How Do You Spend $400 Billion? Part IV: A Least Cost Strategy for SG 2.0

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Dom Geraghty

 

Given the high costs and risks associated with SG 2.0, we recommended in Part III that SG 2.0 be implemented based on a “Managed Deployment Strategy”.

What is a Managed Deployment Strategy? It comprises:

(1) Picking SG 2.0 applications that provide the best benefit to cost ratio, prioritized within an affordable budget,

(2) Building-in sufficient flexibility to minimize the impact of major future uncertainties, and

(3) All the while maintaining the target level of service reliability.

That is, our Managed Deployment Strategy combines budgeted high-benefit-to-cost-ratio investment commitments (abbreviated to “Least Cost Strategy”) with a risk management strategy.

In this dialog, we look at the Least Cost Strategy component. In the following dialog we will talk about identifying high-value SG 2.0 applications and evaluating their business cases within the context of a risk-managed, Least Cost Strategy.

Developing a Least Cost Strategy for SG 2.0 Deployment

DSC_1310-150x150It has been estimated in several studies that a national deployment of SG 2.0 would cost about $400 billion and provide a benefit to cost ratio of 3:1, including the value of qualitative benefits (which comprised a substantial portion of the total benefits). The studies assume significant national market penetrations for different SG 2.0 applications.

Some studies of service-area deployments by utilities have been less optimistic about the benefits, suggesting a benefit to cost ratio of approximately 1:1. These studies have included less, or no, qualitative benefits, which could likely account for the lower benefit to cost ratio. These studies also include fairly significant market penetrations for different SG 2.0 applications.

In both the national and the utility cases, the costs of various SG 2.0 applications have been derived from similar data sources. We don’t think that there is a lot of disagreement about the “ball-park” costs of deploying various SG 2.0 applications. However, there is much less consensus about the benefits.

We have suggested that the SG 2.0 costs could be much less than the top-down forecast as a result of the 80%/20% rule, i.e., experience in similar situations indicates that one may be able to obtain perhaps 80% of the benefits of SG 2.0 applications by deploying into about 20% of the power system.

Assuming that this rather convenient rule applies here, we could reduce the investment budget for SG 2.0 deployment substantially below the projected $400 billion above, and yet still derive most of its benefits. We’ll see – it sounds somewhat optimistic, but we do buy into the idea of “surgical” deployment of SG 2.0 applications, i.e., focusing on, and limiting the deployments to, high-benefit situations.

Caveat Emptor!

We’ve received a warning. The original business cases for AMI have proven to date to be weak. The lack of delivery of promised benefits has created skepticism among many stakeholders (including potential investors) as to the worth of the smart grid as a whole. This has led to resistance to the deployment of the “real” smart grid, i.e., SG 2.0, because many incorrectly equate SG 2.0 to AMI.

Will stakeholders grant SG 2.0 a fresh start? Probably, but only if SG 2.0 can stand on its own two feet with respect to the transparent viability of its business cases.

10. DSC_1334-150x150We must carefully show how AMI is completely different in character to SG 2.0 applications, as we’ve done previously in our newly proposed definitions related to the SG. A particularly important differentiation for the purposes of this dialog is that SG 2.0 investments differ from AMI investments in that they can be selectively deployed, whereas 100% deployment of smart meters in AMI systems is the norm.

If we want to be successful going forward with SG 2.0, we have to be more diligent and more realistic with our business cases compared to the business cases that were originally provided to justify AMI systems.

What Is Our Recommended Methodology for Developing a Least Cost Strategy?

This question brings us full circle back to the raison d’etre for us here at SGiX – our mission is to build viable business cases for SG 2.0 applications.

We are facing a situation where up to $2 trillion in capital investment is needed over the next three decades for the power system. Justifying the $2 trillion translates into justifying the business cases of the myriad of investments comprising this total amount. The primary justification criterion we recommend is the economic viability of individual business cases. This is the approach we take here to develop the Least Cost Strategy defined above.

In essence, our Least Cost Strategy consists of two steps:

Step 1: Develop a “Base Business Case” for individual SG 2.0 applications that takes quantitative account of the economic, technological, regulatory, and market aspects of viability. As part of the base case, proactively identify capital conservation opportunities provided by existing assets (see below).

Step 2: Then evaluate the impact of uncertainties on the outcome of the business case by looking at the sensitivity of the outcomes of the Base Business Case to key uncertainties, using scenario analysis.

This approach is exactly equivalent to the due diligence that a venture capital investor (or any professional investor for that matter) conducts before making an investment in a SG 2.0 company. We need to emulate that approach in evaluating individual SG 2.0 applications.

Of course we agree that quantitative outcomes are not the only criteria that affect the real-life viability of SG 2.0 business cases -- getting commitment for an SG 2.0 deployment involves a political process among all of the stakeholders, some with more power than others. In this environment, trade-offs will be negotiated or adjudicated.

DSC_0190-150x150This judicial/advocacy and extra-judicial negotiation process, with its consequent delays, compromises, and litigation, is political in nature. Its outcomes will be highly uncertain. And it will continue through the decades of SG 2.0 deployment.  How do you assess the impact of these uncertainties on the viability of SG 2.0 business cases? We will address this in Part V of our dialog on the risk management aspects of our Managed Deployment Strategy.

Even when we identify SG 2.0 applications that have positive benefits to cost ratios, where do we draw the line for the applications that we will fund? We base our “cut-off” on a multi-year budget, an example of which was presented in Part III of this dialog series.

Some Obvious Capital Conservation Opportunities for Our Least Cost Strategy

A SG 2.0 Least Cost Strategy can conserve capital by leveraging or re-purposing existing assets. There are many under-utilized opportunities to do this, including:

  1. Using existing public communications back-hauls instead of building proprietary private communications systems (the norm for traditional AMI systems, with a couple of notable exceptions, i.e., Silver Spring Networks, and SmartSynch,). The high-band-width telecommunications systems available today are perfectly capable of handling SG applications down to very low latency levels, and they are secure; there is no need to invest in new communications systems
  2. Using, and migrating to, IP-based communication protocols, i.e., universal interoperability, saves integration costs and time -- sorry, we have to say it – like everything else, we are moving towards the “Internet of Everything” (not too dissimilar to 'The Feed' in “The Diamond Age” by Neal Stephenson!)
  3. Where latency and band-width is not an issue, leveraging existing legacy AMI systems to supplement the data requirements of SG 2.0 applications. AMI’s less-than-complete interoperability can be bridged using APIs and overlays of legacy systems. This saves time and costs. Perhaps more importantly, it provides utilities and AMI vendors with the opportunity to deliver additional benefits from existing AMI installations – providing much-needed breathing space for both the vendors and utilities who originally asserted that AMI systems could support SG 2.0 applications
  4. Accessing the capacity of existing and new customer-owned DG/DER, thereby reducing the need to build new centralized capacity
  5. Using the existing power system operating expertise of utilities to manage behind-the-meter DG and SG 2.0 installations – this increases the productivity of the assets and the power system as a whole, improves reliability, and increases safety. We realize that this is a controversial suggestion, but do customers really want to be power system operators?

Is SG 2.0 Simply About Avoided Costs? Well, It’s One Way to Look at It

There are some who point out that we must implement SG 2.0 because the costs without it would be much higher, i.e., we are “avoiding costs” by deploying SG 2.0. They say that bills will be higher if we do nothing, or that doing nothing is more expensive.

From our previous dialog, the “avoided cost” approach that concludes that “doing nothing is more expensive” appears to be true. We define avoided costs as the savings in operating and capital costs from deploying SG 2.0, relative to not deploying it.

These savings are in large part due to the capital expenditure (capex) deferral savings that SG 2.0 deployments begin to generate about, say, 10 years after deployment, against a benchmark of the generation, transmission and distribution system new capacity needs in a non-SG 2.0 environment.

Is “avoided costs” a different methodology to our “Least Cost Strategy” for evaluating the efficacy of the SG? Not really. It is a question of emphasis.

“Avoided costs” tends to look at the SG as a whole from the end-use customer’s perspective and ask the question: “Should we deploy the SG?” It uses the customer’s bill as the criterion for answering this question.

Our Least Cost Strategy assumes that the SG will be deployed in some form and focuses on business cases for individual SG 2.0 applications from a business executive’s or an investor’s perspective. It could also be used to evaluate the Smart Grid as a whole, with the caveats about top-down analyses that we have discussed elsewhere.

There are obviously other potential cost savings created by SG 2.0 besides capex deferrals, although the potential size of capex savings comprises a very material portion of the overall savings.

Some of these other savings should arrive well before any capex savings begin to accrue and, as above, they would not occur without the deployment of SG 2.0. In fact, realizing these short-term savings (e.g., losses reduction, CVR, DR/ADR, Volt/Var management) is a critical part of our Least Cost Strategy.

very light mauve 150x150It is certainly possible (and useful) to simulate the changes in customer bills with and without SG 2.0 applications. A good starting point for this would be the Perfect Power Institute report or the EPRI SG Benefits/Costs report discussed in Part I of this dialog series. This would allow us to quantify the “avoided costs”, and the other benefits of SG 2.0 that would not realize if it isn’t deployed.

The “avoided cost” approach has been used to suggest that it would be economically irrational not to deploy SG 2.0. In our approach, we assume that SG 2.0 applications will be deployed selectively and recommend that the viability of individual business cases be used to make the selections – what we term a “Managed Deployment Strategy”.

Next Dialog -- Part V: A “Managed Deployment Strategy” for SG 2.0

Next time, within the context of our Least Cost Strategy, we will discuss how we can screen and evaluate SG 2.0 applications in order to identify the “Top 20%” high-value SG 2.0 applications; we’ll identify some power system simulation challenges related to quantifying the system benefits of SG 2.0 applications; and we’ll present a risk management approach that can be coupled with our Least Cost Strategy.

As always, comments are welcome and appreciated in the box below.

One thought on “How Do You Spend $400 Billion? Part IV: A Least Cost Strategy for SG 2.0

  1. Bob Wayland

    While I agree that the realized benefits of SG will likely be generated (sorry) predominately by a relatively small proportion of the total investment, I am skeptical that we mere humans will be able to discern in advance which particular components will be responsible. Technology is an evolutionary process and the outcomes are nearly impossible to predict. History is replete with examples of brilliant men disagreeing about the most promising technology. In fact as Nelson and Winter note in their seminal work, An Evolutionary Theory of Economic Change, such diversity of opinion and a willingness to bet on alternative approaches is essential to provide the variety from which evolutionary processes can select those most fit. In his recent book, Rationality in Economics, Nobel Laureate Vernon Smith distinguishes constructivist and ecological reasoning and notes that constructivist (essentially the analytical rational approach) serves well at producing the fodder for the ecological selection process. This leads me, by routes too long and tedious to capture in a short comment, to look for ways to open up and provide more variety for SG options and approaches upon which the environment may select, to loosen the reins in some way. The financial and product innovations in the electricity market could not have been fully anticipated nor could they have been created until the system was opened up. (SmartgridIX is, for example, an effort to open the intellectual dialogue)

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