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CREATIVE DESTRUCTION IN THE ENERGY SECTOR PAPER SERIES 2014
CREATIVE DESTRUCTION IN THE ENERGY SECTOR
From Disruption to Transformation
GUILLAUME XAVIER-BENDER
IAN MUIR
ALBERT BRAVO BIOSCA
JOHN W. JIMISON
GERARD REID
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2014 Te German Marshall Fund o the United States. All rights reserved.
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rom the German Marshall Fund o the United States (GMF). Please direct inquiries to:
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copies are also available. o request a copy, send an e-mail to [email protected].
About the Creative Destruction in the Energy Sector Paper Series
Te Creative Destruction in the Energy Sector paper series presents timely policy analysis on emerging trends reshaping
traditional dynamics in the energy sector including how innovations outside the sector, such as telecommunications or
inormation technology, could transorm existing systems. Te paper series is conducted in close collaboration with GMFs
Energy ransition Forum (EF), which was created in 2012 to provide a regular venue or open, structured, and act-based
dialogue among senior leaders rom the private and public sectors in the United States and Europe about the market condi-tions and policy rameworks needed or a timely transition to a secure, affordable, and low-carbon energy uture. EFs
intention is to bring together a coalition o leaders to produce new thinking on how to address the key challenges acing the
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is to create and distribute value in the international energy market, to the benefit o their customers needs, their sharehold-
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Te GMF Paper Series presents research on a variety o transatlantic topics by staff, ellows, and partners o the German
Marshall Fund o the United States. Te views expressed here are those o the author and do not necessarily represent the
views o GMF. Comments rom readers are welcome; reply to the mailing address above or by e-mail to [email protected].
About GMF
Te German Marshall Fund o the United States(GMF) strengthens transatlantic cooperation on regional, national, and
global challenges and opportunities in the spirit o the Marshall Plan. GMF does this by supporting individuals and institu-tions working in the transatlantic sphere, by convening leaders and members o the policy and business communities,
by contributing research and analysis on transatlantic topics, and by providing exchange opportunities to oster renewed
commitment to the transatlantic relationship. In addition, GMF supports a number o initiatives to strengthen democra-
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Marshall Plan assistance, GMF maintains a strong presence on both sides o the Atlantic. In addition to its headquarters in
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smaller representations in Bratislava, urin, and Stockholm.
On the cover: ransmission lines and turbines. BE/istockphoto
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C D E S
F D T
C E P P S
M
Guillaume Xavier-Bender,1Ian Muir,2Albert Bravo Biosca,3
John W. Jimison,4and Gerard Reid5
1 Guillaume Xavier-Bender is a program officer in the Brussels Office of the German Marshall Fund of the United States.
2 Ian Muir is a fellow for GMFs Energy & Society Program. He holds a bachelors in chemistry from Trinity College, Dublin,and is currently pursuing a masters in international relations from the Johns Hopkins School of Advanced InternationalStudies.
3 Albert Bravo Biosca is a senior economist at NESTA, which he joined in 2007. He holds a Ph.D. in economics at HarvardUniversity, a masters in economics from the London School of Economics, and a bachelors in economics from PompeuFabra University in Barcelona, Spain.
4 John W. Jimison is the managing director of the Energy Future Coalition. Prior to joining the Energy Future Coalition in2011, he served as senior counsel to the Energy and Commerce Committee of the U.S. House of Representatives. Jimisonpracticed energy and regulatory law from 1987 through 2006 in Federal and state forums.
5 Gerard Reid is the founder and managing director of Alexa Capital, a firm that provides advisory and financial solutions inenergy, energy infrastructure, and technology sectors. He holds a higher diploma in education and a masters in business &economics from Trinity College, Dublin.
Preliminary Findings and RecommendationsGuillaume Xavier-Bender . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Workshop on Creative Destruction in the Energy Sector: SummaryIan Muir . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Creative Destruction and Innovation: Views from Outside the Energy SectorAlbert Bravo-Biosca . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
A Changing Future for U.S. Electric UtilitiesJohn Jimison . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Appendix: Financing the Energy RevolutionGerard Reid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
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C D E S 1
The German Marshall Fund of the UnitedStates is publishing the preliminary find-
ings of its project on Creative Destruction in
the Energy Sector. The project examines, through
convening and analysis, the disruptive effect of
innovation on the energy sector, particularly
focusing on the electricity sector.
In the fall of 2013, GMFs Brussels office hosted a
half-day workshop bringing together a group of
experts from the private sector, EU institutions,
member states, and non-governmental organiza-
tions from the United States and Europe. To informthe discussion, input papers were commissioned by
Albert Bravo-Biosca, senior economist at NESTA;
John W. Jimison, managing director of the Energy
Future Coalition; and Gerard Reid, head of Euro-
pean operations at Alexa Capital. Miriam Maes,
non-resident senior fellow at GMF, chaired the
meeting, which focused on the growing pressures
facing utilities as innovation disrupts their tradi-
tional business models, and the new opportunities
that could potentially emerge.
In his summary of the workshop, Ian Muir, non-
resident fellow at GMF, highlights the disruptions
of traditional utility business models by non-energy
players. Additional dialogue between all key actors
is required to ensure smooth transformation of
the power sector. John Jimison examines market
trends and technical innovations that are destined
to reshape the operations of the U.S. electric utility
sector and its institutions, anticipating major
change in a service integrated into every element
of modern life. In his paper, Albert Bravo-Biosca
explains why the process of creative destruction is
so important; particularities to the electric powersector and externalities such as technological
advances suggest it may be at the early stages of
transformation. Gerard Reid looks at the tech-
nology-driven ongoing energy revolution with a
particular emphasis on the impact of that revolu-
tion on investors and the power markets.
P F
R
G X-B
1
Complimentary discussions took place in Warsawin November 2013, on the official sidelines of the
United Nations Framework Convention on Climate
Changes (UNFCCC) 19thsession of the Conference
of the Parties (COP19). At this occasion, GMF and
Duke Universitys Nicholas Institute for Environ-
mental Policy Solutions organized a panel discus-
sion on innovation regarding decarbonization. It
shed light on transatlantic policies and technolog-
ical advancements changing the way we produce,
sell, and consume energy.
Paul Bledsoe, senior fellow at GMF; David King,special representative for climate change for the
British foreign secretary; Jonas Monast, climate and
energy program director at the Nicholas Institute;
Simone Mori, executive vice president for regula-
tion, environment, and innovation at Enel; and
Jonathan Pershing, deputy assistant secretary for
climate policy at the U.S. Department of Energy
took part in the discussion.
Implications
These activities and reports are part of GMFs
broader work on Energy & Society. As such, theycomplement existing initiatives conducted on
energy, economic, technological, and social transi-
tions. Disruptive technologies can have a deter-
mining impact on the future of utilities in Europe
and the United States. In turn, they also have the
potential of radically changing the way the power
sector is financed and organized. Much depends as
well on existing and future symbioses with other
economic sectors.
When it comes to the implications of creative
destruction in the power sector, they often dependon challenges and opportunities for the system as a
whole. As such, they can include:
for utilities and investors: the transformative
role of innovation in the power sector; lessons
learned from other network sectors such as the
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T G M F U S2
Internet industry; adapting business modelsto evolving technologies; and unlocking the
potential of energy storage
for policymakers: the governmental support
of technology champions; helping bridge the
Valley of Death (the financial gap between
the development of a technology and its
commercialization); promoting private-public
partnerships for technology; and the role of
renewables in energy efficiency
for consumers: understanding the power of
demand side management; enjoying affordable
clean electricity; and better living with smart
appliances
for non-traditional energy industries: the
impact of cross-sectoral innovation on the
power sector; taking stock of the implication
of ICTs in the grid; and not perceiving
incumbents as the blockers of change
Findings & Recommendations
From the discussions and analysis conducted
throughout the project, a number of preliminary
findings and recommendations can be drawn:
Change in the electric power sector is
happening, and it is happening much faster
than expected by many.
The process of creative destruction in the
power sector is transformative, and one that
affects all levels of the energy system.
For major transformations to take place in the
electric power sector, mindsets need to changeas well.
Common insights and understanding
are necessary in order to move toward an
affordable, low-carbon, and secure energy
economy.
Technology trends are driving the energyrevolution, and the intersection between these
technologies, policies, and consumers is a game
changer for the power sector.
New business models need to be determined in
order to create a sustainable utility of the future
built on smart investments.
Creating the utility of the future involves
having figured out where the value is created
in the power sector, where the benefits go, and
what power consumers have in the process.
Cross-sectoral innovation will be instrumental
in driving the transformation of the
power sector, as external technologies will
increasingly rely on a smarter network.
The way the Internet sector developed can
provide an insightful model for the grid of the
future both in terms of business developmen
and regulation.
The role of non-traditional actors in the power
sector, such as ICTs, will be instrumental inbringing utilities closer to the consumer with
the possibility of ICTs becoming larger energy
service providers themselves.
Incumbents are not blocking transformation,
and transition toward a more efficient electric
power system involves greater cooperation and
coordination among all stakeholders.
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C D E S 3
A major transforma
in the electricity se
is inevitable, but
outcomes that ens
energy affordability
security, and minim
climate impacts are
Background
On September 19, 2013, GMFs Brussels
Office hosted a half-day workshop on
Creative Destruction in the Energy Sector.
The workshop brought together two dozen partici-
pants with diverse backgrounds, representing a
range of private-sector, public-sector, and non-
governmental organizations from both the United
States and Europe. GMF Senior Fellow Miriam
Maes chaired the meeting and guided the ensuing
discussion, which centered on the growing pres-
sures facing utilities as innovation disrupts their
traditional business models, and the new opportu-nities that could potentially emerge.
The discussion was informed by input papers
commissioned by Gerard Reid, head of European
operations at Alexa Capital; Albert Bravo-Biosca,
senior economist at NESTA; and John W. Jimison,
managing director of the Energy Future Coalition.
Their insights fueled the discussion on the poten-
tial for innovation in the electricity sector as well
as the challenges that are likely to accompany such
innovation.
Seeding the Discussion: The Major
Transformation in the Power Sector
The worlds energy systems are undergoing a
period of rapid evolution. Many developed markets
are seeing demand stagnate just as alternative,
distributed power supplies are becoming increas-
ingly cost-competitive. In the electricity sector,
these trends are putting remarkable pressure on
utilities, calling into question the staying power of
traditional business models. At a minimum, these
models are expected to evolve considerably toaccommodate new realities.
However, a lack of innovation through coordi-
nation risks hampering the rollout of a smarter
system that both reduces uncertainty for utilities,
encourages good behavior, and fosters integration
of lower-carbon energy sources. The stability of theplanets climate hinges on both more rapid decar-
bonization and the more efficient use of energy.
A major transformation in the electricity sector is
inevitable, but outcomes that ensure energy afford-
ability, security, and minimize climate impacts are
not. Holistic discussions are required to comple-
ment specific innovations and to ensure the occur-
rence of the necessary knowledge transfer that will
benefit society as a whole.
Selected interrogations:
We see balance sheets going down and utility
business models under stress. How can we help
utilities given that we dont want them to disap-
pear?
Wouldnt new market-based mechanisms such
as a real-time consumer electricity price drive
energy efficiency at all levels? How can we
further encourage demand response?
How do we Finance the Energy Revolution?
The financial markets look at utilities in their ownway. Notably, they have identified the existing wave
of industry developments as an energy revolution
driven by shale gas, increasingly cheap renew-
ables, and information technology. Smart utilities
have reacted to this and gotten involved in these
burgeoning arenas; the rest have faltered. And
traditional investments have become riskier given
that renewables production earns priority dispatch.
EU power prices have fallen from 70 per mega-
watt-hour in 2008 to just 35 per megawatt-hour,
putting considerable pressure on generators thathave not hedged prices at higher levels. Moreover,
prices are now often defined by the weather, namely
if the wind is blowing or the sun is shining. These
uncertainties have stressed utilities to the point
that they are no longer considered safe financial
W C D
E S: S
I M2
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T G M F U S4
bets, thus requiring higher dividend payments, andeffectively driving up their cost of capital.
Fortunately, there are opportunities for Europe to
emerge from this so-called trough of disillusion-
ment. Utilities need to get into the renewable
energy game and to take advantage of the price
certainty offered by feed-in-tariffs (FITs). Such
investments have proven successful even at returns
under 5 percent.
The integration of the European electricity markets
will pose additional challenges but at the same
time promises considerable benefits in terms of
cost-efficiency and greenhouse gas emission reduc-
tions. And the faster that industry leaders act and
innovate, the greater the benefits to utilities and
consumers alike.
Selected commentary:
The utilities have already failed. Some are on the
verge of bankruptcy. But dont worry; I think its
a good thing if they go bankrupt. It helps bring
creative destruction into the world.
This is the issue that we [the utilities] need
to find business models and landscapes for,
otherwise were going to be dead We need [to
become involved in] the biggest game-changers,
namely small-scale renewables, which are
changing the game and making customers far
more involved.
The EU really needs to push for one market. Its
not that the grid needs to become bigger but that
it needs to become smarter. We need to change
the whole incentive structure so were pushing
more technology and not just more cables.
Europe is in the trough of disillusionment. In the
United States, its very different because there
is a focus on costs. The United States invested
more in wind last year than all other areas put
together. And there a lots of exciting new busi-nesses and business models emerging.
Storage needs to come at the local level. For PV
[photvoltaics], thats definitely going to happen.
If as a consumer, I can take electricity at a nega-
tive price, save it, and feed it back in or create
gas from it. An engineer will tell you its ineffi-
cient, but its not about efficiency, its about cost.
Utilities are not going to build nuclear, coal, etc.,
if their returns cant be guaranteed. So theyre
looking to new markets because the cost of
capital is too high.
The renewable movement has been all about
capacity and not enough about intelligence. No
one in Germany talks about demand manage-
ment, and I think thats a big mistake. Its a
significant contrast with the United States.
What are the Lessons on Creative Destruction
from Outside the Energy Sector?
Innovation is a product of both coordination and
competition. An electric car, for example, has
little value if there is no way to charge its batteries.
And innovation is a continuous process, often
initially involving many players competing vigor-
ously, followed by consolidation and a handful of
remaining winners.
With respect to creative destruction, there are
significant differences between the United States
and Europe. Companies in Europe tend to be older
and more static whereas in the United States, they
are younger and there is a greater distribution of
high- and low-growth firms. It should be little
surprise that static firms do not have a tendency to
drive innovation.
Comparing the internet and the electricity grid is a
useful exercise in that it can highlight key similari-
ties and differences. Moreover, could smart grid
nnovation is a product
of both coordination
and competition. An
ectric car, for example,
has little value if there
is no way to charge its
batteries.
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C D E S 5
Outstanding questi
remain in terms of
adapting business
models that reflect
the impact of new
technologies and o
creative destructionprocess.
technology bring the electricity system closer to the
internet model?
When it comes to the electricity sector, outstanding
questions remain in terms of adapting business
models that reflect the impact of new technologies
and of the creative destruction process: where will
value be created? Which bits of the value chain will
be completely commoditized and who will capture
the profits? What are the platforms and systemsthat will emerge?
Selected commentary:
Who is likely to dominate the industry? Startups
or incumbents? I cant think of any utilities that
sell solar panels to their customers.
[Incumbents do not] have a monopoly of ideas,
and companies are often not as good as they
should be about creating and adopting ideas.
They also have a fear of cannibalizing their own
products and assets. In the end, entrepreneurs
support radical innovation whereas incumbents
look to incremental innovation.
Were institutionally very rigid. And regula-
tory rigidity is not likely to change since thats
an element of the political power. And thatpreserves [utilities]. Were bringing this fast-
growing, fast-shrinking ethos into the industry
and the incumbents dont know how to deal with
it.
There are no policymakers against company
growth, but there are many against companies
failing. But you cant have one without the other.
You cant protect incumbents and expect to have
high growth companies.
The [electric] industry is decentralizing. With
solar, you can have an 8 kW system that is
almost the same cost as doing 5 MW. Thats the
game changer as size no longer seems to matter
so much. I look at Africa and India and see
that theyre going to decentralize. Think about
telephony in these parts of the world where they
skipped landlines completely.
I think we also need to acknowledge the limits
of decentralization. Take the U.K., which is
really trying to meet its decarbonization targets.
It needs to balance the intermittencies, which
is more difficult in an island system. You needsomeone to take that role. I think its important
to reflect that role. I still agree that it will be a
hybrid system.
What is the Future for Electric Utilities
in the United States?
Technology is driving this energy revolution,
and there are a number of market trends that are
affecting the way we think about the future of the
power system. The continued electrification of
energy services illustrates the value of electricityas a means of providing energy to consumers. And
this value is further evidenced by the increasing
cost of electrical downtime, which can now reach
millions of dollars per hour for single firms.
The Internet The Electricity Grid
Decentralized Centralized
Low capital intensity High capital intensity
Low cost of experimenta-tion
High cost of experimenta-tion
Low cost of deployment High cost of deployment
Easy market access Difficult market access
Difficult to block newentrants
Easy to block newentrants
Limited policy uncer-tainty
Considerable policyuncertainty
High creative destruction Low creative destruction
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T G M F U S6
IT and service
companies see
considerable
opportunities to profit
through the disruption
of traditional utility
business models, whileutilities themselves
ften get caught playing
catch-up.
To meet future demand and reliability expectations,the consensus is that massive capital investments
are required. The increasing competition in the
utility business ought to increase the efficiency of
these capital allocations, but uncertainties regarding
payback times are stifling investment. And while
clean energy has grown popular, existing policies
will likely need to be strengthened if the United
States is to play a proactive role in climate change
mitigation.
The emergence of the smart grid is expected to
revolutionize the operational system, allowingplayers to be able to react more efficiently as
demand comes and goes. Furthermore, a break-
through in low-cost electricity storage would be
a game changer, radically reducing the need for
backup and peaking generation. And lower-cost
renewables will only spur additional decentraliza-
tion of generating assets.
There are significant implications for U.S. utilities
going forward. By 2030, there will be a different
customer relationship whereby utilities are
rewarded for performance rather than kilowatt-
hours sold. The high-risk aspects of the business
will likely be spun off, competing with third-party
entrants, while a healthy balance of distributed and
centralized generation resources will emerge.
Selected commentary:
The hourly costs of outages are phenomenal.
For a brokerage, it averages $7 million per hour!
There is a tremendous reliability premium on
the market now.
I see financial markets forcing these changes by2020. The financial markets are what are really
driving changes.
Despite being the only country still having a
debate on climate change, the United States still
wants clean energy no matter what.
One point to pick on is what the investmentmarket would look like, namely the monopoly
nature of the sunk parts of the value chain.
Theres critical national infrastructure where the
government deems that its vital to go ahead
you might find if the market didnt do that, then
other players would need to step in.
Utilities fear this vicious cycle where lost
revenues require rate increases that further
incentivize distributed generation.
There is not going to be a guarantee of a return
like before, but there will be opportunities for
large returns. It will be a significant, difficult
migration.
Disruptive Innovation in Practice: Private-Sector
Experience
Private-sector players have been reporting a wide
range of experiences as the electricity sector under-
goes its transformation. IT and service companies
see considerable opportunities to profit through the
disruption of traditional utility business models,
while utilities themselves often get caught playingcatch-up. Greater proactivity on behalf of the
incumbents will be required if they are to achieve
new profit streams that can offset dwindling
revenues upstream.
While we are still only in the early days of the
electricity sector transformation, fast movers will
have the opportunity to capture a greater share of
new revenue streams. Moreover, innovative use of
IT can help ease supply and demand imbalances,
limiting further incidence of stranded generation
assets and reducing the need for costly new infra-structure.
Selected commentary:
The utility industry itself is going to have to
become the biggest consumer of telecommuni-
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C D E S 7
The uncertainty
regarding future
regulatory trajector
remains palpable a
is surely a significa
impediment to mor
rapid, widespreadinnovation in the po
sector.
cation services. To take all of the [data] fromthese smart meters, process them, and learn
from them. I see potential for major convergence
between the electricity and telecommunications
sectors.
Regarding telecoms, its true that utilities are
going to become big consumers of telecommuni-
cations services. Perhaps [their] past error was
trying to compete with the incumbents in this
area... We will probably see very interesting busi-
ness models in the near future.
The Market and Regulatory Framework
As traditional power sector business models
undergo a range of challenges, many are ques-
tioning how governments and regulatory agencies
might react to potential change. In certain coun-
tries, there is a risk that governments will move
to protect state-owned utilities, thereby stifling
innovation. However, in others, there is evidence of
considerable public-sector willingness to support
greater leverage of technology, increased competi-
tion, and innovative business models. But positive
impacts will be limited without further coordina-tion.
The uncertainty regarding future regulatory trajec-
tories remains palpable and is surely a significant
impediment to more rapid, widespread innovation
in the power sector. Governments and regulators
will need to do more and coordinate more carefully
if they are to drive positive change while mini-
mizing negative impacts on ratepayers and thoseinvesting in progress. It is clear that, going forward,
additional dialogue will be required between all the
key actors in this increasingly vital sector.
Selected commentary:
The European Parliament [is] unable to say
unequivocally that something needs to be done.
All of the companies here are active in umbrella
organizations that have a tendency to act to
protect their slowest movers. If there is a way to
bring together the companies not so interested in
slowing things down, it could go a long way.
How do you build coalitions for change? The
question is whether there are some blocking
elements in the way. Surely the large consumers
of electricity have an interest in seeing progress
on this front, and thus cheaper electricity.
I think a dynamic market needs technology-
neutral regulations that take care of externali-
ties But theres also the question of invest-
ment certainty. We dont know how targets and
regulations will change. We need to be carefulnot to overregulate and create lock-ins. The less
information we have, the more careful we need
to be about regulation Given the 28 members
states in Europe, we need a more harmonized
market. For investors, its very difficult to judge
the average direction when countries move in
different directions.
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T G M F U S8
Innovation activity happens in a system, and it isthe result of two opposing dynamics that comple-
ment each other: one of competition and another
one of coordination. Our understanding of the
process of innovation would be incomplete if we
didnt consider both of them, and so would be our
analysis of the policy levers to support this process.
In this chapter, I consider both of these dynamics,
and draw some tentative implications of what they
may mean for the energy sector.
Why Creative Destruction Matters
Innovation activity is an uneven process. Many tryto innovate but only a few succeed. As a result, only
a minority of businesses and entrepreneurs intro-
duce really novel products, services, processes, or
business models. Even among large U.K. businesses
(250+ employees), only one in five says that they
have introduced a new-to-market product innova-
tion.
This is what makes the process of creative destruc-
tion so important. Entrepreneurs, but also existing
firms, experiment with new ideas. Some work,
most do not. Successful ones scale up and grow tochallenge incumbents. Some incumbents are able
to react in time, while others fail to do so and are
replaced, shrinking and exiting the market. But a
new generation of innovators emerges and the cycle
starts again. It is this creative destruction the
combination of experimentation, selection, and
adoption that ultimately drives productivity
growth.
Experimentation is even more important when
new opportunities or challenges emerge. Innova-
tion, after all, is a discontinuous process. It is bettercharacterized as a series of waves rather than as a
continuous flow. When a new radical technology
is discovered, be it the internet or the combus-
tion engine, a flurry of experimentation follows,
sometimes accompanied by a speculative bubble.
Entrepreneurs and firms experiment with differentapproaches to take advantage of this opportunity,
and eventually the industry consolidates around a
few successful dominant players.
Creative destruction is also more important as
industries converge on the global technology fron-
tier. Far from the frontier, firms can improve their
productivity by imitating what others have already
invented, but at the frontier they need to innovate.
However, innovation is risky and the outcome
uncertain, so only the successful few expand while
the unsuccessful ones shrink.
A puzzling question is how entrepreneurs can
ever be successful when challenging incum-
bents? Incumbents have access to finance, a good
customer base, strong networks, and an up-and-
running organization, while entrepreneurs have
none or very little of these. But incumbents do not
have a monopoly on ideas, sometimes listen too
closely to their existing customers (ignoring the
needs of other potential customers) and can also
be too afraid of cannibalizing their own products
by launching new ones. In addition, they also
have inflexible bureaucracies optimized to deliver
existing processes rather than to adapt to change,
sunk investments that depreciate very quickly if
new technologies make them obsolete, and have a
series of legacy costs that make it difficult for them
to re-invent themselves.
As a result, incumbents tend to have an advan-
tage at undertaking more incremental innova-
tion, continuously improving their products and
processes, since it builds on their accumulated
strengths and capabilities. Instead, when it comes
to radical innovation that is, imagining totally
new ways of tackling new or old problems some
of the incumbents strengths can quickly become
weaknesses, providing opportunities for entrepre-
neurs wiling to exploit them.
C D I:
V O E S
A B-B3
Incumbents tend to
have an advantage
at undertaking more
ncremental innovation,
continuously improving
their products and
processes, sinceit builds on their
accumulated strengths
and capabilities.
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C D E S 9
European policyma
have long worried a
Europes inability to
generate an equiva
to Google or Micros
There are,however, large
differences
between Europe
and the United
States in the
business growth
dynamics that
underlie creative
destruction and
productivity
growth. Both
Europe and theUnited States
have highly
successful
companies, but the European ones are generally
much older. A study by Bruegel shows that only 2
percent of the European companies in the worlds
largest 500 firms by market capitalization were
founded after 1975, compared to 14 percent in the
United States (Vron, 2008).
This is not just about differences in rates of
entrepreneurship. Researchers at the Organisa-tion for Economic Co-operation and Development
(OECD) and the World Bank have shown that the
main differences between the United States and
Europe lie in the rate at which new firms grow
rather than the number of new firms. U.S. start-ups
grow several times faster in their early years than
their European counterparts (Figure 1).1European
countries also have fewer high-growth firms than
the United States (OECD, 2008).
To shed further light on the dynamism of Europes
business landscape, FORA and Nesta, withsupport from the International Consortium for
1 Bartelsman, Scarpetta, and Schivardi (2003) assemble a newdataset for the 1980s and mid-1990s based on harmonizednational microdata sources and provide measures of survivaland growth of new entrants for up to seven years for 10 OECDcountries, later expanded to 17 with the inclusion of some devel-oping countries (Bartelsman, Haltiwanger, & Scarpetta, 2004).
Entrepreneurship, collaborated with researchers
and statistical agencies in eleven countries across
three continents to collect new and comparable
data on business growth. The resulting database
measures how quickly businesses grow or shrink in
each country, drawing on individual records for 6
million businesses.
European policymakers have long worried about
Europes inability to generate an equivalent toGoogle or Microsoft, innovative start-ups that grow
quickly to dominate their markets. But this data-
base shows that this is only part of a wider picture.
Figure 2 summarizes distribution of business
growth for private sector firms in Europe and the
United States Each column indicates the share of
firms with ten or more employees with average
annual employment growth rates over a three-year
period falling within that growth interval.2
Four key findings emerge from this analysis (Bravo-Biosca, 2010):
1. Europe has a much larger share of static
firms, while the United States has more
2 With the range covering 11 intervals from less than -20 percentto more than +20 percent employment growth per annum.
Figure 1: Average firm size relative to entry by age
Source: Bartelsman, Scarpetta, and Haltiwanger (2004)
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T G M F U S10
European countries
have a lower share of
high-growth firms than
the United States But
they also have fewer
medium-growth firms
and fewer shrinkingfirms.
fast-growing and fast-shrinking firms.
Differences in growth dynamics go beyond
the much documented gap in high-growth
firms. European countries have a lower share
of high-growth firms than the United States
But they also have fewer medium-growth firms
and fewer shrinkingfirms. At the same
time, Europe has a
much larger share
of firms that remain
static, that is, firms
that neither expand
nor contract over
time. This gap is
common across
different size classes
(although there
is some evidencesuggesting that it is
particularly difficult
for medium-sized
firms to chal-
lenge large firms in
Europe). Similarly,
it is not explained
by differences in
industry composi-
tion, and it arises
across all major
sectors (even if it ismuch lower when
looking specifically
at utilities).
2. Creative
destruction is at
work. The faster
successful compa-
nies grow, the
faster unsuccessful
companies shrink.
In other words, thereis a strong negative correlation between the
growth rate of firms at the top and the bottom
of the growth distribution across industries
and countries. So if the aim is to have more
Figure 2: Business growth and contraction in Europe and the United States
Source: Bravo-Biosca(2011)
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C D E S 11
The success of an
innovative product
on innovation in oth
parts of the system
high-growth firms, this may require lettingother firms shrink as well.
3. High-growth firms account for a dispropor-
tionate share of new jobs, but the full growth
distribution should be considered. The
debate on high-growth firms often considers
them in isolation. But policies targeted solely
at high-growth businesses, such as improving
the climate for venture capital, are not
enough to address the lack of dynamism that
hampers Europes productivity. They need to
be combined with deeper structural reformsthat remove not just barriers to entry, but also
barriers to growth and contraction, such as
improving product and labor market regula-
tion and tackling access to finance.
4. A less dynamic business growth distribu-
tion, with more static firms as in Europe, is
associated with lower productivity growth.
Importantly, both a higher share of growing
and shrinking firms are correlated with higher
productivity growth, which is consistent with a
faster reallocation of resources (both labor and
capital) toward successful innovators. Specifi-
cally, we find that a five percentage point (pp)
increase in the share of static firms is asso-
ciated with 1pp lower annual productivity
growth.
Consequently, the lack of dynamism observed
across European business may help to explain why
they are less productive than those in the United
States, a gap that had been widening for over a
decade before the recession took hold.
Why Systems Matter
The competitive pressures that sustain creative
destruction are a key driver of innovation, but not
the only one. Coordination is as well. No one would
buy a DVD if DVD players were not available in
the market. Yet no one would buy a DVD player
without DVDs in the market. This is why the intro-duction of DVDs into the market required coordi-
nation between content producers and electronics
manufacturers. Moreover, how well coordination
works can determine which innovation succeeds at
dominating the market, as the past success of VHS
over Beta shows (despite being an inferior standard,
VHS triumphed thanks to having more content
available).
While this is not a new idea, some argue that it is
becoming more important as innovation activities
shift from creating new products toward creatingnew systems. Geoff Mulgan and Charlie Leadbeat-
ers recent discussion paper on systemic innova-
tion sum up why it matters, what new challenges
it involves, and how to address them to make it
happen (Mulgan & Leadbeater, 2013).
The starting point in their argument is that systems
matter more than products. Innovative products,
such as electrical cars, cannot function without the
systems that would support them, such as charging
stations for their batteries. More generally, the
success of an innovative product relies on innova-
tion in other parts of the system, given the strong
complementarities that exist. This makes coordina-
tion much more important, and may suggest that
policy has a more important role to play, whether
helping to set up a common vision or supporting its
development.
Systemic innovation also has implications about
where value is created and who captures it. As the
example of Apple shows, most value is likely to
be captured by system innovators that create new
platforms rather than by the product innovators
that just launch a new product as part of it (even
if they will still get a share of the benefits, as app
developers do).
Systems can take many different shapes and forms,
so how systemic innovation happens (including
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T G M F U S12
who, if anyone, is in the driving seat) dependson several of their characteristics. If it requires
large capital investment, those that have access to
finance will have more influence. If there is already
a system in place, adapting it or creating a new one
that competes with it will typically involve conflict.
System dynamics will also be very different if it is
dominated by someone (e.g., Apple) or if power is
distributed across different players.
What About the Energy Sector?
Defining the boundaries of what we mean by the
energy sector is not trivial. Are we talking onlyabout those firms that sell energy? Or also those
that sell the key inputs used in the production
of energy, such as wind turbines or nuclear reac-
tors? Or those that help us to avoid consuming
energy, whether they are creating new insula-
tion materials or digital tools? Or also those that
intensively use energy, and can dramatically shift
consumption patterns, such as automotive manu-
facturers developing electrical cars? If one lesson
emerges from other sectors, it is that it is difficult
to understand innovation in one part of the system
without considering others, given how interlinked
they are. For instance, developments in energy
storage solutions can radically change not only
transport systems but the whole make up of energy
production. Despite this, the discussion that follows
focuses on the utilities that produce and distribute
energy.
The changing landscape in the energy sector, driven
by technological advances, the climate change chal-
lenge, and geopolitical shifts, suggests that it may
be entering a major phase of transformation, even if
the destination is still unclear.
These are the times for disruptive innovation, when
after much experimentation new dominant players
can emerge and replace existing incumbents.
Whether this is likely to happen in the energy
sector is yet to be seen, given the unique character-istics of the sector, which have traditionally limited
creative destruction. After all, most major players
in Europe are the successors of state monopolies,
and until very recently vertical integration made
it very difficult to enter the market. Even with the
more level playing field being currently developed,
it is still difficult for start-ups to enter and challenge
incumbents.
Silicon Valley provides an interesting contrast. The
cost of experimentation for web entrepreneurs is
very low. They do not even need to a buy a serveranymore. They also can get almost immediate
feedback from customers, learning very quickly
whether their innovation is worth something, or
whether they should give up on that one and move
onto other things. In other words, it is very cheap
and quick to resolve the uncertainty, whether
it ends in success or failure. (The advantages of
being able to fail cheaply and quickly are too often
underestimated!) Not only is the cost of experimen-
tation low, but so is the cost of deployment. Energy
entrepreneurs on the other hand not only need
significant investments to test new technologies,but also to roll them out, given their capital inten-
sity. Moreover, these may be difficult to finance,
since tangible assets are not such a good collateral
when they can become obsolete very fast, which is
definitely a possibility in these uncertain times.
Successful digital start-ups can quickly get millions
of customers around the world by exploiting the
web; in contrast energy entrepreneurs need to deal
with national regulators (and incumbent competi-
tors) to access markets. Operating in a regulated
market also makes energy entrepreneurs subjectto policy uncertainty. And the long life length of
investments in the energy sector decades rather
than years makes incumbents extremely resistan
to change. In the digital world, incumbents quickly
adapt (even if sometimes not fast enough). In the
energy sector, given their sunk investments, their
These are the times for
disruptive innovation,
when after much
experimentation new
dominant players can
emerge and replace
existing incumbents.
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C D E S 13
The question is whe
the grid will becom
more like the intern
the near future.
incentives are not to adapt but to resist, and, ifpossible, block any change that can make their
investments obsolete.
Ultimately, the internet and the grid are both
networks, but of very different nature. The former
was set up to be decentralized, without a central
command-and-control center, unregulated and
open to all, making it easy to experiment and diffi-
cult to block competitors. The latter is tightly regu-
lated, controlled from the center, and limits access.
Even if there are good reasons for this, it also makes
it much easier for well-connected incumbents toinfluence regulators and limit competition.
The question is whether the grid will become more
like the internet in the near future. Smart grids have
the potential to seed such a transformation, but
what happens will ultimately depend on how the
overall system evolves, and who pilots this transi-
tion. In a nutshell, electricity markets need systemic
innovation, and the opportunity is there. But as
with other systems, its future will depend on a
combination of factors, including what technologies
become available, what alliances are formed, how
infrastructures evolve, and how consumer behavior
changes.
A Few Questions Worth Considering
What the future of the energy sector will be is still
an open question, and so is the role that policy-
makers will play in this transition. So rather than
providing answers, this chapter ends with a set of
three questions that can help to inform the debate.
Where will value-added be created?
The value chain in the energy sector is beingbroken into smaller pieces, unbundling a previ-
ously vertically integrated process. The question
that follows is which bits of the process will be
totally commoditized, only being able to compete
based on low prices, and what new sources of value
will emerge? For instance, will most profits in theindustry be captured by energy producers, by the
networks that distribute it, or by those that sell
services that allow reducing energy consumption
(or shifting peak demand)? In other words, what
will be the distinctive features on which competi-
tion in the energy sector will be based? And, closely
related to this, where will most of the innovation
happen (upstream, production, distribution, or
demand-side)?
Taking the internet analogy somewhat further, it
has been the companies that have created new plat-forms that have profited the most from the internet
revolution, not the telecom companies that sustain
it with their fiber optic networks. The internet
contains a series of systems within a large system, as
the examples of Google or Apple show, and so can
the smart grid. The challenge is to identify where
the systems (or platforms) will emerge and what
business models will sustain them.
Who is likely to dominate the industry?
Will creative destruction reach the electricity
sector? It depends is the typical answer from aneconomist. Ultimately, where value is being created
will determine how difficult it is for incumbents to
maintain their leading positions, and this depends
in part on the direction of technological change.
The potential for disruption is higher if start-ups
can innovate at the margins, tackling new markets
that did not exist or developing new technologies
that make existing investments obsolete (assuming
incumbents lobbying does not block them). If
innovation at the core dominates, is complementary
with existing capabilities, and is capital intensive,
dominant firms have a better chance to continue todominate the market. There is, however, another
source of creative destruction: large business in
other sectors (such as some of the internet giants)
challenging energy incumbents with their deep
pockets and their digital capabilities.
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T G M F U S14
Energy policies will
ave to encourage both
better technologies as
well as their adoption.
But many other factors can have an impact onthe sectors landscape. Energy firms may develop
a similar symbiotic relationship with start-ups as
pharmaceutical companies have been doing for a
while in their own sector: letting start-ups do much
of the radical innovation as well as take on the risk,
in order to buy the successful ones later on to scale
them up, taking advantage of their size, expertise,
and comparative advantage in deployment. (This is
not necessarily bad if it is not used to prevent the
development of the technology.)
How competitive the market becomes is also afactor to consider. The smart grid allows for a
much more distributed model of energy genera-
tion, which means that a larger number of energy
producers is sustainable. Moreover, energy
producers may also have to compete against their
own customers, as the option of self-generation
becomes more feasible, which is already starting
to happen. Much value will therefore be captured
by consumers rather than by producers. However,
profitable opportunities will continue to exist in
those segments of the market where competi-
tive pressures are counterbalanced by some othersources of scale economies such as network exter-
nalities, even if those are not linked to the grid per
se but to the platforms that are built on top of it.
What is the role for policymakers?
Given the energy sectors important role
throughout the economy, being an input to all
production sectors and a significant item in
households expenditures, lower innovation and
creative destruction in the energy sector can have a
significant negative impact on downstream sectors,
households budgets, and, ultimately, on economicgrowth. In addition, the climate change challenge
makes achieving innovation in the energy sector a
societal priority.
The challenge for policymakers is how to encourage
both creative destruction and coordination to
maximize innovation and adoption, in other wordsto create a system that makes experimentation
cheaper, facilitates wide learning, and where best
solutions are selected and widely adopted.
Several choices and tradeoffs are likely to emerge:
Markets vs. governments: Is governments role
to take the back seat and let the private sector
take the initiative, or should it be actively
setting direction and providing the funding to
make it happen?
Incumbents vs. start-ups:Should the focus beon incentivizing incumbents to make the most
of new technologies, or on supporting start-up
to challenge incumbents, or both? (Or none?)
Picking winners vs. diversified portfolio:
How diversified should the portfolio be when
backing new technologies, since they are
expensive and many benefit from externalities?
Is picking winners a good strategy, and if
so, should the focus be on sources of energy,
specific technologies, or particular companies?
Early vs. late adoption:What is the right time
to adopt a new technology? Given the risks
of lock-in into inferior and more expensive
technologies, a wait and see approach can be
a temptation, both for governments as well
as for industry. But by acting too late, they
will miss the opportunity to lead an industry.
They may have been investing into much
older technologies that become obsolete very
quickly. (Alternatively, technology and policy
uncertainty may generate a risk of paralysis
with investments stopping given their long lifelength, constraining future energy supply.)
Energy policies will have to encourage both better
technologies as well as their adoption. New solu-
tions are more likely to emerge if policymakers
combine classical instruments, whether SBIR-
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C D E S 15
type schemes3
or technology grants, with otherapproaches to encourage new radical ideas, such
as challenge prizes. For instance, Nesta is currently
running a new Dynamic Demand Challenge Prize
to encourage thinking out of the box on how to
shift peak demand.
Re-thinking how the role of regulation changes in
this new environment may also encourage innova-
tion and adoption, for instance by learning from
other network-based regulated sectors such as
telecoms (including some attempts to facilitate
disruptive business models).
Adoption is likely to be faster if governments tackle
coordination failures, going beyond standard-
setting (which also plays an important role); if they
align incentives, being extremely careful when
designing schemes in order to avoid unintended
consequences (e.g., Spanish solar premiums); and if
they take advantage of nudging and transparency to
induce behavioral change.
3 Small Business Innovation Research program in the United
States.
References
Bartelsman, E. J., Haltiwanger, J., & Scarpetta, S.
(2004). Microeconomic Evidence on Creative
Destruction in Industrial and Developing Coun-
tries. World Bank Policy Research Working
Paper No. 3464.
Bravo-Biosca, A. (2010). Growth Dynamics:
Exploring business growth and contraction in
Europe and the U.S..London: FORA-NESTA
Research Report.
Bravo-Biosca, A. (2011). A look at business growth
and contraction in Europe. Nesta Working
Paper No. 11/02.
Mulgan, G., & Leadbeater, C. (2013). Systems Inno-
vation.London: Nesta.
OECD. (2008).Measuring Entrepreneurship: A
Digest of Indicators.
Vron, N. (2008). The Demographics of Global
Corporate Champions. Bruegel Working Paper
no. 2008/03.
Adoption is likely to
faster if governmen
tackle coordination
failures, going beyo
standard-setting.
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T G M F U S16
Introduction
The U.S. electric utility industry is respon-
sible for a greater capital investment in
the U.S. economy than any other industry,
constructing a unified electric grid that the U.S.
National Academy of Sciences called the single
greatest engineering achievement of the 20th
century. So it is somewhat ironic that the early
decades of the 21stcentury will see this achievement
radically altered by market forces, new technology,
and its customers new options. This chapter notes
the market trends and anticipates the technical
innovations that are destined to reshape theoperations of the U.S. electric utility sector and its
institutions, anticipating major change in a service
integrated into every element of modern life.
The Market Trends
Without accounting for imminent changes in its
basic technology, the U.S. utility industry would
nonetheless already be confronting significant
change from a rapidly evolving market environ-
ment. Six compounding market trends have
combined to put the utility industry under growingeconomic and operational pressure.
First, the ongoing migration to energy services
delivered to consumers in the form of electricity is
not a new trend. It used to be that direct use of fuels
was a major part of an advanced life-style. Virtually
every energy service used in a modern society can
now be provided by an electric-powered device.
Electronics and computing are only the most
obvious. Our lighting, heating, motors, cooling,
communication, manufacturing, and now even our
personal transportation increasingly run on elec-tricity. A gas furnace cannot operate without it.
This is the latest stage of a centuries-long process
of users deciding what form of energy they wanted
for the purposes that they could afford. Electricity
is almost perfect energy infinitely control-
lable, silent, pollution-free at the point of end use,versatile, capable of producing the entire range of
temperature and motion, and uniquely qualified to
produce light and operate electronic equipment. It
is remarkably affordable throughout the industrial-
ized world. Thanks to generation, transmission,
and distribution investments made at huge scale
and priced at their cost through government regu-
lation as a natural monopoly, electricity service has
become ubiquitous in the United States and other
advanced societies, and it has become affordable to
almost all their participants for business and indi-
vidual applications. It is now clearly indispensableto modern life, perhaps especially in the United
States.
A second ongoing trend, balancing the implicit
growth of the first, is the improving efficiency of
major end use applications. In lighting, heating,
cooling, motors, appliances, data centers, and
electronics, the ability to achieve the desired work
from ever smaller amounts of electricity keeps
improving. As a result, the Energy Information
Administration (EIA), often accused of unduly high
projections for future U.S. energy growth, currentlyprojects electricity demand growth at less than 1
percent per year for the projection period to 2040.
Many other estimators see demand growth falling
to less than 0 percent declining sales of power
despite ongoing electrification of the United States.
This originates from productivity improvements as
older equipment is gradually replaced or upgraded
with on-the-shelf technology. Even as we power
more devices with electricity, we will use less.
These competing forces are complicated by a third
factor in the electricity market environment: theincreasing frequency, impacts, and costs of outages.
Unnoticed by many consumers, their increasing
dependence on electricity to operate more of the
critical functions they depend on has actually
raised the real value of electricity. They use less,
but it is worth more. Americans have increasingly
A C F
U.S. E U
J J4
Six compounding
market trends have
combined to put the
utility industry under
growing economic and
operational pressure.
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C D E S 17
had their attention called to this when a stormtakes out the grid for more than a few hours. They
find themselves helpless, unable to be productive,
threatened with the deprivation of basic human
needs, and angry at their utility company even as it
struggles to restore service. The wealthier may find
it warranted to invest several thousand dollars in
a back-up single-home generator to assure service
of a commodity for which they are accustomed to
paying less than $100 per month.
With a warming climate, scientists have warned
that the greater strength and number of destructiveweather patterns experienced in recent years will
continue. Our typically overhead electric infra-
structure is hanging in harms way, and has taken
many of these natural hits. But perhaps even more
threatening is the potential for man-made intru-
sion via the internet in a massive cyber-attack or a
focused physical attack on critical transformers or
control centers, which could deprive huge regions
of electric service for months with potentially
devastating impacts on economic productivity,
human need, and social stability. There is an
unspoken awareness throughout the power-consuming public that electricity is both more
necessary than ever and more threatened in its
reliability, and some private citizens are beginning
to act on that understanding.
A fourth ongoing market driver, recognizing that
electricity generation is itself the greatest global
contributor to greenhouse gas emissions, is the
need to decarbonize a largely-carbon-based genera-
tion infrastructure. While this is still a matter of
debate in the U.S. Congress, it is no longer a matter
of debate in the U.S. electricity industry. In manyways, this could be seen as a measure of self-defense
for the electricity grid, the most vulnerable energy
system to extreme climate events. But one will not
hear many utility executives express eagerness to
back away from expensive and often recently built
coal and gas-fired generators.
This factor points in a back-handed way to thegreat weakness of the electricity system: generating
electricity embodies a huge waste of energy in
conversion losses. Simple-cycle steam generators,
which provide the great majority of the worlds
and the United States capacity in coal, nuclear,
and other fossil-fired power plants, cannot convert
more than about 40 percent of the raw energy they
consume into the electricity they produce. They
waste on average two-thirds of their energy input,
emitted into the atmosphere as hot combustion
products or warm water. Combined-cycle gas plants
can push that to about 60 percent used, 40 percentwasted. The even lower percentages achieved by
renewable energy generation are forgiven by many
because the energy they waste is not emitted as
globe-damaging combustion products. Their ineffi-
ciency is not, however, forgiven by capital markets.
The fifth market reality, connected to the others, is
the need for massive new and continuing invest-
ment. Such investment should keep the system
operating, capable of connecting and supporting
new service, of operating under extreme condi-
tions, of maximizing productivity, and ofresponding to the need for global environmental
protection. Trillions of dollars are needed to sustain
the current system, never mind the new system that
is coming. This requirement will reinforce both the
political pressure on regulators, state governments,
and utility companies, as well as higher electricity
prices even in the face of falling demand.
Finally, perhaps the most significant market
trend that is certain to change the U.S. electricity
sector is the advent of competitive market forces
at all levels of an industry that for a century wasimmune to them as a government-sanctioned and
-controlled monopoly that owned and operated
all necessary infrastructure. The genie of competi-
tive forces is clearly out of the bottle. Starting with
independent generation in the 1980s as a function
of laws favoring cogeneration, and expanding to
Trillions of dollars a
needed to sustain t
current system, nev
mind the new syste
that is coming.
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T G M F U S18
include non-discriminatory and then independenttransmission services, competition in the United
States is now driving new customer behaviors and
threatening to leave major rate-base investments in
generation and transmission stranded and useless.
From passive recipients of monthly invoices that
they could neither limit nor avoid, customers have
increasingly become active participants in elec-
tricity markets, selling their own willingness to be
curtailed back to utilities in the form of demand-
response, bidding their future efficiency gains into
capacity markets, and participating in price-setting
through time-of-use electricity markets whereregulators have permitted them, timing their use
to take advantage of cheaper hours and to avoid
expensive peak power.
The emergence of competition in electricity
markets does not merely challenge utilities invest-
ments and market share; it challenges their funda-
mental economics. Under standard U.S. regulatory
economics, they are assured the recovery of their
capital investments, debt, and the opportunity
to earn a reasonable profit; under competitive
economics, investments are largely sunk costs,debts are at the risk of the success of the debtors
business, and profits are the rents that can be
collected between the sellers cost and the market
price, whatever that happens to be. To the extent
utilities are drawn or driven to compete for their
own continued business, they will be driven to and
by this new and much harsher regime. Whether
utilities can maintain their traditional role as
safe investments with access to low-cost capital
lies entirely on their success in negotiating these
competitive forces where they arise, and in relying
on their regulatory protectors where they do not.
As a result, the U.S. electricity market is a strange
one, one in which a critical commodity is selling
in stagnant or declining volumes but demon-
strating ever higher penetration into societal needs
and developing ever greater dependence from
its customers. For these customers, electricitysessential nature combines with the grids vulner-
ability and unreliability to create incentives to
move toward independence and self-reliance from
the utility despite the costs. At once the greatest
environmental threat and cleanest form of delivered
energy, electricity is at the crux of dealing with
climate change. It is produced, transported, and
sold in a market that remains necessarily regulated
for system governance, largely regulated for siting
of new facilities, optionally regulated in most areas
for commodity pricing, and increasingly unregu-
lated where competitive forces can operate in bulkpower markets and utility services. Customers
and other stakeholders have found little political
consensus on where regulation should stop and
competition should start, but the United States has
3,200 separate utilities with individual service areas
where such judgments will make a lot of difference.
Mix in Some Breakthrough New Technologies
Starting from this set of market realities, any prog-
nostication of the future for the U.S. electric system
must then add to the key influences accounted for
a set of technological developments already under
way and accelerating in the timing and scale of
their potential impact. Some of these are clearly
responsive to the insecurity, vulnerability, environ-
mental insults, inefficiency, cost, and monopolistic
character of the current system. Others are coming
into being because they can. They break into a few
large categories of technological change.
Computerization
The essence of the smart grid that is coming is
the integration into all facets of the electric systemof digital monitoring and controls, and the ability
to process this information for operational and
planning purposes. In other words, the infrastruc-
ture industry that provides the essential power
and lifeblood for computers is becoming comput-
erized itself seemingly the last of the major
At once the greatest
environmental threat
and cleanest form
of delivered energy,
electricity is at the crux
of dealing with climate
change.
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C D E S 19
economic sectors to embrace digital informationprocessing. Over coming years, machine intel-
ligence will continue to rapidly penetrate gener-
ating plants, transmission systems, distribution
networks, and individual customer services and
applications (and probably in that order). Myriad
functions that today still require a human beings
thoughts and actions will be programmed. They
will be instantaneous, and, unfortunately, also
vulnerable to the malicious intervention of other
human beings. Programmable remotely accessible
appliances and building systems able to respond
to variable prices and system conditions will notmerely require computerization for the systems
sake, but also because the modest cost savings their
individual efficiencies will generate would not be
worth the time of a human being to accumulate by
direct control. Only if they are programmed to save
money will they pay for themselves, and only then
will they achieve their value on the electric grid.
The millions of monitors that in coming years will
watch and report the activities across every part
of the grid on the utility side of the meter will be
multiplied by billions that track the operations ofindividual consumer applications. Together, these
will generate quintillions of bits of computer data
that must be transmitted, received into databases
and control systems, distinguished by origin,
processed, analyzed, and acted upon. Utilities will
either need major server and processing installa-
tions of their own, or they must become perhaps
the largest and most demanding tenants of the
cloud. Whether utilities and their critical func-
tions can be trusted to third-party computer
storage and processing facilities is a troubling ques-
tion. Whether the United States 3,200 utilities canmanage their own computer systems at that level
of data input and integrated operation is an equally
troubling question. And whether such computer-
ized operations can be protected from cyber-attack,
and restored to operation quickly after intrusions, isperhaps the most troubling question of all.
Concomitant with the computerization and
data requirements this technological revolu-
tion is bringing to utilities is a parallel (but less
recognized) expansion of the utilities require-
ments for telecommunication services. As the
electricity industrys ability to sense and control
its operations remotely down to the last water
heater increases, the need to send information
in both directions will demand massive incre-
mental communications capacity. Ideally, much ofthis could take place through wireless radio, but
the radio-wave spectrum is a limited resource of
rapidly increasing value, and an industry that is by
definition completely wired might be thought to
be one with the least priority for precious wire-
less band-width. But broadband over powerline
continues to face technical hurdles, and the utility
industry cannot afford for communications to be
disrupted precisely when power flows are. Thus
the utility industry must participate in the tele-
communications technology revolution as a major
projected customer for its services, in order tocontinue rendering its own services in a fully digital
era. This represents a further massive necessary
investment to be made. Increasingly, electric utility
communications are being appropriately seen as
sharing the same privileged access to wireless spec-
trum as first-responders and emergency workers
in the event of catastrophe, but privileges only go
so far as the available capacity can honor them. It is
also not clear that taxpayers will pony up the costs
of such access in the place of ratepayers.
StorageElectricity has been, from the beginning, a
commodity that had to be consumed as it was
being generated, since it traveled and could not
cost-effectively be stored. That is about to change.
Storage of electricity is now practiced in a few loca-
The utility industry
must participate in
telecommunication
technology revoluti
as a major projecte
customer for its
services.
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T G M F U S20
tions blessed with the topography to pump waterup into reservoirs that offers hydroelectricity on
its way back down. Utilities with customer permis-
sion are also achieving indirect power storage by
dispatching surplus energy to well-insulated water
heaters, curtailing them at peak while the extra-hot
water effectively stores that surplus power.
New approaches, however, appear likely to make
storage of electricity affordable and ubiquitous over
coming years. Already, utility-scale batteries and
super-capacitors are being tested in commercial
utility applications, installed to levelize the genera-tion of variable-output wind-farms, and used to
capture the power of braking trains to boost their
acceleration after a station stop. It seems inevi-
table that one or more of the various large-voltage
battery storage technologies under test and devel-
opment will prove viable over coming years. And
these batteries will compete with compressed-air
storage, flywheels, and possibly other demonstrated
utility-scale options that are working on coming
down the cost curve.
At a smaller scale, however, commercial elec-
tricity storage devices are already being rolled off
automobile assembly lines on a daily basis. The
lithium-ion battery is a proven technology rapidly
penetrating portions of the electricity market that
were thought beyond its wattage only a few years
ago. And rumors of dramatic further improve-
ments in vehicle-battery power density and weight
make them sound imminent. The fact that every
major vehicle manufacturer is creating a line of
battery-electric vehicles is eloquent testimony to
the near-term viability of electricity storage in huge
amounts, albeit divided into thousands of mobileplatforms.
The question is not whether battery-electric
storage will change the utilities own opera-
tions and markets even as it adds a welcome new
transportation load. The question is instead how
thoroughly personal power storage will changeour electricity consuming practices other than for
mobile applications. The answer depends more on
institutional than on technological factors. Vehicle
manufacturers argue that they cannot tolerate their
warranties having to cover the vehicle batterys use
for anything but moving the vehicle. And utilities
are leery of accelerating customer independence
from the grid, and therefore are slow to facilitate
vehicle-to-grid applications. The fact remains
that a full vehicle battery could power most of the
critical functions of a typical residence during at
least a brief outage. One with a portable batterycharger (i.e., a gasoline engine in the vehicle) could
power critical functions for an extended outage. At
some point, it seems inevitable that electric vehicle
batteries will have stationary uses as well, if only for
emergencies.
For utilities themselves, given the increasing
premium on reliability and resiliency in their
mandate to serve the public, it seems likely that
putting storage devices downstream on the custom-
ers side of potential outages would make more
sense than siting large-scale power storage nextto large generators or elsewhere upstream of all
those exposed wires that are implicated in outages.
Putting storage devices into the customers own
applications and premises will not be a big step
from putting them in substations, on utility poles,
or elsewhere on the closest part of the utilitys prop-
erty. It will depend on how the utility can make and
get paid for making the accompanying investments
Called a game-changer, electricity storage will
change the game the electricity industry plays
about as much as putting 11 balls on the fieldwould change the game of soccer. Utilities could
forget the distinctions between baseload, mid-
range, and peaking generators, as the fluctuations
of demand would more economically be matched
by dispatching power from storage, either centrally
or at the point of consumption. Generation could
alled a game-changer,
electricity storage will
change the game
the electricity industry
lays about as much as
putting 11 balls on the
field would change thegame of soccer.
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C D E S 21
rely exclusively on the cheapest means, or, increas-ingly, on the cleanest, because the intermittent
timing of renewable generation could be mitigated
as effectively as the intermittent timing of customer
demand. A struggle might ensue between advo-
cates for 24/7 operation of major nuclear or coal
plants to keep storage batteries and other devices
at full charge, versus advocates for using integrated
storage as the key means of utilizing variable
renewable generation to meet variable load. Even-
tually, the latter perspective is likely to win. The
variable operating costs of the renewable genera-
tors, like those of the storage devices themselves,are likely to verge on zero, while fossil and nuclear
generation may never be able to avoid fuel costs as
well as emissions or waste. Storage is the ultimate
enabler to allow a fully clean power sector.
Decentralization
Even as the utility industry inevitably is drawn into
the modern central systems for telecommunication,
digital information, and control, and as cost-
effective power storage finally emerges to eliminate
time-sensitivity as a critical factor for utility opera-
tors or planners, a third technological revolution isthreatening to flood over the industry and divide
it into small pieces. Insecurity, environmental
impacts, and declining costs are motivating a rush
toward distributed resources, programmable smart
controls, and individual self-sufficiency in power,
which in turn is motivating advances in small-scale
electricity technology. Distributed power will come
from generating resources of various types: fuel
cells, micro-turbines, heat-engines, solar arrays,
small windmills, generators operating on locally
produced biofuels, etc. Distributed resources will
include local controls, inverter technologies, smart
appliances, and the above-described potential for
individual storage. One must add in the potential
for combining electric generation and use with
thermal requirements that can only be served
locally.
Ultimately, decentralization has the potential foran entirely different grid architecture, one centered
on many small and islandable microgrids intercon-
nected with each other and a central backbone grid
for cost and convenience. These microgrids would
be self-controlling, self-sufficient, and potentially
free-standing economically and in load-service
priorities. Microgrids are essentially sub-parts of
the larger grid with automatic sectionalization and
reclosure. This would enable the area to be cut
off from the surrounding system, after which one
can potentially employ independent generation
and load controls to sustain service even when thelarger system is down. As the generation, distribu-
tion, and end-use technologies at the retail level
continue to improve in efficiency and remote
operation, the opportunity to segregate them into
self-sufficient microgrids is becoming attractive
for economic, reliability, and resiliency reasons. In
this case, one can easily imagine that customers of
an economically successful microgrid would argue
that they should avoid sharing in some of the costs
of the central system, causing furth