Some 60 percent of the U.S. electricity distribution system, which is the part of the grid that covers “the last mile” of delivering power to homes and businesses, is older than its 50-year life expectancy. It was designed when power plants in central locations exclusively controlled a one-way flow of electricity to customers. That is not the world we live in now; a modern system would accommodate greater consumer control and two-way flows of power, facilitating decentralized generation.

Grid Modernization (GM) can have different meanings, but it generally refers to actions making the electricity system more resilient, responsive, and interactive. GM investments digitize a utility’s distribution system to improve operators’ ability to monitor grid conditions, analyze those conditions with software, and take appropriate action in near-real time (e.g., restoring power after an outage). GM has the potential to improve the reliability of the electrical grid, better integrate alternative energy, and enable pricing that reflects the marginal cost of generation.

The U.S. Department of Energy (DOE) identifies five general GM technologies:

  • integrated communications that allow for real-time information and control
  • sensing and measuring technology that enhances rapid system and human responses
  • advanced components such as electricity storage and superconductivity
  • advanced control methods such as voltage optimization
  • improved interfaces and decision support for distribution system managers

These technologies include advanced metering infrastructure and associated communications networks, intelligent grid devices for real-time or near-real-time system information, distribution system hardening projects for circuits and substations designed to reduce service outages or service restoration times, and systems or technologies that enhance or improve distribution system planning capabilities.

Previously in Regulation, Vanderbilt law professor Jim Rossi described state regulation that is stifling the development of new cost-effective long-distance transmission lines, which are what deliver electricity from far-away generators to the local distribution systems. (See “Promoting Cost-Effective Grid Modernization,” Winter 2022–2023.) In this article I examine a very different problem: state regulations that promote the modernization of local distribution systems with little regard for costs.

The GM coalition / Proponents of GM vastly outnumber both skeptics and opponents. Proponents include utilities themselves, environmentalists, GM technology vendors, consultants, labor unions, and state and federal politicians and bureaucrats.

Environmentalists and some utilities, for example, view GM as necessary to satisfy “net zero emissions” aspirations. An example of this comes from a statement by the Union of Concerned Scientists:

Grid modernization can deliver greater quantities of zero- to low-carbon electricity reliably and securely, including handling variable renewables like wind and solar power. It can support the electric vehicle revolution and increase grid resilience to withstand climate impacts. It can spread economic opportunity in rural and urban communities through electricity and transportation infrastructure investment and upgrades. And, it can improve system efficiencies and reduce costs by reducing the need for expensive and dirty power plants that only run a few hours per year.

The federal government has subsidized GM and encouraged its development. The 2001 Infrastructure Investment and Jobs Act will provide more than $65 billion for upgrading the grid. The DOE has established the Grid Modernization Initiative to help “create the modern grid of the future.”

In my home state of New Mexico, the Grid Modernization Statute authorizes the state’s public utility commission (PUC) to approve distribution GM projects. In evaluating utility-proposed projects, the commission must consider the reasonableness of the project and whether it would advance certain objectives like a reduction in greenhouse gases, facilitation of grid access for renewable and other forms of clean energy, and improved reliability and resilience. Other states have comparable statutes to encourage electric utilities to modernize their distribution systems.

Evaluation of GM / During my career in public utility regulatory economics, I have too often seen utility customers pay for the advancement of political objectives without their receiving compensatory benefits. Are we repeating this for GM investments? Or as one reviewer of this article expressed, “Is GM just another way to line utility pockets and promote renewable energy and kill fossil fuels”? While this view seems extreme, it may be close to the truth. Although special interest support for GM does not inexorably imply that GM has costs that exceed benefits, PUCs should be wary because utility customers will ultimately pay the costs.

PUCs should ask themselves two critical questions:

  • Do the total benefits from GM to utility customers exceed the costs?
  • Will poor households overpay while wealthy households disproportionally benefit from their purchase of electric vehicles and roof-top solar systems that GM tries to accommodate?

Consider the until-recently darling of both environmentalists and the upper class: the Tesla automobile. To be sure, it is a technological marvel. But given its cost and limitations, is it really the right vehicle choice for nearly everyone, or is it just a good choice for households with incomes high enough to afford both a Tesla and a conventional vehicle? If the latter, then it is difficult to justify raising electricity rates on middle- and lower-income households to finance grid improvements to help upper-class households charge their second (or third) car.

There is great uncertainty about the benefits and costs of GM investments. Cost overruns are common, and benefits are difficult to quantify and require different methods of varying complexities. According to the Lawrence Berkeley National Laboratory:

For jurisdictional utilities, grid modernization plans pose some new and complex challenges for state public utility commissions in determining whether projects will provide net benefits to customers. Plans typically include multiple grid modernization components that have interactive effects and are difficult to analyze or justify separately. Many benefits are hard to quantify or monetize, making it difficult to compare all benefits and costs. Part of the rationale for some grid modernization investments is to meet state energy goals, which can be difficult to quantify and account for in [cost–benefit analysis]. Equity issues arise when investments may benefit some types of customers more than others.

Under traditional regulation, utilities are allowed a return on capital expenditures only after the regulator has deemed the investments prudent or reasonable. But utilities and environmentalists have argued for, and regulators have accepted, new cost-recovery approaches for certain environmental investments. Wall Street has also supported these new approaches, forming an “Iron Triangle” of influential special interests that makes it difficult for PUCs to reject the proposals.

One popular approach is the increased use of “riders” or “trackers” that allow for cost recovery outside of the general utility regulatory framework. The greater the use of such exceptions, the lower the risk to utility shareholders from imprudent investment behavior, and the less shareholders monitor utility investments. Utilities protected from such consequences are more likely to invest prematurely, unnecessarily, or incorrectly when the consequences of such decisions fall on customers. Using GM as a justification, a utility can significantly expand its rate base to increase its profits while passing on most if not all risks to customers. This reallocates risk from diversified utility shareholders to utility customers even though the shareholders can bear risk at a lower cost than utility customers who cannot diversify across monopoly electricity-distribution providers.

GM investments are modular: a utility can spread out components over several years. Waiting to invest creates what analysts call an option value. Real options theory says that when the future is uncertain, it pays to have a broad range of options available and to maintain the flexibility to exercise those options. Stepwise investments over several years, as suggested by real options theory, may represent a more reasonable and cost-effective strategy than massive short-term investments that PUCs are under political pressure to approve and utilities and other groups favor. For example, a utility could create a long-term grid modernization plan with annual short-term action plans.

Utilities should be held accountable for subpar performance from GM investments. These investments have often fallen short of achieving the benefits included in utilities’ proposed plans and have raised other concerns.

For example, there is evidence that reliability has not improved in states that have so far invested the most in GM. Critics have also questioned whether it is too soon to replace the current infrastructure. It may be cheaper to do incremental modifications than to leave costly current infrastructure stranded. Another criticism is that many customers receive few benefits from GM, especially low-income households. Advanced metering infrastructure (AMI) has in some jurisdictions failed to live up to its promise to realize dispatch efficiencies and cost savings. Most utilities have also under-exploited the benefits of AMI by failing to launch granular time-of-use rates (e.g., real-time pricing, electric vehicle charging rates) that could produce large efficiency gains. Another problem recognized by PUCs is utilities proposing to make large-scale, multi-technology investments, some of which have questionable, ill-defined benefits that may not emerge for several years, if at all.

Since GM plans are extremely expensive (in some instances over a billion dollars), regulators should demand that utilities demonstrate the benefits to customers from improved performance attributable to the capital expenditures recovered from those customers. Regulators can establish performance benchmarks to evaluate a utility and take appropriate action. Without accountability, a utility can perform poorly and still recover all its GM costs—an outcome that shifts all the risk of poor performance to customers.

Conclusion / Evaluating utility GM plans could be the most important task that PUCs will face in the coming years. My advice to them: judiciously review utilities’ plans, which will improve the likelihood that a decision is in the public interest and not just beneficial to special interests. Experience shows that utilities have a propensity to over-promise and under-perform.

Of course, PUCs should not reject a GM plan just because it would require an increase in electricity rates. But, likewise, they should not accept a plan just because it would support clean energy and the state’s energy agenda (which is one reason that PUCs have articulated), while ignoring the effect on utility customers. Instead, PUCs should approve GM plans that have net benefits for utility customers and for the state as a whole. Unaccountability in the form of moral hazard can have a devastating effect. Getting the incentives right is the key element for achieving socially desirable GM investments.

Readings

  • “Alternative Ratemaking in the US: A Prerequisite for Grid Modernization or an Unwarranted Shift of Risk to Customers?” by Paul Alvarez, et al. Electricity Journal 35(9): 107200 (2022).
  • Benefit-Cost Analysis for Utility-Facing Grid Modernization Investments: Trends, Challenges, and Considerations, by Tim Woolf, et al. Report prepared for the Grid Modernization Laboratory Consortium, U.S. Department of Energy, February 2021.
  • “Duke, SCE, Other Grid Modernization Proposals Faced Big Cost Questions, More Regulatory Scrutiny in 2021,” by Herman K. Trabish. Utility Dive, January 4, 2022.
  • The 50 States of Grid Modernization: Q3 2022 Quarterly Report, by North Carolina Clean Energy Technology Center. October 2022.
  • Investing in a Modern Electric Grid for New Mexico, by Gridworks. Report prepared for the New Mexico Public Regulation Commission, September 2022.
  • Investment under Uncertainty, by Avinash K. Dixon and Robert S. Pindyck. Princeton University Press, 1994.
  • Modernizing the Electric Grid: State Role and Policy Options, by Glen Anderson, et al. Report prepared by the National Conference of State Legislatures, November 2019.
  • “Rate of Return Regulation Revisited,” by Karl Dunkle Werner and Stephen Jarvis. Energy Institute at Hass Working Paper no. 329, September 2022.
  • Regulatory Incentives and Disincentives for Utility Investments in Grid Modernization, by Steve Kihm, Janice Beecher, and Ronald Lehr. Report prepared for the Lawrence Berkeley National Laboratory, May 2017.