Ben Hertz-Shargel, Global Head of Grid Edge at Wood Mackenzie
The distributed technologies and innovations known collectively as the grid edge will be integral to effectively powering an electrified world. So, where will the capital come from to fund it? And what role will utilities play in its future?
Increasing electrification and the dramatic growth of distributed energy resources, such as rooftop solar, represent a doubling down on society’s reliance on the electric grid. At the same time, natural disasters, extreme weather events, and rising fuel costs are putting unprecedented pressure on existing infrastructure.
Rewiring the grid
Hundreds of billions of dollars will be needed to improve regional and interregional transmission, allowing population and commercial centers to access clean energy produced hundreds or even thousands of miles away, where the natural resource exists. Novel grid-enhancing technologies (GETs) such as dynamic power flow and line-rating technologies will be invaluable to maximize the capacity of transmission lines. Meanwhile, smart metering – a requirement for advanced utility rates, efficient billing, and insights on customer energy use – 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.
Building new classes of infrastructure
Investing in transmission and distribution networks is only the start, however. Customer demands for building and transportation electrification, distributed generation and energy resilience necessitate new classes of infrastructure at the grid edge:
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 required for drivers without access to off-street parking, or while traveling.
Microgrids: Businesses, governments, educational facilities and at-risk population centers are increasingly demanding microgrids to provide backup power when the grid goes down.
Battery storage: “Behind the meter” storage at homes and businesses is increasingly being relied on not only by the end customer for resilience and bill savings, but by utilities as local, low-carbon power capacity when their grid gets constrained.
How will it be paid for?
Annual expenditure on non-traditional grid edge infrastructure is projected to reach US$20 billion by 2026 (see market breakdown below).
Projected 2026 US grid edge market sizes by type
Electric Vehicle Charging Infrastructure (ECVI)
Commercial & Industrial (C&I) storage
A key question is where the capital will come from to fund this new infrastructure? There are three main options: end customers, private capital, or utilities.
Empowering end customers
One option is for homeowners and businesses to own the assets that locally serve them. However, the cost of capital is high for end customers, who are often unable to afford the upfront cost. Furthermore, asset ownership comes with maintenance and operation responsibilities for increasingly complex technology. While this can be contracted out, buying the asset exposes the customer to risks around the performance and lifespan of the asset.
Drawing on private capital
A second possibility is for private equity funds, asset managers and other investors to supply the necessary capital. Investor capital is deployed by developers of distributed energy resources (DER) through what are generally termed “energy-as-a-service” offerings. Under this model, the investor funds installation and holds the asset on their balance sheet, while the customer pays a recurring service fee to use it. It is typically a turnkey solution, with the service fee covering operations, maintenance, and even asset upgrades. Private equity firms and technology suppliers often set up joint ventures, which act as a developer with an enormous balance sheet.
In the microgrid space, market share for this approach has grown from 18% in 2019 to 44% in 2022. Meanwhile, despite lower cost of ownership, the huge upfront price premium for electric vehicles is making the fleet-as-a-service model critical for startups seeking to electrify small commercial vehicle and bus fleets.
An advantage of the energy-as-a-service model for developers is that they are free to monetize the asset by offering sophisticated energy services to the utility or wholesale power market. While these are risky value streams, some developers are willing to underwrite them, reducing the service fees to customers based on expected earnings over the contract term.
Another possibility is to spin off the assets as an asset-backed security, 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 in lieu of selling them the solar system outright.
One challenge is that grid edge infrastructure must compete for capital with costly, large-scale renewable investments. Projects are smaller and riskier than infrastructure funds are used to, while rates of return may not satisfy their risk tolerance – particularly for EV 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
Banking on utilities
A third option is for utilities to fund grid edge projects. In nearly all states, investor-owned utilities (IOUs) are incentivized 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 increasingly see grid edge infrastructure as a revenue opportunity.
Eighteen utilities across the US and Canada have set up their own public EV charging networks, while at least four have sought regulatory approval for resilience-as-a-service offerings – where they would own and operate batteries installed on customer premises. And 27 US states – all on the West Coast or in the Southeast – have utilities that have deployed microgrids. At the same time as investing in these assets which earn a regulated return, many utilities have spun off their unregulated businesses, whose investments involve risk.
Those in favor argue that grid edge infrastructure is a public good whose cost should be borne by all utility ratepayers. Opponents fear that utilities may stifle competition by asserting their market power. Moreover, it may be hard to justify ratepayers footing the bill for an asset when private capital stands ready to finance it instead.
Utilities as operators
The alternative to utilities owning grid edge infrastructure is the well-established trend of leveraging third-party assets – from residential smart thermostats to utility-scale battery systems – to meet their reliability needs cost effectively. In bring-your-own-device (BYOD) programs, for instance, utility customers can enrol their thermostat, battery, EV charger, EV itself, or even a connected water heater to provide grid services to the utility.
As customers continue to adopt distributed energy resources and seek to monetize them, it may become harder for policymakers and regulators to avoid the approach of leveraging existing assets rather than compensating utilities to build their own. Jurisdictions that are either electrical islands or face particularly rapid distributed resource adoption are at the forefront of moving towards alternative regulatory approaches which support this model.
In California, the Public Utility Commission has ruled that going forward, utilities may only invest in electrical infrastructure behind charging stations, leaving investment in the stations themselves to other companies. The state has also enacted a framework that requires utilities to procure grid services from third parties, and is considering fully decoupling utility revenue from capital investment in a landmark regulatory proceeding.
In Hawaii, regulators have gone even further, adopting a new performance-based ratemaking paradigm that penalizes utilities for owning generation assets rather than procuring grid service from third parties. Other jurisdictions may evolve in this direction as they approach their own tipping points of distributed energy adoption.
Utilities are motivated, but watch private equity
It is unlikely homeowners and businesses will be able to fund the substantial investments in grid edge infrastructure required to decarbonize the grid while enabling widespread electrification and ensuring reliability. That leaves the responsibility – and opportunity – to private capital markets and public utilities.
Unless conventional regulation that rewards utilities for investing in infrastructure is reformed, utility companies will aggressively pursue these types of investments. However, all eyes should be on whether large private equity funds are willing to step forward. By investing in grid edge infrastructure at scale, funds will signal unmistakably to policymakers and regulators that they stand ready to bankroll 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.