risk that governments will move

to protect state-owned utilities, thereby stifling

innovation. However, in others, there is evidence of

considerable public-sector willingness to support

greater leverage of technology, increased competi-

tion, and innovative business models. But positive

impacts will be limited without further coordina-tion.

The uncertainty regarding future regulatory trajec-

tories remains palpable and is surely a significant

impediment to more rapid, widespread innovation

in the power sector. Governments and regulators

will need to do more and coordinate more carefully

if they are to drive positive change while mini-

mizing negative impacts on ratepayers and thoseinvesting in progress. It is clear that, going forward,

additional dialogue will be required between all the

key actors in this increasingly vital sector.


The European Parliament [is] unable to say

unequivocally that something needs to be done.

All of the companies here are active in umbrella

organizations that have a tendency to act to

protect their slowest movers. If there is a way to

bring together the companies not so interested in

slowing things down, it could go a long way.

How do you build coalitions for change? The

question is whether there are some blocking

elements in the way. Surely the large consumers

of electricity have an interest in seeing progress

on this front, and thus cheaper electricity.

I think a dynamic market needs technology-

neutral regulations that take care of externali-

ties But theres also the question of invest-

ment certainty. We dont know how targets and

regulations will change. We need to be carefulnot to overregulate and create lock-ins. The less

information we have, the more careful we need

to be about regulation Given the 28 members

states in Europe, we need a more harmonized

market. For investors, its very difficult to judge

the average direction when countries move in

different directions.


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T G M F U S8

Innovation activity happens in a system, and it isthe result of two opposing dynamics that comple-

ment each other: one of competition and another

one of coordination. Our understanding of the

process of innovation would be incomplete if we

didnt consider both of them, and so would be our

analysis of the policy levers to support this process.

In this chapter, I consider both of these dynamics,

and draw some tentative implications of what they

may mean for the energy sector.

Why Creative Destruction Matters

Innovation activity is an uneven process. Many tryto innovate but only a few succeed. As a result, only

a minority of businesses and entrepreneurs intro-

duce really novel products, services, processes, or

business models. Even among large U.K. businesses

(250+ employees), only one in five says that they

have introduced a new-to-market product innova-

tion.

This is what makes the process of creative destruc-

tion so important. Entrepreneurs, but also existing

firms, experiment with new ideas. Some work,

most do not. Successful ones scale up and grow tochallenge incumbents. Some incumbents are able

to react in time, while others fail to do so and are

replaced, shrinking and exiting the market. But a

new generation of innovators emerges and the cycle

starts again. It is this creative destruction the

combination of experimentation, selection, and

adoption that ultimately drives productivity

growth.

Experimentation is even more important when

new opportunities or challenges emerge. Innova-

tion, after all, is a discontinuous process. It is bettercharacterized as a series of waves rather than as a

continuous flow. When a new radical technology

is discovered, be it the internet or the combus-

tion engine, a flurry of experimentation follows,

sometimes accompanied by a speculative bubble.

Entrepreneurs and firms experiment with differentapproaches to take advantage of this opportunity,

and eventually the industry consolidates around a

few successful dominant players.

Creative destruction is also more important as

industries converge on the global technology fron-

tier. Far from the frontier, firms can improve their

productivity by imitating what others have already

invented, but at the frontier they need to innovate.

However, innovation is risky and the outcome

uncertain, so only the successful few expand while

the unsuccessful ones shrink.

A puzzling question is how entrepreneurs can

ever be successful when challenging incum-

bents? Incumbents have access to finance, a good

customer base, strong networks, and an up-and-

running organization, while entrepreneurs have

none or very little of these. But incumbents do not

have a monopoly on ideas, sometimes listen too

closely to their existing customers (ignoring the

needs of other potential customers) and can also

be too afraid of cannibalizing their own products

by launching new ones. In addition, they also

have inflexible bureaucracies optimized to deliver

existing processes rather than to adapt to change,

sunk investments that depreciate very quickly if

new technologies make them obsolete, and have a

series of legacy costs that make it difficult for them

to re-invent themselves.

As a result, incumbents tend to have an advan-

tage at undertaking more incremental innova-

tion, continuously improving their products and

processes, since it builds on their accumulated

strengths and capabilities. Instead, when it comes

to radical innovation that is, imagining totally

new ways of tackling new or old problems some

of the incumbents strengths can quickly become

weaknesses, providing opportunities for entrepre-

neurs wiling to exploit them.

C D I:

V O E S

A B-B3

Incumbents tend to

have an advantage

at undertaking more

ncremental innovation,

continuously improving

their products and

processes, sinceit builds on their

accumulated strengths

and capabilities.


12/59

C D E S 9

European policyma

have long worried a

Europes inability to

generate an equiva

to Google or Micros

There are,however, large

differences

between Europe

and the United

States in the

business growth

dynamics that

underlie creative

destruction and

productivity

growth. Both

Europe and theUnited States

have highly

successful

companies, but the European ones are generally

much older. A study by Bruegel shows that only 2

percent of the European companies in the worlds

largest 500 firms by market capitalization were

founded after 1975, compared to 14 percent in the

United States (Vron, 2008).

This is not just about differences in rates of

entrepreneurship. Researchers at the Organisa-tion for Economic Co-operation and Development

(OECD) and the World Bank have shown that the

main differences between the United States and

Europe lie in the rate at which new firms grow

rather than the number of new firms. U.S. start-ups

grow several times faster in their early years than

their European counterparts (Figure 1).1European

countries also have fewer high-growth firms than

the United States (OECD, 2008).

To shed further light on the dynamism of Europes

business landscape, FORA and Nesta, withsupport from the International Consortium for

1 Bartelsman, Scarpetta, and Schivardi (2003) assemble a newdataset for the 1980s and mid-1990s based on harmonizednational microdata sources and provide measures of survivaland growth of new entrants for up to seven years for 10 OECDcountries, later expanded to 17 with the inclusion of some devel-oping countries (Bartelsman, Haltiwanger, & Scarpetta, 2004).

Entrepreneurship, collaborated with researchers

and statistical agencies in eleven countries across

three continents to collect new and comparable

data on business growth. The resulting database

measures how quickly businesses grow or shrink in

each country, drawing on individual records for 6

million businesses.

European policymakers have long worried about

Europes inability to generate an equivalent toGoogle or Microsoft, innovative start-ups that grow

quickly to dominate their markets. But this data-

base shows that this is only part of a wider picture.

Figure 2 summarizes distribution of business

growth for private sector firms in Europe and the

United States Each column indicates the share of

firms with ten or more employees with average

annual employment growth rates over a three-year

period falling within that growth interval.2

Four key findings emerge from this analysis (Bravo-Biosca, 2010):

1. Europe has a much larger share of static

firms, while the United States has more

2 With the range covering 11 intervals from less than -20 percentto more than +20 percent employment growth per annum.

Figure 1: Average firm size relative to entry by age

Source: Bartelsman, Scarpetta, and Haltiwanger (2004)


13/59

T G M F U S10

European countries

have a lower share of

high-growth firms than

the United States But

they also have fewer

medium-growth firms

and fewer shrinkingfirms.

fast-growing and fast-shrinking firms.

Differences in growth dynamics go beyond

the much documented gap in high-growth

firms. European countries have a lower share

of high-growth firms than the United States

But they also have fewer medium-growth firms

and fewer shrinkingfirms. At the same

time, Europe has a

much larger share

of firms that remain

static, that is, firms

that neither expand

nor contract over

time. This gap is

common across

different size classes

(although there

is some evidencesuggesting that it is

particularly difficult

for medium-sized

firms to chal-

lenge large firms in

Europe). Similarly,

it is not explained

by differences in

industry composi-

tion, and it arises

across all major

sectors (even if it ismuch lower when

looking specifically

at utilities).

2. Creative

destruction is at

work. The faster

successful compa-

nies grow, the

faster unsuccessful

companies shrink.

In other words, thereis a strong negative correlation between the

growth rate of firms at the top and the bottom

of the growth distribution across industries

and countries. So if the aim is to have more

Figure 2: Business growth and contraction in Europe and the United States

Source: Bravo-Biosca(2011)


14/59

C D E S 11

The success of an

innovative product

on innovation in oth

parts of the system

high-growth firms, this may require lettingother firms shrink as well.

3. High-growth firms account for a dispropor-

tionate share of new jobs, but the full growth

distribution should be considered. The

debate on high-growth firms often considers

them in isolation. But policies targeted solely

at high-growth businesses, such as improving

the climate for venture capital, are not

enough to address the lack of dynamism that

hampers Europes productivity. They need to

be combined with deeper structural reformsthat remove not just barriers to entry, but also

barriers to growth and contraction, such as

improving product and labor market regula-

tion and tackling access to finance.

4. A less dynamic business growth distribu-

tion, with more static firms as in Europe, is

associated with lower productivity growth.

Importantly, both a higher share of growing

and shrinking firms are correlated with higher

productivity growth, which is consistent with a

faster reallocation of resources (both labor and

capital) toward successful innovators. Specifi-

cally, we find that a five percentage point (pp)

increase in the share of static firms is asso-

ciated with 1pp lower annual productivity

growth.

Consequently, the lack of dynamism observed

across European business may help to explain why

they are less productive than those in the United

States, a gap that had been widening for over a

decade before the recession took hold.

Why Systems Matter

The competitive pressures that sustain creative

destruction are a key driver of innovation, but not

the only one. Coordination is as well. No one would

buy a DVD if DVD players were not available in

the market. Yet no one would buy a DVD player

without DVDs in the market. This is why the intro-duction of DVDs into the market required coordi-

nation between content producers and electronics

manufacturers. Moreover, how well coordination

works can determine which innovation succeeds at

dominating the market, as the past success of VHS

over Beta shows (despite being an inferior standard,

VHS triumphed thanks to having more content

available).

While this is not a new idea, some argue that it is

becoming more important as innovation activities

shift from creating new products toward creatingnew systems. Geoff Mulgan and Charlie Leadbeat-

ers recent discussion paper on systemic innova-

tion sum up why it matters, what new challenges

it involves, and how to address them to make it

happen (Mulgan & Leadbeater, 2013).

The starting point in their argument is that systems

matter more than products. Innovative products,

such as electrical cars, cannot function without the

systems that would support them, such as charging

stations for their batteries. More generally, the

success of an innovative product relies on innova-

tion in other parts of the system, given the strong

complementarities that exist. This makes coordina-

tion much more important, and may suggest that

policy has a more important role to play, whether

helping to set up a common vision or supporting its

development.

Systemic innovation also has implications about

where value is created and who captures it. As the

example of Apple shows, most value is likely to

be captured by system innovators that create new

platforms rather than by the product innovators

that just launch a new product as part of it (even

if they will still get a share of the benefits, as app

developers do).

Systems can take many different shapes and forms,

so how systemic innovation happens (including


15/59

T G M F U S12

who, if anyone, is in the driving seat) dependson several of their characteristics. If it requires

large capital investment, those that have access to

finance will have more influence. If there is already

a system in place, adapting it or creating a new one

that competes with it will typically involve conflict.

System dynamics will also be very different if it is

dominated by someone (e.g., Apple) or if power is

distributed across different players.

What About the Energy Sector?

Defining the boundaries of what we mean by the

energy sector is not trivial. Are we talking onlyabout those firms that sell energy? Or also those

that sell the key inputs used in the production

of energy, such as wind turbines or nuclear reac-

tors? Or those that help us to avoid consuming

energy, whether they are creating new insula-

tion materials or digital tools? Or also those that

intensively use energy, and can dramatically shift

consumption patterns, such as automotive manu-

facturers developing electrical cars? If one lesson

emerges from other sectors, it is that it is difficult

to understand innovation in one part of the system

without considering others, given how interlinked

they are. For instance, developments in energy

storage solutions can radically change not only

transport systems but the whole make up of energy

production. Despite this, the discussion that follows

focuses on the utilities that produce and distribute

energy.

The changing landscape in the energy sector, driven

by technological advances, the climate change chal-

lenge, and geopolitical shifts, suggests that it may

be entering a major phase of transformation, even if

the destination is still unclear.

These are the times for disruptive innovation, when

after much experimentation new dominant players

can emerge and replace existing incumbents.

Whether this is likely to happen in the energy

sector is yet to be seen, given the unique character-istics of the sector, which have traditionally limited

creative destruction. After all, most major players

in Europe are the successors of state monopolies,

and until very recently vertical integration made

it very difficult to enter the market. Even with the

more level playing field being currently developed,

it is still difficult for start-ups to enter and challenge

incumbents.

Silicon Valley provides an interesting contrast. The

cost of experimentation for web entrepreneurs is

very low. They do not even need to a buy a serveranymore. They also can get almost immediate

feedback from customers, learning very quickly

whether their innovation is worth something, or

whether they should give up on that one and move

onto other things. In other words, it is very cheap

and quick to resolve the uncertainty, whether

it ends in success or failure. (The advantages of

being able to fail cheaply and quickly are too often

underestimated!) Not only is the cost of experimen-

tation low, but so is the cost of deployment. Energy

entrepreneurs on the other hand not only need

significant investments to test new technologies,but also to roll them out, given their capital inten-

sity. Moreover, these may be difficult to finance,

since tangible assets are not such a good collateral

when they can become obsolete very fast, which is

definitely a possibility in these uncertain times.

Successful digital start-ups can quickly get millions

of customers around the world by exploiting the

web; in contrast energy entrepreneurs need to deal

with national regulators (and incumbent competi-

tors) to access markets. Operating in a regulated

market also makes energy entrepreneurs subjectto policy uncertainty. And the long life length of

investments in the energy sector decades rather

than years makes incumbents extremely resistan

to change. In the digital world, incumbents quickly

adapt (even if sometimes not fast enough). In the

energy sector, given their sunk investments, their

These are the times for

disruptive innovation,

when after much

experimentation new

dominant players can

emerge and replace

existing incumbents.


16/59

C D E S 13

The question is whe

the grid will becom

more like the intern

the near future.

incentives are not to adapt but to resist, and, ifpossible, block any change that can make their

investments obsolete.

Ultimately, the internet and the grid are both

networks, but of very different nature. The former

was set up to be decentralized, without a central

command-and-control center, unregulated and

open to all, making it easy to experiment and diffi-

cult to block competitors. The latter is tightly regu-

lated, controlled from the center, and limits access.

Even if there are good reasons for this, it also makes

it much easier for well-connected incumbents toinfluence regulators and limit competition.

The question is whether the grid will become more

like the internet in the near future. Smart grids have

the potential to seed such a transformation, but

what happens will ultimately depend on how the

overall system evolves, and who pilots this transi-

tion. In a nutshell, electricity markets need systemic

innovation, and the opportunity is there. But as

with other systems, its future will depend on a

combination of factors, including what technologies

become available, what alliances are formed, how

infrastructures evolve, and how consumer behavior

changes.

A Few Questions Worth Considering

What the future of the energy sector will be is still

an open question, and so is the role that policy-

makers will play in this transition. So rather than

providing answers, this chapter ends with a set of

three questions that can help to inform the debate.

Where will value-added be created?

The value chain in the energy sector is beingbroken into smaller pieces, unbundling a previ-

ously vertically integrated process. The question

that follows is which bits of the process will be

totally commoditized, only being able to compete

based on low prices, and what new sources of value

will emerge? For instance, will most profits in theindustry be captured by energy producers, by the

networks that distribute it, or by those that sell

services that allow reducing energy consumption

(or shifting peak demand)? In other words, what

will be the distinctive features on which competi-

tion in the energy sector will be based? And, closely

related to this, where will most of the innovation

happen (upstream, production, distribution, or

demand-side)?

Taking the internet analogy somewhat further, it

has been the companies that have created new plat-forms that have profited the most from the internet

revolution, not the telecom companies that sustain

it with their fiber optic networks. The internet

contains a series of systems within a large system, as

the examples of Google or Apple show, and so can

the smart grid. The challenge is to identify where

the systems (or platforms) will emerge and what

business models will sustain them.

Who is likely to dominate the industry?

Will creative destruction reach the electricity

sector? It depends is the typical answer from aneconomist. Ultimately, where value is being created

will determine how difficult it is for incumbents to

maintain their leading positions, and this depends

in part on the direction of technological change.

The potential for disruption is higher if start-ups

can innovate at the margins, tackling new markets

that did not exist or developing new technologies

that make existing investments obsolete (assuming

incumbents lobbying does not block them). If

innovation at the core dominates, is complementary

with existing capabilities, and is capital intensive,

dominant firms have a better chance to continue todominate the market. There is, however, another

source of creative destruction: large business in

other sectors (such as some of the internet giants)

challenging energy incumbents with their deep

pockets and their digital capabilities.


17/59

T G M F U S14

Energy policies will

ave to encourage both

better technologies as

well as their adoption.

But many other factors can have an impact onthe sectors landscape. Energy firms may develop

a similar symbiotic relationship with start-ups as

pharmaceutical companies have been doing for a

while in their own sector: letting start-ups do much

of the radical innovation as well as take on the risk,

in order to buy the successful ones later on to scale

them up, taking advantage of their size, expertise,

and comparative advantage in deployment. (This is

not necessarily bad if it is not used to prevent the

development of the technology.)

How competitive the market becomes is also afactor to consider. The smart grid allows for a

much more distributed model of energy genera-

tion, which means that a larger number of energy

producers is sustainable. Moreover, energy

producers may also have to compete against their

own customers, as the option of self-generation

becomes more feasible, which is already starting

to happen. Much value will therefore be captured

by consumers rather than by producers. However,

profitable opportunities will continue to exist in

those segments of the market where competi-

tive pressures are counterbalanced by some othersources of scale economies such as network exter-

nalities, even if those are not linked to the grid per

se but to the platforms that are built on top of it.

What is the role for policymakers?

Given the energy sectors important role

throughout the economy, being an input to all

production sectors and a significant item in

households expenditures, lower innovation and

creative destruction in the energy sector can have a

significant negative impact on downstream sectors,

households budgets, and, ultimately, on economicgrowth. In addition, the climate change challenge

makes achieving innovation in the energy sector a

societal priority.

The challenge for policymakers is how to encourage

both creative destruction and coordination to

maximize innovation and adoption, in other wordsto create a system that makes experimentation

cheaper, facilitates wide learning, and where best

solutions are selected and widely adopted.

Several choices and tradeoffs are likely to emerge:

Markets vs. governments: Is governments role

to take the back seat and let the private sector

take the initiative, or should it be actively

setting direction and providing the funding to

make it happen?

Incumbents vs. start-ups:Should the focus beon incentivizing incumbents to make the most

of new technologies, or on supporting start-up

to challenge incumbents, or both? (Or none?)

Picking winners vs. diversified portfolio:

How diversified should the portfolio be when

backing new technologies, since they are

expensive and many benefit from externalities?

Is picking winners a good strategy, and if

so, should the focus be on sources of energy,

specific technologies, or particular companies?

Early vs. late adoption:What is the right time

to adopt a new technology? Given the risks

of lock-in into inferior and more expensive

technologies, a wait and see approach can be

a temptation, both for governments as well

as for industry. But by acting too late, they

will miss the opportunity to lead an industry.

They may have been investing into much

older technologies that become obsolete very

quickly. (Alternatively, technology and policy

uncertainty may generate a risk of paralysis

with investments stopping given their long lifelength, constraining future energy supply.)

Energy policies will have to encourage both better

technologies as well as their adoption. New solu-

tions are more likely to emerge if policymakers

combine classical instruments, whether SBIR-


18/59

C D E S 15

type schemes3

or technology grants, with otherapproaches to encourage new radical ideas, such

as challenge prizes. For instance, Nesta is currently

running a new Dynamic Demand Challenge Prize

to encourage thinking out of the box on how to

shift peak demand.

Re-thinking how the role of regulation changes in

this new environment may also encourage innova-

tion and adoption, for instance by learning from

other network-based regulated sectors such as

telecoms (including some attempts to facilitate

disruptive business models).

Adoption is likely to be faster if governments tackle

coordination failures, going beyond standard-

setting (which also plays an important role); if they

align incentives, being extremely careful when

designing schemes in order to avoid unintended

consequences (e.g., Spanish solar premiums); and if

they take advantage of nudging and transparency to

induce behavioral change.

3 Small Business Innovation Research program in the United

States.

References

Bartelsman, E. J., Haltiwanger, J., & Scarpetta, S.

(2004). Microeconomic Evidence on Creative

Destruction in Industrial and Developing Coun-

tries. World Bank Policy Research Working

Paper No. 3464.

Bravo-Biosca, A. (2010). Growth Dynamics:

Exploring business growth and contraction in

Europe and the U.S..London: FORA-NESTA

Research Report.

Bravo-Biosca, A. (2011). A look at business growth

and contraction in Europe. Nesta Working

Paper No. 11/02.

Mulgan, G., & Leadbeater, C. (2013). Systems Inno-

vation.London: Nesta.

OECD. (2008).Measuring Entrepreneurship: A

Digest of Indicators.

Vron, N. (2008). The Demographics of Global

Corporate Champions. Bruegel Working Paper

no. 2008/03.

Adoption is likely to

faster if governmen

tackle coordination

failures, going beyo

standard-setting.


19/59

T G M F U S16

Introduction

The U.S. electric utility industry is respon-

sible for a greater capital investment in

the U.S. economy than any other industry,

constructing a unified electric grid that the U.S.

National Academy of Sciences called the single

greatest engineering achievement of the 20th

century. So it is somewhat ironic that the early

decades of the 21stcentury will see this achievement

radically altered by market forces, new technology,

and its customers new options. This chapter notes

the market trends and anticipates the technical

innovations that are destined to reshape theoperations of the U.S. electric utility sector and its

institutions, anticipating major change in a service

integrated into every element of modern life.

The Market Trends

Without accounting for imminent changes in its

basic technology, the U.S. utility industry would

nonetheless already be confronting significant

change from a rapidly evolving market environ-

ment. Six compounding market trends have

combined to put the utility industry under growingeconomic and operational pressure.

First, the ongoing migration to energy services

delivered to consumers in the form of electricity is

not a new trend. It used to be that direct use of fuels

was a major part of an advanced life-style. Virtually

every energy service used in a modern society can

now be provided by an electric-powered device.

Electronics and computing are only the most

obvious. Our lighting, heating, motors, cooling,

communication, manufacturing, and now even our

personal transportation increasingly run on elec-tricity. A gas furnace cannot operate without it.

This is the latest stage of a centuries-long process

of users deciding what form of energy they wanted

for the purposes that they could afford. Electricity

is almost perfect energy infinitely control-

lable, silent, pollution-free at the point of end use,versatile, capable of producing the entire range of

temperature and motion, and uniquely qualified to

produce light and operate electronic equipment. It

is remarkably affordable throughout the industrial-

ized world. Thanks to generation, transmission,

and distribution investments made at huge scale

and priced at their cost through government regu-

lation as a natural monopoly, electricity service has

become ubiquitous in the United States and other

advanced societies, and it has become affordable to

almost all their participants for business and indi-

vidual applications. It is now clearly indispensableto modern life, perhaps especially in the United

States.

A second ongoing trend, balancing the implicit

growth of the first, is the improving efficiency of

major end use applications. In lighting, heating,

cooling, motors, appliances, data centers, and

electronics, the ability to achieve the desired work

from ever smaller amounts of electricity keeps

improving. As a result, the Energy Information

Administration (EIA), often accused of unduly high

projections for future U.S. energy growth, currentlyprojects electricity demand growth at less than 1

percent per year for the projection period to 2040.

Many other estimators see demand growth falling

to less than 0 percent declining sales of power

despite ongoing electrification of the United States.

This originates from productivity improvements as

older equipment is gradually replaced or upgraded

with on-the-shelf technology. Even as we power

more devices with electricity, we will use less.

These competing forces are complicated by a third

factor in the electricity market environment: theincreasing frequency, impacts, and costs of outages.

Unnoticed by many consumers, their increasing

dependence on electricity to operate more of the

critical functions they depend on has actually

raised the real value of electricity. They use less,

but it is worth more. Americans have increasingly

A C F

U.S. E U

J J4

Six compounding

market trends have

combined to put the

utility industry under

growing economic and

operational pressure.


20/59

C D E S 17

had their attention called to this when a stormtakes out the grid for more than a few hours. They

find themselves helpless, unable to be productive,

threatened with the deprivation of basic human

needs, and angry at their utility company even as it

struggles to restore service. The wealthier may find

it warranted to invest several thousand dollars in

a back-up single-home generator to assure service

of a commodity for which they are accustomed to

paying less than $100 per month.

With a warming climate, scientists have warned

that the greater strength and number of destructiveweather patterns experienced in recent years will

continue. Our typically overhead electric infra-

structure is hanging in harms way, and has taken

many of these natural hits. But perhaps even more

threatening is the potential for man-made intru-

sion via the internet in a massive cyber-attack or a

focused physical attack on critical transformers or

control centers, which could deprive huge regions

of electric service for months with potentially

devastating impacts on economic productivity,

human need, and social stability. There is an

unspoken awareness throughout the power-consuming public that electricity is both more

necessary than ever and more threatened in its

reliability, and some private citizens are beginning

to act on that understanding.

A fourth ongoing market driver, recognizing that

electricity generation is itself the greatest global

contributor to greenhouse gas emissions, is the

need to decarbonize a largely-carbon-based genera-

tion infrastructure. While this is still a matter of

debate in the U.S. Congress, it is no longer a matter

of debate in the U.S. electricity industry. In manyways, this could be seen as a measure of self-defense

for the electricity grid, the most vulnerable energy

system to extreme climate events. But one will not

hear many utility executives express eagerness to

back away from expensive and often recently built

coal and gas-fired generators.

This factor points in a back-handed way to thegreat weakness of the electricity system: generating

electricity embodies a huge waste of energy in

conversion losses. Simple-cycle steam generators,

which provide the great majority of the worlds

and the United States capacity in coal, nuclear,

and other fossil-fired power plants, cannot convert

more than about 40 percent of the raw energy they

consume into the electricity they produce. They

waste on average two-thirds of their energy input,

emitted into the atmosphere as hot combustion

products or warm water. Combined-cycle gas plants

can push that to about 60 percent used, 40 percentwasted. The even lower percentages achieved by

renewable energy generation are forgiven by many

because the energy they waste is not emitted as

globe-damaging combustion products. Their ineffi-

ciency is not, however, forgiven by capital markets.

The fifth market reality, connected to the others, is

the need for massive new and continuing invest-

ment. Such investment should keep the system

operating, capable of connecting and supporting

new service, of operating under extreme condi-

tions, of maximizing productivity, and ofresponding to the need for global environmental

protection. Trillions of dollars are needed to sustain

the current system, never mind the new system that

is coming. This requirement will reinforce both the

political pressure on regulators, state governments,

and utility companies, as well as higher electricity

prices even in the face of falling demand.

Finally, perhaps the most significant market

trend that is certain to change the U.S. electricity

sector is the advent of competitive market forces

at all levels of an industry that for a century wasimmune to them as a government-sanctioned and

-controlled monopoly that owned and operated

all necessary infrastructure. The genie of competi-

tive forces is clearly out of the bottle. Starting with

independent generation in the 1980s as a function

of laws favoring cogeneration, and expanding to

Trillions of dollars a

needed to sustain t

current system, nev

mind the new syste

that is coming.


21/59

T G M F U S18

include non-discriminatory and then independenttransmission services, competition in the United

States is now driving new customer behaviors and

threatening to leave major rate-base investments in

generation and transmission stranded and useless.

From passive recipients of monthly invoices that

they could neither limit nor avoid, customers have

increasingly become active participants in elec-

tricity markets, selling their own willingness to be

curtailed back to utilities in the form of demand-

response, bidding their future efficiency gains into

capacity markets, and participating in price-setting

through time-of-use electricity markets whereregulators have permitted them, timing their use

to take advantage of cheaper hours and to avoid

expensive peak power.

The emergence of competition in electricity

markets does not merely challenge utilities invest-

ments and market share; it challenges their funda-

mental economics. Under standard U.S. regulatory

economics, they are assured the recovery of their

capital investments, debt, and the opportunity

to earn a reasonable profit; under competitive

economics, investments are largely sunk costs,debts are at the risk of the success of the debtors

business, and profits are the rents that can be

collected between the sellers cost and the market

price, whatever that happens to be. To the extent

utilities are drawn or driven to compete for their

own continued business, they will be driven to and

by this new and much harsher regime. Whether

utilities can maintain their traditional role as

safe investments with access to low-cost capital

lies entirely on their success in negotiating these

competitive forces where they arise, and in relying

on their regulatory protectors where they do not.

As a result, the U.S. electricity market is a strange

one, one in which a critical commodity is selling

in stagnant or declining volumes but demon-

strating ever higher penetration into societal needs

and developing ever greater dependence from

its customers. For these customers, electricitysessential nature combines with the grids vulner-

ability and unreliability to create incentives to

move toward independence and self-reliance from

the utility despite the costs. At once the greatest

environmental threat and cleanest form of delivered

energy, electricity is at the crux of dealing with

climate change. It is produced, transported, and

sold in a market that remains necessarily regulated

for system governance, largely regulated for siting

of new facilities, optionally regulated in most areas

for commodity pricing, and increasingly unregu-

lated where competitive forces can operate in bulkpower markets and utility services. Customers

and other stakeholders have found little political

consensus on where regulation should stop and

competition should start, but the United States has

3,200 separate utilities with individual service areas

where such judgments will make a lot of difference.

Mix in Some Breakthrough New Technologies

Starting from this set of market realities, any prog-

nostication of the future for the U.S. electric system

must then add to the key influences accounted for

a set of technological developments already under

way and accelerating in the timing and scale of

their potential impact. Some of these are clearly

responsive to the insecurity, vulnerability, environ-

mental insults, inefficiency, cost, and monopolistic

character of the current system. Others are coming

into being because they can. They break into a few

large categories of technological change.

Computerization

The essence of the smart grid that is coming is

the integration into all facets of the electric systemof digital monitoring and controls, and the ability

to process this information for operational and

planning purposes. In other words, the infrastruc-

ture industry that provides the essential power

and lifeblood for computers is becoming comput-

erized itself seemingly the last of the major

At once the greatest

environmental threat

and cleanest form

of delivered energy,

electricity is at the crux

of dealing with climate

change.


22/59

C D E S 19

economic sectors to embrace digital informationprocessing. Over coming years, machine intel-

ligence will continue to rapidly penetrate gener-

ating plants, transmission systems, distribution

networks, and individual customer services and

applications (and probably in that order). Myriad

functions that today still require a human beings

thoughts and actions will be programmed. They

will be instantaneous, and, unfortunately, also

vulnerable to the malicious intervention of other

human beings. Programmable remotely accessible

appliances and building systems able to respond

to variable prices and system conditions will notmerely require computerization for the systems

sake, but also because the modest cost savings their

individual efficiencies will generate would not be

worth the time of a human being to accumulate by

direct control. Only if they are programmed to save

money will they pay for themselves, and only then

will they achieve their value on the electric grid.

The millions of monitors that in coming years will

watch and report the activities across every part

of the grid on the utility side of the meter will be

multiplied by billions that track the operations ofindividual consumer applications. Together, these

will generate quintillions of bits of computer data

that must be transmitted, received into databases

and control systems, distinguished by origin,

processed, analyzed, and acted upon. Utilities will

either need major server and processing installa-

tions of their own, or they must become perhaps

the largest and most demanding tenants of the

cloud. Whether utilities and their critical func-

tions can be trusted to third-party computer

storage and processing facilities is a troubling ques-

tion. Whether the United States 3,200 utilities canmanage their own computer systems at that level

of data input and integrated operation is an equally

troubling question. And whether such computer-

ized operations can be protected from cyber-attack,

and restored to operation quickly after intrusions, isperhaps the most troubling question of all.

Concomitant with the computerization and

data requirements this technological revolu-

tion is bringing to utilities is a parallel (but less

recognized) expansion of the utilities require-

ments for telecommunication services. As the

electricity industrys ability to sense and control

its operations remotely down to the last water

heater increases, the need to send information

in both directions will demand massive incre-

mental communications capacity. Ideally, much ofthis could take place through wireless radio, but

the radio-wave spectrum is a limited resource of

rapidly increasing value, and an industry that is by

definition completely wired might be thought to

be one with the least priority for precious wire-

less band-width. But broadband over powerline

continues to face technical hurdles, and the utility

industry cannot afford for communications to be

disrupted precisely when power flows are. Thus

the utility industry must participate in the tele-

communications technology revolution as a major

projected customer for its services, in order tocontinue rendering its own services in a fully digital

era. This represents a further massive necessary

investment to be made. Increasingly, electric utility

communications are being appropriately seen as

sharing the same privileged access to wireless spec-

trum as first-responders and emergency workers

in the event of catastrophe, but privileges only go

so far as the available capacity can honor them. It is

also not clear that taxpayers will pony up the costs

of such access in the place of ratepayers.

StorageElectricity has been, from the beginning, a

commodity that had to be consumed as it was

being generated, since it traveled and could not

cost-effectively be stored. That is about to change.

Storage of electricity is now practiced in a few loca-

The utility industry

must participate in

telecommunication

technology revoluti

as a major projecte

customer for its

services.


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T G M F U S20

tions blessed with the topography to pump waterup into reservoirs that offers hydroelectricity on

its way back down. Utilities with customer permis-

sion are also achieving indirect power storage by

dispatching surplus energy to well-insulated water

heaters, curtailing them at peak while the extra-hot

water effectively stores that surplus power.

New approaches, however, appear likely to make

storage of electricity affordable and ubiquitous over

coming years. Already, utility-scale batteries and

super-capacitors are being tested in commercial

utility applications, installed to levelize the genera-tion of variable-output wind-farms, and used to

capture the power of braking trains to boost their

acceleration after a station stop. It seems inevi-

table that one or more of the various large-voltage

battery storage technologies under test and devel-

opment will prove viable over coming years. And

these batteries will compete with compressed-air

storage, flywheels, and possibly other demonstrated

utility-scale options that are working on coming

down the cost curve.

At a smaller scale, however, commercial elec-

tricity storage devices are already being rolled off

automobile assembly lines on a daily basis. The

lithium-ion battery is a proven technology rapidly

penetrating portions of the electricity market that

were thought beyond its wattage only a few years

ago. And rumors of dramatic further improve-

ments in vehicle-battery power density and weight

make them sound imminent. The fact that every

major vehicle manufacturer is creating a line of

battery-electric vehicles is eloquent testimony to

the near-term viability of electricity storage in huge

amounts, albeit divided into thousands of mobileplatforms.

The question is not whether battery-electric

storage will change the utilities own opera-

tions and markets even as it adds a welcome new

transportation load. The question is instead how

thoroughly personal power storage will changeour electricity consuming practices other than for

mobile applications. The answer depends more on

institutional than on technological factors. Vehicle

manufacturers argue that they cannot tolerate their

warranties having to cover the vehicle batterys use

for anything but moving the vehicle. And utilities

are leery of accelerating customer independence

from the grid, and therefore are slow to facilitate

vehicle-to-grid applications. The fact remains

that a full vehicle battery could power most of the

critical functions of a typical residence during at

least a brief outage. One with a portable batterycharger (i.e., a gasoline engine in the vehicle) could

power critical functions for an extended outage. At

some point, it seems inevitable that electric vehicle

batteries will have stationary uses as well, if only for

emergencies.

For utilities themselves, given the increasing

premium on reliability and resiliency in their

mandate to serve the public, it seems likely that

putting storage devices downstream on the custom-

ers side of potential outages would make more

sense than siting large-scale power storage nextto large generators or elsewhere upstream of all

those exposed wires that are implicated in outages.

Putting storage devices into the customers own

applications and premises will not be a big step

from putting them in substations, on utility poles,

or elsewhere on the closest part of the utilitys prop-

erty. It will depend on how the utility can make and

get paid for making the accompanying investments

Called a game-changer, electricity storage will

change the game the electricity industry plays

about as much as putting 11 balls on the fieldwould change the game of soccer. Utilities could

forget the distinctions between baseload, mid-

range, and peaking generators, as the fluctuations

of demand would more economically be matched

by dispatching power from storage, either centrally

or at the point of consumption. Generation could

alled a game-changer,

electricity storage will

change the game

the electricity industry

lays about as much as

putting 11 balls on the

field would change thegame of soccer.


24/59

C D E S 21

rely exclusively on the cheapest means, or, increas-ingly, on the cleanest, because the intermittent

timing of renewable generation could be mitigated

as effectively as the intermittent timing of customer

demand. A struggle might ensue between advo-

cates for 24/7 operation of major nuclear or coal

plants to keep storage batteries and other devices

at full charge, versus advocates for using integrated

storage as the key means of utilizing variable

renewable generation to meet variable load. Even-

tually, the latter perspective is likely to win. The

variable operating costs of the renewable genera-

tors, like those of the storage devices themselves,are likely to verge on zero, while fossil and nuclear

generation may never be able to avoid fuel costs as

well as emissions or waste. Storage is the ultimate

enabler to allow a fully clean power sector.

Decentralization

Even as the utility industry inevitably is drawn into

the modern central systems for telecommunication,

digital information, and control, and as cost-

effective power storage finally emerges to eliminate

time-sensitivity as a critical factor for utility opera-

tors or planners, a third technological revolution isthreatening to flood over the industry and divide

it into small pieces. Insecurity, environmental

impacts, and declining costs are motivating a rush

toward distributed resources, programmable smart

controls, and individual self-sufficiency in power,

which in turn is motivating advances in small-scale

electricity technology. Distributed power will come

from generating resources of various types: fuel

cells, micro-turbines, heat-engines, solar arrays,

small windmills, generators operating on locally

produced biofuels, etc. Distributed resources will

include local controls, inverter technologies, smart

appliances, and the above-described potential for

individual storage. One must add in the potential

for combining electric generation and use with

thermal requirements that can only be served

locally.

Ultimately, decentralization has the potential foran entirely different grid architecture, one centered

on many small and islandable microgrids intercon-

nected with each other and a central backbone grid

for cost and convenience. These microgrids would

be self-controlling, self-sufficient, and potentially

free-standing economically and in load-service

priorities. Microgrids are essentially sub-parts of

the larger grid with automatic sectionalization and

reclosure. This would enable the area to be cut

off from the surrounding system, after which one

can potentially employ independent generation

and load controls to sustain service even when thelarger system is down. As the generation, distribu-

tion, and end-use technologies at the retail level

continue to improve in efficiency and remote

operation, the opportunity to segregate them into

self-sufficient microgrids is becoming attractive

for economic, reliability, and resiliency reasons. In

this case, one can easily imagine that customers of

an economically successful microgrid would argue

that they should avoid sharing in some of the costs

of the central system, causing furth

creative destruction in the energy sector: from disruption to transformation

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