Category Archives: Business Models

A Trojan Horse: Time-Varying Rates

A majority of Canadian households and small businesses are in provinces where time-varying rates or peak pricing or rebates are available or proposed, thanks to smart meters installed over the last few years. Tariffs for large business already include a demand charge that makes up a big chunk of their bills, inciting them to have a constant power draw. Many businesses also have critical peak pricing or rebates. Therefore, most of the electricity in Canada is sold to people having financial incentives to not only be energy efficient (i.e., consume fewer kWh overall), but to manage when electric power is drawn from their utility. However, with the possible exception of large electricity users, most customers simply do not want (or can’t) manage the minutia of consuming electricity on an hourly or daily basis. This is to be expected, as it’s a lot of work and inconvenience for little pay: running the dishwater off-peak rather than on-peak may save a dime, but it means noise when people are trying to sleep and emptying it during the morning rush to school or work. Although all the saved dimes may add up to significant dollars at the end of a year, human nature makes us lazy, and we just go on whining about high hydro cost instead.

In aggregate, everybody’s dimes also add up to a lot of money for the society. For most people and businesses, electricity is not something to get passionate about. It is a significant – but not the largest – component in the budget. We mostly notice electricity when it is not there, as we can’t do much without it. Most people don’t know or care how electricity get to them, as long as they can benefit from it and that its rates appear to be fair. The significant yet stealthy nature of electricity makes it the perfect commodity. Electrons have no brand, no color, no flavor. It becomes easy to rationalize outsourcing the management of electricity to a third party if it reduces cost and make our lifes easier.

Time-varying rates and peak pricing or rebates thus create the financial incentives for new energy services to emerge and help individual customers save money – they are a Trojan horse inside the utility castle. Essentially, energy service companies are introducing themselves in the value chain – it’s a form of value-added intermediation, although energy service companies are not allowed to resell in most provinces. In addition to rate arbitrage, the business model of energy service companies leverages the dropping cost of rooftop solar power and energy storage, supported by mass-market smart home devices (for residences) or off-the-shelf building management systems (for businesses) connected over the Internet. Lower electricity costs with cool gadgets and better comfort. Voilà! A competitor is born.

Energy service companies are offering what amounts to a partial substitute for electric utility services. Rooftop solar panels, batteries, smart home thermostats, water heaters and lighting, building management systems, EV chargers, thermal storage and other technologies marketed by energy services companies, engineering firms and solar developersdo not replace mains electricity. However, energy service companies provide financing and remove the complexity of managing electricity rates and provide other benefits such as comfort or backup during outages. In the process, energy service companies capture a decent chunk of the electricity value stream as they turn electricity service into even more of a commodity service. Less energy (kWh) gets delivered by utilities, pushing rates up for all, although few customers will actually go off the grid.

Storms on the horizon. Ouch. That’s competition, and it is new for many in electricity utilities.

Energy service companies are not directly competing with utilities – not like, say, Bell or Telus competing with Rogers or Vidéotron – but it is competition nevertheless – a bit like Bell being in a strange love-hate relationship with Google. In fact, customers must buy still their electricity from their local utility in most provinces[i]. If energy service companies are not direct competition, it has almost the same effect: skimming profitable segments.

Canadian generation, transmission and distribution utilities are affected at different levels and in varying ways, depending on provincial regulations and on their position along the electricity value chain.

One issue is that the tariffs structure for electricity generators and for T&D networks poorly reflects the underlying system cost structure. If rates along the electricity value chain were perfectly set, then utilities should not care if customers shift their energy consumption – after all, that’s the objective of time-varying rates and demand charges. In practice, rates are far from perfectly matching costs. For example, demand charges for small business accounts are typically set for a year or two based on the peak power demand (in kVA) in a past month. This rate structure is essentially a leftover from electromechanical meters where a meter reader would come to a business every month to read energy (kWh) and power (kVA), and then reset the power register on the meter with an actual physical key – the power register would ratchet up until the next read, when they would be reset again. That’s as good as it could be with electromechanical meters, but the maximum demand that was registered didn’t likely coincide with the peak demand on the system. The resultant tariffs structure incites business customers to minimize monthly maximum demand (and, hence, demand charges), but still allow them to draw a lot of power during a system peak, although energy management systems could have reduced demand during the peak and shift it to a different time. Working on behalf of their customers, energy service companies may end up optimizing customer demand around prevailing tariffs to minimize customer charges but may increase overall system costs in the process.

Upstream in the value chain, traditional generators and independent power producers are affected by energy efficiency and demand management initiatives that can potentially reduce energy and power demand of customers. The effects vary depending on the market structure in each province. Contracted generators are less exposed; in Ontario, the “global adjustment” mechanism compensates large generators, while Alberta has a capacity market. However, spot generators may face large variations in prices. Overall, generators are at risk of having stranded assets as energy efficiency improves in the economy and as customers contract with energy service providers to better manage power demand.

Many distribution-only utilities in Canada are partially shielded[ii]. They charge their customers a energy and power rates set by the province and a separate distribution charge that is intended to pay for the costs of their stations and network. The energy and power generation charges are pass-through, and transmitters and generators bear any issues. The distribution charge is often allocated on a per-kWh basis, plus a fixed monthly charge. Because of the per-kWh allocation of their costs, local distributors are somewhat exposed to the vagaries of energy service companies. However, the distributors have more operating costs and lower capital costs than transmitters and generators, meaning that a per-kWh distribution charge is not as far off the mark.

Mid-size municipal utilities also face a different reality than large integrated provincial utilities. Owned by the city, they are accountable local actors, close to their customers (or constituents), using their agility to respond to issues in a way that is just not happening with large integrated utilities. Municipal utilities become instruments of the local mayor and city council, like water, sewers, snow removal and other municipal services. Mayors’ challenges are about their constituents getting sick, having clean water, being warm or cool, holding productive jobs, commuting efficiently, surviving disasters. They see that the local utility supports the needs of a smart city, to be both resilient to face increasing disasters and be sustainable to reduce its environmental impact and to improve quality of life – while being financially affordable. In this context, working with third parties, like energy service companies, just becomes another means to satisfy the needs of citizens and local businesses[iii].

Large vertically integrated provincial utilities face more complex challenges than municipal utilities: the impact of energy service companies on generation can be significant, the feedback loop from constituents to the government and the utility is more tenuous, the customer base has more varied needs, and the integrated utility has a large impact on the finances of the province. Not surprisingly, they tend to prefer to maintain a greater control over the relationship with customers. Whether they can maintain control and reduce choice without antagonizing customers is uncertain, especially when consumers get used to energy service alternatives ranging from large telecom companies to Google and Amazon.

 

[i]       The exceptions are Alberta, the most deregulated market in Canada, and Ontario, although wholesale and retail rates in Ontario are such that about95% of Ontarians choose to buy electricity from their local utility. See https://business.directenergy.com/what-is-deregulation#deregmarketand https://www.oeb.ca/about-us/mission-and-mandate/ontarios-energy-sector, retrieved 20181023.

[ii]      However, municipal utilities in Québec pay large business rates, with demand charges.

[iii]     And, perhaps, in the process, help the mayor get re-elected.