State of the Smart Grid – BizCase Challenges

Definition of the Smart Grid

Our definition of the electric smart grid: The smart grid overlays, automates, and controls the entire electric power system including production, transmission, distribution, and end-use of electricity.

Smart Grid 1.0 is mostly concerned with deploying the communications, controls, and metering infrastructure of the smart grid. Smart Grid 2.0 will focus on the value-added applications that overlay intelligence on top of the infrastructure of Smart Grid 1.0. To date, the vast majority of investmenst in the smart grid have been for Smart Grid 1.0 infrastructure.

Performance to Date of Smart Grid 1.0

The performance of smart grid businesses in the electricity sector and smart grid infrastructure investments to date has been disappointing, for the most part. In particular, the lack of delivery of promised benefits has disappointed customers, regulators, and investors. Market barriers have been underestimated or unanticipated.

Business cases that hoped for, or promoted, regulatory policy change simply confirmed the viscosity of the process. Those smart grid investments that depended on subsidies were at the mercy of the vagaries of politics. The American Recovery and Reinvestment Act of 2009 (ARRA), through its awards of major grants to some smart grid infrastructure investments provided an ephemeral boost to the market only to create a vacuum after it ended.

The root cause of this sub-par performance has been the over-optimistic and incomplete business cases that were used to justify the initial investments, and the lack of differentiation between infrastructure investments and investments in value-added applications.

Several independent surveys confirm much of the above and provide interesting perspectives as to which factors are considered to have been the most detrimental to the market. For example, the West Monroe Partners LLC survey in June 2012 found that there was a lack of a solid smart grid business case in 66% of this survey respondents.

Of course, the economic recession did not help.

Investors Have Turned Bearish

It was not so long ago that investors, from VCs to private equity to institutionals, were very bullish about the smart grid. But they’ve gradually turned bearish as they watch formerly intriguing companies struggle for growth, profitability, and sometimes liquidity. Notable disappointments include (but certainly are not limited to) Elster, Sensus, Beacon, Echelon, and Silver Spring Networks, Current Group, Comverge, the City of Boulder’s “Smart City” – not to pick on just these few companies – I’m sure you can all add your own examples.

Anecdotally, what have we heard? Venture capital investors (VCs) have become wary of investments in the smart grid because of the poor track record of incumbents, the growing acceptance that the sales cycle of utilities is lengthy and much longer than the VC investment cycle, and increasing recognition that the payback period of the majority of smart grid investments is long.

It should be said that many of the VCs that invested in the smart grid had never invested previously in the energy/electricity sector, so it was to be expected that mistakes would be made. But even VCs experienced in the workings of the electricity sector didn’t do all that well either. Quick learners, VCs are now mostly limiting their investments in smart grid opportunities to low capital requirement, early-revenue-generating, software and services companies that better match their investment cycle.

How Do We Take Advantage of the Large Smart Grid 2.0 Opportunity?

Still, the opportunity remains large, and the need great – we do need to replace aging infrastructure and modernize the critical infrastructure of our power system.

So, we need to re-calibrate our business models (and our expectations!)

We’ll first discuss the main factors that negatively affected the outcomes of smart grid initiatives. And we’ll wind up with some of the positives going forward, and some realism.

Market Factors Affecting the Smart Grid

Before asking the smart grid community to embark upon a major re-design of business cases associated with smart grid opportunities, SGX decided that it was important to carefully research, categorize and document the primary factors contributing to the disappointing performance of Smart Grid 1.0 investments to date. Here is what we’ve found:

  • Utilities are conservative (for good reasons), have tremendous influence over the sales cycle, and exhibit with the following behavioral characteristics (as they have always!):
    • Slow decision-making
    • “Pilotitis” – deceptively easy “wins” to test new technology followed by repetitive testing using pilot demonstrations, delaying implementation of complete systems
    • Slow sales cycle involving request for proposal processes
    • Desire to control all things electric
    • Monopolistic in terms of protecting existing revenues
    • Legitimate concerns about technology risks when being measured on the basis of service reliability
    • Concern about their evident failure to deliver promised benefits
    • Less-than-stellar marketing to their customers

     

  • Regulators operate within a political (intervenors) and legal (docketed) process, resulting in the following:
    • Slow pace of evolution of policy/tariff/rule changes
    • Slow rate-case processes
    • Utilities favoring capital accumulation (i.e., the Averch-Johnson effect)
    • Allocation of costs is not always commensurate with the derivation of benefits
    • Lack of tariffs necessary to incentivize more efficient behavior
    • The need to deal with a hybrid wholesale competitive market/regulated retail market that can distort economic behavior
    • Acceptance of less-than-perfect business cases in support of very large rate increases
    • Sharp increases in electricity bills
    • Strong pressures from consumer advocates as promised benefits are not delivered
  • Venture-type investors are concluding that many of the Smart Grid 1.0 investment opportunities, while very attractive in the long haul, will not provide the nearer-term returns their limited partners demand – this has led to a shortage of risk capital
    • Long pay-back periods and 15-year assets not in consonance with VCs shorter investment cycles
    • Electricity infrastructure is capital intensive and many smart grid opportunities require very large sums of capital
    • Profitability difficult to achieve
    • Misgivings are being confirmed by the poor financial performance or even highly visible failures of earlier smart grid investments
    • Concern about the dependence on subsidies, the continuing existence of which is uncertain due to unpredictable political processes
    • Deep questioning of business models presented by entrepreneurs in investor presentations
  • Customers are frustrated and resistance is hardening as a result of the unfulfilled promises of the smart grid, based on:
    • Promised benefits are not observable
    • Bills continue to increase
    • Cost overruns, e.g., Smart City Boulder @ $2,000/customer (original target: $500/customer)
    • Privacy concerns about metering and personal behavior data
    • Health concerns related to possible radiation emanating from radios in meters
    • Information overload related to energy use management resulting in a lack of understanding and the creation of confusion
    • Distrust of their utilities and regulators
  • Technology performance and costs that were forecast have not materialized
    • Smart grid technology is expensive, and thus payback times based on operating cost savings and capital investment deferrals are long; some of the new technology is not economically competitive with traditional technology
    • Much of the deployed technology was untested/unproven
    • Performance was over-promised
    • Technology cost reductions were not achieved
    • Difficulties were encountered in ensuring technical fidelity in the context of system complexity
    • Future-proofing flexibility that was supposed to have been built-in has not been realized – witness the discussion today about AMI 2.0, and Smart Grid 2.0
    • Solutions to inter-operability of legacy and disparate systems have progressed, but there is still a long way to go
    • Large vendors control much of the market, and often dictate what technology is used
  • Competition from traditional sources of power at the wholesale and end-use level
    • Natural gas prices are much lower due to the new sediment-fracturing technology, and are expected to remain low
  • A world-wide economic recession lasting for about the past five years

Some Market Barriers Are Being Reduced And Positive Trends Exist

There are some positive trends that offset the historical factors above and could accelerate the market for smart grid applications:

  • Technology risk is decreasing as more experience is gained
  • Some cost savings are being realized from automation and from volume manufacturing, and these are expected to rise
  • As automation increases, there is an increase in electricity service reliability, e.g., outage management systems
  • Cyber-security is a driver to modernize the control systems of the grid and eliminate or protect the large number of existing legacy systems
  • The analog world is inevitably shifting to digital
  • ISO protocols are being improved continuously, enabling wholesale players to take advantage of the “big data” and automation that the smart grid delivers

What Can We Do To Improve the Business Cases for Smart Grid 2.0?

As we move into the future, what should we be doing to improve our business case?

  • Take advantage of the abundant operational information that is being generated
  • Apply stricter quality-control to the information we use
  • Standardize our analyses
  • Distinguish among "enabling" infrastructure investments and value-added "smart" applications
  • Define and calculate the complete benefits stack generated by smart grid opportunities, particularly the hard-to-estimate power system benefits

Some Market Factors Won't Change Much

We need to admit to ourselves that some things will never change, and take proper account of them in our business cases; take a dose of realism:

  • The pace of utility decision-making will not increase
  • A fundamental business transformation to a smart-grid-based operation by utilities will take many years
  • The ability of regulated utilities to market new technologies will remain challenged
  • There will be economic cycles

We Can Act Proactively To Create Better Market Conditions

And it makes sense to develop a strategy for changing difficult-to-change but universally beneficial factors, such as

  • Regulations that support better use of resources and fairly allocate the costs and benefits of smart grid system deployments
  • Incentives that change the traditional behavior of utilities
  • Customer behavior and understanding

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