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Ben Hertz-Shargel, Global Head of Grid Edge at Wood Mackenzie
Distributed technologies and innovations known as the grid edge will be integral to efficiently powering an electrified world. So where will the funding capital come from? And what role will utilities play in his future?
Increased electrification and the dramatic growth of distributed energy resources, such as rooftop solar, represent a doubling of society’s reliance on the electricity grid. At the same time, natural disasters, extreme weather events and rising fuel costs are putting unprecedented pressure on existing infrastructure.
Network rewiring
Hundreds of billions of dollars will be needed to improve regional and interregional transmission, allowing populations and commercial centers access to clean energy produced hundreds or even thousands of miles away, where natural resources exist. New grid enhancement technologies (GET) such as dynamic power flow and line ranking technologies will be invaluable in maximizing transmission line capacity. Meanwhile, smart metering – a requirement for advanced utility pricing, efficient billing and insight into consumers’ energy consumption – must be fully rolled out. So far, after tens of billions of dollars invested, only 63% of homes and businesses have a smart meter installed.
Construction of new classes of infrastructure
However, investment in transmission and distribution networks is only the beginning. Customer demands for electrification of buildings and transportation, distributed generation and energy resilience demand new classes of grid-edge infrastructure:
EV charging points: Over 36 million EVs will be on the road in the US by 2030; home charging will predominate, but robust public charging infrastructure will be needed for drivers who do not have access to off-street parking or while commuting.
microgrids: Businesses, governments, educational institutions, and at-risk population centers increasingly require microgrids to provide backup power when the grid goes down.
Battery storage: “Behind the meter” storage in homes and businesses increasingly relies not only on end customers for resilience and bill savings, but also on utilities as local, low-carbon energy capacity when their grid is constrained.
How will it be paid?
Annual spending on non-traditional edge network infrastructure is projected to reach US$20 billion by 2026 (see market analysis below).
Forecast 2026 United States Mesh Edge Market Size by Type
Electric Vehicle Charging Infrastructure (ECVI)
10.1 billion dollars
Residential Storage
6.0 billion dollars
Microgrids
4.2 billion dollars
Commercial and Industrial (C&I) Storage
1.7 billion dollars
The key question is where will the capital come from to finance this new infrastructure? There are three main options: end customers, private equity or utilities.
Empowering end customers
One option is for homeowners and businesses to own property that serves them locally. However, the cost of capital is high for end customers, who are often unable to afford the upfront costs. Moreover, asset ownership comes with maintenance and operation responsibilities for increasingly complex technology. Although this can be negotiated, the purchase of the asset exposes the client to risks related to the performance and lifetime of the asset.
Relying on private capital
Another option is for private equity funds, asset managers and other investors to provide the necessary capital. Investor capital is deployed by distributed energy resource (DER) developers through what are generally referred to as “energy as a service” offerings. Under this model, the investor finances the installation and holds the asset on its balance sheet, while the user pays a periodic service fee to use it. It’s usually a turnkey solution, with a service fee covering operations, maintenance and even asset upgrades. Private companies and technology providers often form joint ventures, which act as developers with huge balance sheets.
In the microgrid space, the market share for this approach has grown from 18% in 2019 to 44% in 2022. Meanwhile, despite the lower cost of ownership, the huge price premium for electric vehicles makes the fleet-as-a-service model critical for startups looking to electrify fleets small commercial vehicles and buses.
The advantage of the energy-as-a-service model for developers is that they are free to monetize assets by offering sophisticated energy services to the utility or wholesale electricity market. Although these are risky value streams, some developers are willing to take them on, reducing service fees to clients based on expected earnings over the life of the contract.
Another option is to spin off assets as asset-backed securities, allowing others to invest in tranches according to their risk tolerance. Solar retailers already do this for power purchase agreements (PPAs) and leases that they sell to homes and businesses rather than selling them a solar system directly.
One of the challenges is that edge-of-the-grid infrastructure must compete for capital with expensive, large-scale investments in renewables. The projects are smaller and riskier than infrastructure funds are used to, while rates of return may not meet their risk tolerance – especially for electric vehicle charging stations, which currently suffer from high utility bills but low utilization.
It’s also worth noting that homeowners are increasingly opting for low-interest loans over PPAs. However, PPA
PPA
Banking for utilities
A third option is for utilities to fund grid-edge projects. In almost all states, investor-owned utilities (IOUs) are encouraged to make capital investments, on which they can earn a regulated rate of return. Typically, these investments are in poles and wires, but ambitious utilities are increasingly seeing infrastructure at the grid’s edge as a revenue opportunity.
Eighteen utilities across the US and Canada have set up their own public electric vehicle charging networks, while at least four have sought regulatory approval to offer resilience as a service – where they would own and manage batteries installed on customer premises. And 27 US states – all on the West Coast or Southeast – have utilities that have deployed microgrids. At the same time as investing in these regulated return assets, many utilities have divested their unregulated businesses, whose investments involve risk.
Those who are in favor of it argue that the infrastructure at the edge of the network is a public good, the cost of which should be borne by all utility payers. Opponents fear that utilities could stifle competition by asserting their market power. Furthermore, it may be difficult to justify taxpayers footing the bill for the property when private capital is willing to finance it instead.
Utilities as operators
An alternative to utilities owning infrastructure at the grid’s edge is the well-established trend of using third-party assets—from residential smart thermostats to utility battery systems—to meet their reliability needs cost-effectively. In bring-your-own-device (BIOD) programs, for example, utility customers can enroll their thermostat, battery, EV charger, EV itself, or even a connected water heater to provide network services to the utility.
As customers continue to adopt distributed energy resources and seek to monetize them, it may become more difficult for policymakers and regulators to avoid the approach of leveraging existing assets instead of compensating utilities to build their own. Jurisdictions that are either electrical islands or face particularly rapid adoption of distributed resources are at the forefront of the move toward alternative regulatory approaches that support this model.
In California, the Public Utilities Commission has ruled that in the future utilities can only invest in the electrical infrastructure behind charging stations, leaving investment in the stations themselves to other companies. The state has also adopted a framework that requires utilities to procure network services from third parties, and is considering fully separating utility revenues from capital investments in a significant regulatory process.
In Hawaii, regulators went even further, adopting a new performance-based rate calculation paradigm that punishes utilities to own generating assets instead of procuring network services from third parties. Other jurisdictions may develop in this direction as they approach their own distributed energy adoption tipping points.
Utilities are motivated, but looking at private equity
Homeowners and businesses are unlikely to be able to finance the significant edge-of-the-grid infrastructure investments needed to decarbonize the grid while enabling widespread electrification and ensuring reliability. That leaves the responsibility – and the opportunity – to private capital markets and public companies.
Unless the conventional regulation that rewards utilities for investing in infrastructure is reformed, utilities will aggressively pursue these types of investments. However, all eyes should be on whether the big private equity funds are willing to step forward. By investing in infrastructure at the grid’s edge, the funds will unmistakably signal to policymakers and regulators that they are ready to finance the energy transition.
Ben will be speaking at Wood Mackenzie’s Grid Edge Innovation Summit in Phoenix, this December. Click here to find out more.
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