In Part 1 of this article series, we provided an overview of energy markets and explained how they are impacting utility behavior. We also discussed advances in battery technology. If you haven’t read Part 1, we suggest reading it before this article as it introduces the concepts that are examined in more detail below.
Within this article, we continue our exploration of battery technology and highlight the ways in which it could impact both utility and consumer behavior. We also discuss the consequences if utilities do not implement pricing schemes that send proper price signals to consumers.
Battery Implementation Could Alter Historical Norms
Batteries could represent a dramatic shift for the energy industry. Certain forms of energy storage, such as pumped-storage, have existed in the past for utility use cases, such as load balancing. However, these technologies have not been feasible for the broader market to apply to a wide range of scenarios. Pumped-storage, for example, consists of a massive industrial system that must reside near a large water reservoir or dam. Clearly, this arrangement isn’t feasible at scale. In addition to the logistical difficulties, pumped-storage is only around 70%-80% efficient versus 90%-95% efficient for batteries.
Moving forward, batteries will likely present the first mass scalable storage technology. As batteries begin to gain widescale adoption, it will be the first time in history that electricity doesn’t need to be used at the time of delivery for most consumers. Due to this, consumers stand to have an unprecedented amount of control over the economics of the energy that they use.
Throughout history, energy supply and demand have operated at a virtually constant equilibrium because there was no way to store power to be used at a later time. In other words, the amount of energy supplied was the same amount that was needed and used at any given time.
Since energy has always had to operate in a constant balance, a key component of traditional power generation has been “ramping rates,” which are essentially the amount of time that it takes for power plants to begin producing energy. In general, plants with slow ramping rates, such as coal and nuclear, are called baseload power and have low costs, whereas plants with fast ramping rates, such as natural gas, are called peaking power and have high costs.
All of these traditional forms of power are dispatchable, which means that they can be turned on and off on demand. Fluctuations in supply and demand historically have been handled through this ability to dispatch electricity on demand. However, batteries present a new methodology to meet these needs.
Aside from the ability to balance supply and demand, batteries also provide a benefit to the renewable energy industry. Unlike traditional generation, renewable energy is non-dispatchable and can’t be turned on or off on demand. Due to this, it is likely that as consumers more broadly adopt renewable energy, they will also accompany that adoption with battery technology.
Batteries indirectly provide renewable generators with the ability to dispatch electricity, which has previously been a benefit reserved for traditional generation. This capability coupled with utilities implementing market based pricing schemes referenced previously creates unprecedented financial opportunities for consumers. For the first time, consumers are able to actively manage their electricity usage to minimize their electricity bill through a practice known as grid defection.
What Is Grid Defection, and How Does it Impact Utilities?
Consumers are able to realize utility savings by pairing renewable energy production and battery technology through a practice known as grid defection. Essentially, this means that these consumers will become more self sufficient in their energy usage and rely less on the traditional electricity grid.
There are two types of grid defection - partial & full.
Partial Defection: Partial defection consists of a consumer purchasing their own solar panel(s) (or other renewable generator) as well as a battery, which allows them to generate and subsequently store energy to be used when it is needed. When they are unable to generate enough of their own electricity, they use electricity from the traditional power grid. In certain cases, this is already becoming financially viable.
Full Defection: Full defection is the same as partial defection except consumers also add their own traditional electric generator. This allows consumers to fully remove themselves from the traditional energy grid. When a consumer can’t generate enough power through their renewable system, they make up the difference using the traditional generator. At this time, full grid defection is not financially advantageous.
It is easy to see how this scenario is problematic for utilities. As consumers become less reliant upon utilities and the traditional grid for their energy needs, there is less utility revenue to cover the massive fixed costs needed to run the grid. In order to offset for the declining customer base, it could be necessary to increase rates for the remaining consumers.
The image below outlines this dilemma and illustrates that, in certain instances, partial grid defection is already beneficial to consumers and will be almost uniformly beneficial by 2030. Full grid defection still lags, but is projected to be reasonably equivalent by 2030.
Grid Access Fees Are A Potential Solution
A potential solution to this problem is to implement grid access fees, which would essentially be fees to access the traditional electricity grid. In the past, consumers have generally disliked these types of fees. Since there has never been an alternative to using the electricity grid, access fees have been seen as an unfair sunk cost on top of the money consumers already pay for the electricity they use.
Since access fees have been unpopular with consumers, most utilities don’t utilize them, but as consumers continue to defect and use the grid more as a reliable backup rather than their sole means of energy, access fee models may begin to make sense given that viable alternatives exist.
While batteries present utilities with complications “behind the meter” (at a consumer level), they also present opportunities “in front of the meter” (at a utility level). As we discussed in our article on the evolving energy grid, distributed, renewable generation (microgrid) technologies are becoming increasingly prevalent.
However, as we laid out, these scenarios can present potential issues related to transmission congestion due to the non-dispatchable nature of renewable generation. Batteries help to solve this problem and can allow microgrids to store the energy that they generate so that it can be used or sold back into the grid at a later time. Since batteries can be used to curb transmission congestion, microgrids that generate more power will become increasingly viable. Once again, this has never been possible in the past as too much generation would create congestion.
The ability of microgrids to store their energy to be deployed or used at the best times can dramatically delay the need for utilities to invest in expensive traditional power plants and minimize the risk of unused assets. This is an important opportunity for utilities and is a partial driver of the current movement towards distributed generation.
Batteries & Energy Markets
Clearly, the advent of battery technology will create both beneficial and deleterious effects for utilities, which will inevitably bring about the need for altered business models. One of the immediate ways that utilities have been trying to change is by implementing the tiered pricing approaches that we previously described.
Battery technology allows consumers to time-shift demand for the first time in history. Time shifting demand is essentially using electricity at one time rather than another time. In historical single rate arrangements, there was no benefit for a user to time shift their demand because the price of electricity was constant. However, with tiered pricing and batteries, consumers can charge their batteries when electricity prices are low and then use or sell the stored power when prices are high.
This activity of charging with low prices and selling the energy back into the grid when prices are high is called arbitrage.
Effective Pricing Signals & Mechanics
While arbitrage opportunities from tiered pricing can be great for consumers, there is a risk to utilities as certain tiered structures can send inaccurate price signals, which can lead to increased costs and unprofitable energy usage.
Unfortunately, one of the more common tiered pricing approaches, two-tier rates, is one that can send inaccurate price signals, especially in volatile markets. A two-tier pricing model is essentially an arrangement where electricity has a high price during the day when demand is high and a low price at night when demand is low.
This can create inaccurate price signals because, as we mentioned previously, real-time energy prices can have drastic swings with a magnitude of 10 to 20 times. Due to this, it’s possible for a consumer to generate electricity when it is cheap and sell it back to the utility when it is expensive. This can create a loss for the utility if the real-time price is significantly higher than the upper-tier price that they are passing onto consumers. Since the utilities take a loss in this scenario, it is clear that a two-tier approach doesn’t always convey proper price signals to the consumer.
However, this is not to say that dynamic pricing is a bad concept as a whole. As we explained above, single rate pricing is no longer feasible. Real-time pricing is a dynamic pricing model that does convey accurate price signals to consumers. In real-time pricing, consumers receive hourly updates as to their current price for electricity. The price that consumers receive is based upon the cost to the utility plus a necessary premium.
With real-time pricing, both utilities and consumers win as consumers can still benefit from arbitrage while utilities receive a guaranteed premium. Ultimately, it will likely be necessary for utilities to move toward this in the future in order to avoid the risk of taking losses from consumer arbitrage opportunities.
Why Don’t All Utilities Use Real-Time Pricing?
Many utilities have adopted the two-tier pricing approach for a variety of reasons. One of the main reasons is due to the difficulty of real-time pricing implementation. Traditionally, electricity meters simply haven’t been advanced enough to track prices on such a rapid scale. They simply counted the energy that was used and each month and the utility took the difference from the prior month. It is only in recent years with modern electricity meters and smart meters that real-time tracking and two way communication has become possible.
Additionally, real-time pricing adds an additional layer of work and process management for utilities, which increases their cost structure. Going from two static prices to a new price every hour is simply a task that utilities have never done and figuring out how to do it effectively is a large scale initiative that to date hasn’t been necessary.
Most utilities that have adopted two-tier pricing believe that it generally captures the fluctuations in their cost structure so it is adequate for pricing purposes. However, this line of thinking is really only accurate when taking a historical look at the energy grid. The logic comes apart with a forward looking view that takes into account the opportunities provided by distributed renewable generation and battery technology.
If utilities do not preemptively update their pricing models, they run the risk of significant operational and financial hurdles in the future.
How Anderson Optimization Helps
At Anderson Optimization, we use the latest in optimization research so that we are able to best simulate the energy markets for our customers. These models can help utilities understand how the energy markets will flow allowing them to create better operational plans and analyze opportunities for battery usage as well as other infrastructure implementation.
Additionally, we are able to use these simulations to provide pricing models that utilities can use to implement real-time pricing initiatives. Our simulations can run analysis at a 5-minute interval and provide projected prices, trade offs, pros & cons, etc. This allows utilities to anticipate their cost structure and in turn provide customers with lower prices while still guaranteeing their own profitability even when arbitrage opportunities occur.
Batteries and Future
With the advent of ISOs and an energy industry based upon energy markets as opposed to long-standing, vertically integrated utilities, the energy industry was opened up to allow for new competition, technology, and business models.
As we move further into this relatively new power landscape, utilities are beginning to embrace the new environment and restructure long-standing business models. However, with new opportunities provided by renewable generation, battery technology, and the broader energy marketplace, it will likely be necessary for utilities to undergo even more dramatic business model shifts than we have seen to date.
Battery technology creates new and exciting opportunities for consumers as it allows them to have more control over the economics of their energy usage. Benefits can also be seen for utilities in front of the meter, but unless they update their pricing models to send accurate price signals that better align with real-time energy markets, behind the meter issues will likely create significant difficulty in the future.