Framework for the future

The Electric Power Research Institute (EPRI) carried out a series of regional workshops to develop a report detailing the Electricity Sector Framework for the Future (ESFF) in the USA. A broad cross-section of stakeholders were involved, including representatives from business, labour unions, government and consumer and environmental organisations.

This produced a vision of a transformed electricity sector. In general terms, the vision is one of a reliable, affordable, environmentally friendly power system that provides essential public services and supports the economic aspirations of all customers. It embraces regional and ownership diversity and supports an economic framework of efficient, transparent electricity markets. The key issues

limiting the achievement of this transformation are the depressed financial health of the sector and the continuing jurisdictional confusion in regulation.

The past as prologue

Historically, development of the electricity industry was dominated by the quest for lower commodity costs. During the first 70 years of the 20th century, this quest for lower costs was consistently successful as rapid demand growth, coupled with economy-of-scale advances in both production and delivery technology, led to electricity cost reductions that averaged 20% per decade. During this period, the electricity industry became a franchised, vertically-integrated monopoly enterprise, regulated to assure the essential balance between owner and consumer. The obligation to serve resulted in a high level of investment and a consequent standard of performance that made electricity a highly dependable, low-cost product.

By 1970, the extended period of declining cost came to an end. Diminishing economy-of-scale returns

coupled with slower demand growth, higher fuel costs and rising environmental requirements converged to challenge the traditional declining cost commodity business model and structure of the electric utility industry.

In the past 30 years, electricity has become increasingly politicised as an essential retail entitlement where market price volatility is effectively allowed to operate in only one direction ­ downward, often at the expense of longer-term value. This combination of rising supply cost and artificially constrained price creates a cost vice on electricity that is steadily tightening. As a result, there is growing concern that the electricity sector's ageing infrastructure, workforce and institutions are losing touch with the needs and opportunities of the 21st century.

This threat results from the financial imperative to contain immediate costs at the expense of infrastructure development and investment. While the obligation to serve remains, the incentives to build the means to serve have declined. For example, the capital expenditures of the electricity sector, both regulated and deregulated, as a fraction of its electricity

revenues over the 1990s was about 12%, less than one-half of its historic minimum levels.

The investment gap, reinforced

by the regulatory uncertainty of electricity restructuring, is exacting a

significant reliability cost.

Current problems

Electricity service is a very capital- and technology-intensive, politically constrained enterprise. Since the open access order in 1992, the institutional structure for the sector has been dismantled, but it has not been replaced by an alternative structure with

coherent institutions and rules. The investor-owned utilities are operating under an inconsistent and conflicting set of regulations. The public power sector, while relatively stable, is now also being impacted by the ripple effects of restructuring. Market reforms have resulted in rules that differ from state to state, and in many cases, from utility to utility within a state. At the federal level, open access has been mandated but without clear direction on how it is to be implemented.

The convergence of several issues has caused turmoil in the business aspects of the sector. Wholesale markets are increasingly thwarted by the inability of an ageing US power delivery system to support transactions. Further expansion of retail deregulation has essentially come to a stop. Credit markets have shut out nearly all high-risk merchant energy companies.

There is a 'trilemma' of economics, politics and technology that circumscribes the development of the sector. All three must be synchronised to meet stakeholder needs. The disappointing results from restructuring policies can be traced to their failure to address and resolve the trilemma. The US electricity supply network is very complex, with some 5000 corporate entities, with multiple forms of ownership and levels of regulatory oversight, serving 130 million customers, that must

function at all times with absolutely balanced supply and demand, while simultaneously trying to satisfy often conflicting economic, social, political and environmental objectives.

Pathway forward

There is no universal solution to the trilemma. It appears that the only effective way forward is for all stakeholders to find the means to move at the same time as a matter of overriding mutual self-interest and the imperative of national security and prosperity. The solution depends on establishing a sustainable balance among the three dimensions of the trilemma such that costs and benefits are equitably shared.

Fortunately, there is flexibility in the pathway forward, allowing regional and sector experimentation with different market models. There are several routes between the boundary conditions

characterised by reliance on either regulation or market forces. A blend of

regulation and market forces will be the most effective transition pathway.

This is reflected in legislative and regulatory decisions that tend to retain regulation on the 'wires', while extending competition in varying degrees to the 'energy' side. Maintaining a combination of regulation and competition requires resolution of several difficult problems, such as:

• The boundary between regulated and competitive activities.

• Redesigning regulation from setting

  electricity price to just setting the price of regulated activities.

• Managing dealings and organisations that cross the regulated/

competitive boundary.

• Determining how regulated and competitive entities cooperate to satisfy the obligation to serve.

The lack of consistency and predictability in resolving these issues is at the heart of a liquidity crunch paralysing much of the sector. Stakeholders have urged that the costs of service responsibilities should be recovered from consumers, and not the taxpayer. However, there is general support for the need to stimulate greater capital investment through government incentives. Such support may include improved tax treatment of dividends, investment tax credits, shorter depreciable lives for tax purposes on new infrastructure investments, and infrastructure lending programmes.

The 21st Century

transformation

Stakeholders generally expect that the various pathways into the future will converge. The 21st century transformation depends on developing and deploying innovations that enable: digital control of the power delivery network; integrated electricity and communications for the user; transformation of the meter into a two-way energy/information portal; integration of distributed energy resources into the network; and robust advanced power generation portfolio.

The transformation will also accelerate end-use energy efficiency and

environmental protection. New consumer-based technology will enable greater empowerment of the consumer, opening the door to new,

innovative service combinations emphasising speed, convenience and comfort. A smart, self-healing power delivery system becomes the conduit for greater use of productivity-enhancing digital technology by all sectors of the economy, leading to accelerated productivity growth rates.

The advantages of transforming the electricity/information infrastructure include: enabling significantly increased productivity and GDP growth rates; improving energy

efficiency; accelerating the rate of

reduction in carbon emissions; improving security of the power system; achieving greater electricity system functionality and consumer value; and reducing total costs of infrastructure system upgrades and expansion.

However, achieving these benefits will require accelerated investment. The pressures of cost containment have stifled and deferred needed infrastructure investment in the electricity sector for at least two decades. This investment deficit is now about $20 billion per year, and must be accounted for over and above the depressed investment levels of the 1990s if 21st century service demands are to be met.

Each consumer would save about $500 per year in the cost of goods and services in exchange for an infrastructure renewal charge of less than $100 added to the annual residential electricity bill. In addition, the investment in smart electricity infrastructure will enable several thousand dollars per year in additional personal income growth.

However, as long as consumer involvement is limited to the on-off switch and to time-of-day pricing, the obsolete 'declining-cost commodity paradigm' will dominate and require counterproductive retail regulation to protect a relatively weak consumer from cost-constrained suppliers. The 21st century transformation places the focus on increasing the functionality and value of electricity, rather than simply reducing its cost. The key instrument becomes the ability to access a growing array of consumer-based electricity/ information services whose value to consumers, society and suppliers far outstrips the costs of transformation.

Framework for action

To be successful, the 21st century transformation must consider diverse stakeholder concerns. To help achieve this, EPRI proposed a five-part 'framework for action'. The five 'high-level' goals were seen as fundamental to any progress in the electricity sector. The framework for action is a tool to stimulate broader stakeholder discussion and provide a nucleus around which diverse stakeholder interests can logically coalesce.

Stabilise electricity markets

Nothing can progress until the financial health of the electricity industry is stabilised, and clarity over the rules, roles and responsibilities of electricity regulation is re-established. This is a problem that must be resolved not by Congressional action, but by agreement among the institutions and

interests most impacted by industry change. The main aims should be to:

• Develop a new public/private

electricity partnership to lower investment and market risks.

• Incorporate regional differences and lessons learned into market rules.

• Resolve uncertainty in federal/state regulatory roles, authority and responsibilities.

• Achieve independent transmission operations.

• Regionalise integrated resource coordination and development.

• Create effective markets.

• Standardise and ensure transparency in electricity trading practices.

Provide for the public good

The marketplace offers no incentives for many aspects of the public good that electricity provides; other provisions must be made to ensure the availability of 'public-good' services in the transformed marketplace. This means

separating public-good regulation from economic regulation for investor-owned utilities. Finding a realistic solution to the question of public and private responsibilities is essential to creating effective markets for all participants.

Protect the environment

The environmental impacts are a challenge for the nation. In addition, the electricity sector remains subject to an uncertain array of new regulations for air quality, water quality, land use and restoration. At the same time, a transformed electricity sector can provide the solution to many environmental issues. It will be important to address the following

environmental requirements to enable real solution opportunities:

• Ensure that the commitment to environmental protection remains integral to all electricity sector operations, planning and investment.

• Provide incentives to promote the most efficient solutions.

• Increase R&D for technologies that result in reduced emissions.

Educate the customer

Until consumers become full partners in the electricity marketplace, the need to protect them will continue to foster the notion of entitlement and distort marketplace dynamics, regulation, and the efficient use of energy and capital resources. Once provisions for the public good are clearly defined and established, consumer economic protection can be reduced, while consumer services and choice are allowed to flourish. The result will be an expanding array of electricity-based services that will transform consumer benefits.

Unleash innovation

In contrast to the current investment climate, prospects for new technology have never been brighter. Technology stands poised to transform the

physical operation and functional capability of the electricity system to meet the complexity and pace of competitive markets, to bring it fully into the digital age, to enhance reliability, resilience and security, and to enable a cleaner and more diverse power generation portfolio. Without technical transformation, today's power system risks losing its viability as the foundation for economic prosperity and

quality of life. New policies are needed to transform the electricity system and serve the growing demands of society and the economy.

Where do we go from here?

Stakeholders suggested there were a number of actions required to develop the electricity sector. The dominant view was that leadership for most of these actions rests with the electricity industry itself.

General

The industry must develop a unified industry leadership vision and

commitment that electricity, through innovative technology, has a service value greater than its traditional basic commodity value.

It must also establish a mission statement to enthuse the public for the vision. A national forum should be convened to facilitate this initiative.

There is a need to expand the ESFF stakeholder outreach and education initiative to strengthen industry credibility, build trust and gain broad public and political support for the sector vision and the required actions.

Finally, it must independently validate the benefits of electricity sector transformation and costs of maintaining the status quo.

Transmission/wholesale markets

The transmission service is the most likely 'first point of meltdown', resulting from the lack of infrastructure investment incentives.

There is a need to promptly resolve the counterproductive debate between national and state regulation. This continues to delay progress.

Grid managers must have enough resources and access to energy, consistent with competitive markets, to

maintain reliability, keep loads balanced, and improve grid control. They must also have the authority to allocate

system upgrade costs efficiently and equitably among system users.

There needs to be a national public/private commitment to transform the transmission system into a smart, self-healing network.

Distribution and retail markets

A consistent set of guidelines are required to evaluate, communicate and act on knowledge gained from the various state restructuring experiments.

An up-to-date design methodology that encourages efficient and equitable allocation of risk and reward sharing among customers, investors and society in restructured, liberalised markets is required.

The USA needs to develop an enlightened state regulatory model to stimulate infrastructure investment while protecting the interests of the various stakeholders. It also needs to demonstrate the innovations that will transform the power supply system in a variety of local, state and regional situations. This will both accelerate confidence and acceptance, and tangibly show the functional benefits and cost savings that advanced technology can achieve.