Wanted: A New Biz Model for Electric Power

There's little return in building big power plants, so utilities are trying out exotic ideas like helping customers conserve electricity

Peter A. Darbee used to dock his three children 50¢ when they left a room without turning out the lights. Now, as CEO of Pacific Gas & Electric (PCG), the former investment banker and high school wrestling champion is trying to save energy on a grander scale. Paradoxically, he is helping his customers to buy less of his product. "When I tell big customers that we actually would be happy if we sell them less electricity, they look at me like I've burned out a few brain cells," says Darbee.

It's a radical departure from the traditional utility business model: making more money by selling more power. And it's not the only challenge to the old ways of doing things. New innovations and technology, such as a smart grid that allows any entrepreneur to be a power generator or a vendor of energy-efficient systems, threaten utilities' monopolies. Their CEOs must scramble to adapt, says Jon Wellinghoff, chairman of the Federal Energy Regulatory Commission (FERC). "You are not making a lot of money anymore building big power plants," says Wellinghoff. "You have to figure out what business you are in."

Here's how a utility can make more by selling less. Instead of spending $2 billion on a new 1,000-megawatt power plant, say, the utility decides to spend $2 billion or less insulating homes, paying customers to install more efficient equipment, and making the grid smarter. Taking those steps would slash power consumption by more than 1,000 Mw, eliminating the need to build the power plant and cutting greenhouse gas emissions at the same time.

Not a Sure Thing

The CEO then takes those calculations to the state public utility commission and makes the case that he must raise electricity rates enough to pay for the $2 billion investment—plus a normal profit—just as he would for a new power plant. If the commission agrees, the utility gets revenue from its investment, and customers' bill may actually go down. How come? Even though the price of electricity will be higher, customers who comply will be using much less power (and those who don't will effectively subsidize those who do). "Energy-efficiency programs cost electricity customers less than half what they pay to help fund a new power project" says Darbee.

In California, PG&E has spent hundreds of millions handing out energy-efficient lightbulbs and performing energy audits for companies to identify potential savings. In return, the California public utility commission has granted PG&E an extra payment representing a share of the energy savings. In Trenton, N.J., as part of a pilot program, workers from the utility Public Service Enterprise Group (PEG) are knocking on people's doors, offering improvements like insulation and energy-efficient light bulbs, all paid for by the company. "We've changed tens of thousands of lights, replaced thousands of thermostats, and done 11 energy audits of hospitals," says CEO Ralph Izzo. Duke Energy (DUK) has won approval in Ohio for a similar program dubbed "save-a-watt" that it hopes to expand to other states. "This is where we will make our money in the future," says Duke CEO James E. Rogers. "The business model fundamentally changes in the 21st century."

The new model isn't a sure thing, though. Duke initially ran into opposition from consumer advocates who charged that the company would make too much money off the energy-saving scheme, forcing Duke to modify the plan. "Some regulators have not yet understood and embraced this," says Darbee. "It really entails stepping through the looking glass, like Alice in Wonderland."

Competition from Small Players

More threatening is the possibility that small, nimble competitors will jump in to work with customers to save energy, thus snaring the profits that come from greater efficiencies. "There are third parties—companies like EnerNOC (ENOC) or Comverge (COMV)—who can do things for customers that are more innovative than what we see from many utilities," says FERC's Wellinghoff. The French national utility, Electricité de France, has already taken a hit. Savings generated by a small company, Voltalis, have cut enough into the utility's revenues that Electricité de France is asking Voltalis to make up some of the deficit.

U.S. CEOs insist they'll do fine in this competition. "We'll have to prove that we can do it cheaper than anyone else, and I think we can," says Rogers.

Utilities will face competitive threats not just on efficiency but also on power generation. Consider the implications of a smart grid. One of the core concepts is that electrons will be able to flow easily in any direction, like information on the Internet. Suddenly it would be possible for Wal-Mart Stores (WMT) to install highly efficient generators and solar panels at its stores and warehouses, both to supply its own energy and to sell electricity on the grid. Or entrepreneurs could develop solar, wind, or other power sources for individual homes and communities.

Loss of Monopoly Status

"This will empower everyone to participate in the energy market," says Alex Q. Huang, professor of electrical engineering at North Carolina State University. Huang foresees waves of innovation in small-scale electricity generation coming along every couple of years, instead of the 40- to 60-year innovation cycle of central power plants. Massachusetts Institute of Technology researcher Daniel G. Nocera is working on a scheme to use sunlight and a catalyst to split water into hydrogen and oxygen, which would allow every home to make its own power. "I'm up to destroying the grid," he says.

CEOs concede this transformation is probably coming—eventually. "I've got to believe that energy production and storage becomes an appliance," says PSEG's Izzo. "It would completely eliminate utilities as a monopoly." So what's left? "Presumably, we then would become the service provider," Izzo says, delivering electricity but actually making less of it.

As a result of these threats, utility industry consultant Roger W. Gale believes, many companies will suffer the fate of the dinosaurs, losing out to creatures that could better adapt to changing climates. "Someone will find a better technology while they are still trying to run the same old units," Gale predicts. David Crane, CEO of NRG Energy (NRGA) in Princeton, N.J., says: "If we are not doing things completely differently by 2030, we will be in a world of hurt."

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