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A Faster Horse: IOUs in the New Energy Economy

April 9, 2019
Samuel Insull’s late-19th century case to create regulated utility franchises is weaker today than it has ever been.

I have had a varied career and I have enjoyed all of it. The different roles have given me a good understanding of many areas. I have met many incredible people who have been dedicated to keeping the lights on. I enjoy visioning and developing early stage project work because they involve thinking more conceptually and not letting the details overwhelm me. Why am I bringing this up? Well, shortly after joining Burns & McDonnell, I was discussing various topics with some colleagues over dinner when one person asked me what I thought of investor-owned utilities (IOU). I thought it was an odd question nonspecific and very open. My glib answer was that I love IOUs because we are working with nearly every top 20 IOU in the country. They help pay our bills and have for a long time. But instead of asking for clarification on the question, I started pontificating about possible interpretations and how I viewed them. Inevitably my thoughts went back to Samuel Insull. I am sure you all know who he was but if you don’t, go and look him up.

Every so often I tend to pull out for discussion the well-worn topic of “natural monopoly characteristics.”  This was almost one of those occasions. I did the same at last year’s Transactive Energy Systems Conference at MIT (check out this year’s conference in Minneapolis in July) because the erosion of these characteristics creates opportunities for market-driven innovation. The five characteristics of a natural monopoly (as described by Posner1) are: (1) capital intensity and minimum economic scale, (2) non-storability with fluctuating demand, (3) locational specificity and locational rents, (4) necessary or essential for the community, and (5) involving direct connection with the customer. It is fascinating to explore the way technical advances are eroding these characteristics for electricity supply.

Our dinner discussion instead focused on a bizarre hypothetical scenario where we had just materialized into the current world but without utilities. What would we do? Would we re-create utilities as we know them today or would we do something different? Or what if all traditional distribution infrastructure vanished? Would we rebuild the same or do something different?

The interesting thing here is not the final conclusion. It is far more fascinating to explore the thought processes of people involved what might they choose to do and why? If you can’t immediately say that we would rebuild things the way they are today, then changes need to be made. But if the reasons can be tied back to changes relating to natural monopoly erosion, then we have a big challenge ahead of us. If not, then the changes you foresee are probably mostly technical.

The impacts we are witnessing result from rapid technical innovation, which in turn causes changes in both consumer and generator behavior. Utilities are caught in the middle. It would be good to delve more deeply into the changes that are happening and the way they are eroding natural monopoly characteristics, but in a short piece like this, it is easier to jump to the conclusion. In short, our thesis is that Samuel Insull’s original, late-19th century case to create regulated utility franchises is weaker today than it has ever been. Does that mean we don’t need utilities anymore?

No, it does not. But what do we need? Henry Ford is famously quoted as saying, “If I had asked people what they wanted, they would have said faster horses.” Samuel Insull did not ask customers what they wanted. Instead he proposed a system of regulation that would allow the industry to grow. One of the roles accepted by utilities is the obligation to serve in return for a monopoly service territory. One of the impacts of technology penetration into the grid is that it highlights the divide between the haves and the have-nots. If large numbers of utility customers decide to go off grid, either on their own or as part of new microgrids, it will be because they can afford to make the investments to do this. As technology becomes more efficient and cheaper, it is easier to do this today than ever before.

The natural monopoly argument is still strong, but it continues to weaken. What does that mean for the obligation to serve, which still exists? It means that the utility would be left with a more and more socially and fiscally biased customer base whose members find it harder to pay their bills. It is relatively easy to find ways to leave the utility if you have the finances to do so, but it is more difficult to serve your customers when more of your costs are spread over a smaller customer base whose members do not have the resources to accept higher costs. So, how does the model need to change? Is it time to ask customers what they want, or should we maintain the status quo and watch carefully as it evolves?

As much as renewable energy and distributed energy resources (DER) continue to grow, we still need shared infrastructure. Does that mean utilities will just own the wires and charge for their use, or will it be more than that? If more, does it include the obligation to serve? If yes, then a suitable business model needs to support utility investment in more networked and resilient distribution grids. Who is going to pay for that?

Natural Monopoly and Its Regulation, Richard A. Posner, Stanford Law Review, 1969

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