This article is a follow-up to “A Faster Horse,” in which I briefly discussed the origin of investor-owned utilities. In that article, I referred to five characteristics of natural monopolies and in this third of five follow-up articles, we take a brief look at another of those characteristics and the impact of current technology developments on it. In this article, I focus on the significance of the location of assets and how this has shaped the industry.
The title of this article is a familiar phrase, often applied in real estate. Whether it is a home or a business, being in the right place is often more important than other considerations. Where there are people there are utilities. We live on the coasts and in the plains. We live on mountains and in valleys. We live in hot climates and in the cold. We live on large landmasses and on islands. If people live in all types of locations, why is location important from a natural monopoly perspective and how is it relevant to the characteristics of a natural monopoly?
The importance of location is a well-understood concept for farming and rural land use: the value of land varies according to the location relative to market centers. The farther you move from your market, the cheaper the land generally becomes. Conversely, it costs more to transport your product to market the farther away you are. In general, the determining factor in determining location rent will be transportation costs. When transportation costs are low, the location rent will be high, and vice versa. This produces a sliding scale along which location rent (income minus expenses) decreases with distance from the market until it becomes uneconomic.
There are many costs associated with moving electricity but the way the industry evolved with centralized generation, infrastructure and losses are two significant costs. Economies of scale plus the desire to keep generation out of population centers led to large remote generators that require transmission to move the electricity to their customers. Robust, heavily networked transmission systems were required because of the fact that, with limited exceptions, it was not possible to store the energy. I have already discussed capitalization and non-storability as characteristics of natural monopolies, but these are also linked to location.
With electricity, losses occur during transmission and distribution. Design decisions need to be made to balance cost and reliability. This creates requirements for placement of some types of equipment and installations at certain locations, thus putting a premium on those locations. Moving these installations and equipment can be very expensive because of the capital-intensive nature of the industry. This can also make it easier (and cheaper) to provide a new service in some areas than in others, but the foundation is remote generation coupled with robust transmission to deliver the power in real time to population centers where electricity is consumed.
I asked in a paper nine years ago whether grid modernization could provide a means to site equipment such that the associated location (transportation and rent) costs would be minimized. While we will need transmission for the foreseeable future, we now have distributed energy resources (DER) to get power to the distribution systems and options to store that energy either at utility/community scale or behind the meter. Locating generation at or near the customer is a disruptive change, so the answer to my question has to be “yes.” Grid modernization opens up opportunities for small-scale distributed generation with limited capital intensity and with the ability to site equipment in smaller sites and in residential areas. We will still need substations, and there will be additional equipment that will need to be deployed on both transmission and distribution circuits. However, there will also be a need for more networked distribution systems to maintain flatter voltages and provide for increased resilience at lower voltages. We will still need large generators and new substations, which will all command location rents appropriate for their required use. But the landscape is changing. It is also placing a burden on utilities to perform many DER interconnection studies.
Grid modernization is not a magic bullet that will fix all of our problems, and DER can create new problems, but it does create the potential to make better use of the resources that we have through better resource coordination and to have more flexibility over equipment siting. Today, generally, we have more flexibility to site generation at more places geographically and at different voltages than ever before. Specifically, this depends on existing infrastructure characteristics but not only are DER located closer to customers, but they also have the potential to create new markets through local coordination with flexible loads. We can only have flexibility over equipment siting if we have a communications infrastructure that can support many different device types and their coordination. This can best be realized with standard protocols based on open standards, so the issue of erosion of location value also has an impact on interoperability requirements if we are to truly realize the benefits of DER.