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Unlocking the value of DERs in building the Next Generation Utility

By Walter Rojowsky, PA energy and utilities expert and Zach Pollock, PA energy and utilities expert

The Next Generation Utility will be required to expertly manage and optimize a portfolio of centralized utility and distributed energy resources (“DERs”), enabling a more efficient, cleaner, safer and more reliable electric power system. However, accurate and equitable valuation of the contribution of DERs to the power grid, which is of central importance to this transformation, has proven difficult to achieve at scale so far. 

This is set to change, with the implementation of the New York Public Service Commission’s landmark Order earlier this month that is essentially a call to action for both utilities and DER providers, as it sets a course to better value DERs. 

Historically, various compensation frameworks such as retail rate net energy metering (“NEM”) have been tremendously successful in promoting the rapid growth of DERs. While lauded for providing customers with expanded choice in how their energy is produced, supplied and priced (a central objective of New York’s Reforming the Energy Vision (“REV”) and other leading regulatory reforms), these frameworks have also been viewed by many as unsustainable. 

Analogues from other countries have illustrated similar lessons, albeit through different financial and policy tools. For example, the feed-in tariffs for solar photovoltaics (“PV”) that were fundamental to Germany’s Energiewende, were equally unsustainable and have had detrimental impacts on the country’s wholesale market. Similar stories have emerged from the rapid growth of solar energy in Australia. 

Calling existing compensation mechanisms for DERs “blunt instruments…incapable of taking into account locational, environmental, and temporal values of projects,” the New York Public Service Commission has declared NEM in its current form to be unsustainable in the long-run, and effectively has deemed it a legacy policy tool that does not ultimately encourage overall efficiency of the distribution system and fair allocation of fixed costs (two other objectives of REV). 

While there are parallels to the value of solar tariffs recently approved in other states, the March 9 “Order on Net Energy Metering Transition, Phase One of Value of Distributed Energy Resources, and Related Matters” is the first of its kind to propose this type of framework at scale and provides clarity not just for New York, but for utilities around the country facing a similar confluence of evolving customer preferences, regulatory pressures, and technological advancements.

First, the Order initiates an immediate transition away from the long-standing NEM tariff compensating DER owners, to a new “VDER Phase One” tariff. Under this new tariff structure, mass market customers (i.e. residential and small commercial) seeking to interconnect DERs will be compensated under a “Phase One NEM” rate structure, which is nearly identical to existing NEM, but with one critical modification: compensation for these  customers will now be limited to a 20-year term. Changes for non-mass-market customers, however, will be more pronounced as the Order aims to define and provide compensation to new types of benefits which DERs can provide based at an hourly level.  These customers will be compensated under a new “Value Stack” tariff, limited to a 25-year compensation term, which is comprised of the value that a particular DER provides in:

  1. Energy output, based on wholesale market prices;
  2. Capacity;
  3. Environmental attributes;
  4. Demand reduction and locational relief to the grid.

Second, the Order acknowledges that the potential cost-shifting issues that can be created by those with DERs to those without them, and notes as DERs proliferate that the “further interconnection of projects under NEM is not in the public interest.” Accordingly, the Order places a soft cap in New York for accepting further interconnections of DERs under the new VDER Phase One tariff, the level of which will be designed to ensure that annual revenues for the utility do not decline by more than 2%. The concept of “cost-shifting” has long been a point of contention between utilities and the DER developers, and to the extent that it already exists in New York, it is notable that the Commission has implemented a mitigation. 

Third, the Order recognizes that the existing marginal cost frameworks and cost allocation methodologies are not granular enough to accurately reflect the value (or potential lack thereof in some cases) that DERs may provide to the grid. While one-off projects in leading areas like New York (e.g. Con Edison’s BQDM project) and California (e.g. DRP demonstration projects) have embodied many of the principles of the VDER framework, it is clear that the new “Value Stack” tariff, as proposed in the Order, attempts to take these learnings and apply them to a more scalable methodology, providing long-term certainty to the market. 

Fourth, the Order recognizes that a transitional period is necessary to provide market certainty and allow developers as well as customers sufficient time to adapt to the newly proposed valuation methodologies. The Order allows mass market customers access to the Phase One NEM tariff until 2020 and maintains capacity-based tranches for a Market Transition Credit (“MTC”) for larger projects compensated under the Value Stack tariff, similar to the mechanisms that were collaboratively proposed by the Joint Utilities and several solar developers in April of 2016. The MTC effectively serves as a declining bridge between prevailing retail NEM rates and the Value Stack Tariff. Importantly, the Order also recognizes that technological advancement and provision of more granular data will be integral to fully transitioning to the new Value Stack Tariff.

Finally, and perhaps most importantly, this Order recognizes that the business models of today, for both utilities and DER providers, cannot be the business models of tomorrow. Acknowledging that “existing DER business models are well-established and based largely on net energy metering,” the commission has set forth the impetus for the evolution of the vendor business model. In reference to the electric utilities, the Commission indicated that “the unidirectional grid must evolve into a more diversified and resilient distributed model engaging customers and third parties.” In other words, the Next Generation Utility will emerge as a result of collaborative change (and in some cases trade-offs) by both utilities and the DER providers evolving in concert. 

With this Order, there appears to be recognition that more sustainable policy and regulatory tools are needed to ensure an effective and equitable transition to the grid of the future—one that will provide value to customers, utilities, and the DER providers.

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