The author suggests that smart metering implemented under a poor policy and regulatory regime will turn out to be an expensive folly. Starting from an overview of smart metering business cases, which includes consideration of the allocation of costs and benefits, risks and uncertainties, the article examines the areas in which regulatory policy is most likely to be required and suggests some critical success factors for such policies. This includes consideration of different models for metering responsibility, and different regulatory policies that could apply to those responsible parties.
Energy Market Consulting associates (EMCa) has recently completed an analysis of the cost of a comprehensive rollout of smart metering in Australia . The scope of the work included consideration of different rollout models – a supplier-led rollout, a distributor-led rollout, or a “centralised’ rollout – and consideration of the incremental costs and benefits of a range of smart functionalities that were being considered.
The following diagram, which presents results from the Australian MCE study under one set of assumptions, shows the dispersion of benefits and costs of the rollout. In a distributor-led rollout, the majority of the costs would fall on the distributors, who are also the current meter service providers for the vast majority of customer sites. The avoided meter replacement costs and meter reading efficiencies would accrue to the meter service providers; however results from the study indicate that they are insufficient to make a positive economic case . Taken together with the distributor efficiencies (such as in regard to connect/disconnect and outage notification), the economic case ranges from positive (shown here) to negative, over the ranges considered for the study assumptions. The addition of retailer (supplier) and consumer benefits, while smaller, make the societal economic case for the rollout positive across the range of assumptions tested.
While most studies find the allocation of benefits to be dispersed between different parties, the relative values of different components of the benefits tend to vary widely from study to study, for reasons that are not readily explainable and which in all likelihood reflect the different focus and different judgments of those undertaking the analyses. For example, some studies focus largely on operational efficiency benefits, avowing that demand response and its benefits are too uncertain and too difficult to assess; more recently, given the more widespread acknowledgment of greenhouse issues, there has been a much greater focus on demand response and energy conservation effects. Particularly in regard to “efficiency” benefits, the author has observed that some benefit components that feature strongly in one study are sometimes absent or much less significant in another.
Around the range of outcomes from the studies, there is an even wider range of opinions. The author has observed large differences between assessments by utilities, regulators and governments of what are in effect the same rollout scenarios – enough to make the difference between a significantly positive and a significantly negative case. The uncertainty implicit in this lack of consensus clearly has significant risk implications for any entity that is mandated to undertake a rollout and for consumers who may be required to fund the cost through tariff increases, based on the uncertain assumption that they will reap equal or greater benefits.
The cost/benefit reality will be revealed with time and experience. However the reality for policy-makers now is that smart metering involves technologies whose evolution over the likely lifespan of a meter is uncertain, and whose success is to a large extent reliant on new utility business strategies and resultant consumer behaviour. Ex ante assessments of lifecycle costs and lifecycle benefits must be considered highly uncertain. All the signs point to a need for humility amongst those of us conducting such analyses and a need for caution amongst policy-makers in making policy decisions based on them.
WHY ARE POLICIES AND REGULATION IMPORTANT OR DIFFICULT? WE DO THIS ALL THE TIME…
It is one thing for energy economic analysts to find a net positive benefit for smart metering. It is a short step from there for government and regulatory policy-makers deciding to mandate a rollout or, depending on the regulatory jurisdiction, to endorse a rollout proposal by the incumbent utility, with associated tariff increase.
But what is it that will lead to such a rollout actually producing a positive net value, without particular entities or consumers bearing unnecessary cost or unnecessary risk? Given that there does not typically appear to be a positive business case for any one party to roll out a smart metering infrastructure, how can the incentives of the various parties be aligned such that net societal benefits result? And can regulation achieve this outcome?
A vital factor here is the regulatory model for such a rollout. There are a number of reasons why regulating a rollout using standard utility building block-based incentive regulation wil pose a significant challenge – one that, in the author’s opinion, may result in smart metering being an expensive folly if it is implemented under such a regulatory model:
- First, as noted above, smart metering involves a new technology that will evolve over the next 15 to 20 years in ways that cannot be predicted
- Second, there is, axiomatically, no comprehensive rollout experience in a particular jurisdiction against which cost estimates can be assessed
- Third, the benefits will involve a range of business strategies that are also likely to be unproven – for example, new tariff structures in a particular jurisdiction ; new ways of connecting, disconnecting and switching customers; new ways of managing outages; and other strategies that will make use of the quantum increase in meter, network and customer data in ways that will evolve over the life of today’s rollout of infrastructure
- Fourth, the “smart” functionalities (by comparison with “remote meter reading” alone) involve costs and potential benefits that go deep into the utility and can affect almost every information system and a wide range of business processes. This makes it difficult to untangle an assessment of a smart metering business case from regulatory assessment of the business as a whole.
These issues significantly exacerbate the challenge that regulators are otherwise familiar with in setting utility tariffs. Clearly there is a significant utility risk that costs will exceed estimates, since these are new programmes that are by definition untried, at least at full-scale. On the other hand, there is a significant regulatory risk that costs will be allowed that may be significantly in excess of those required for an “efficient” rollout.
And the benefit risks are probably greater – the range of uncertainty is likely to lead distributors and retailers (to the extent that they are involved in the regulatory case) to be highly conservative. Determinations involving funding through tariff increases on the basis of assumed benefits to consumers are similarly uncertain, though the risks to them may be less transparent. And the realisation of benefits by other parties typically assumes efficient access by those parties to information, processes and control mechanisms that are enabled by smart metering but which may require new systems, protocols, and contractual and regulatory instruments.
The professional and honourable range of views between a regulator and the party responsible for the rollout is likely to be considerable and it is unlikely that the gap can be closed without either commercial blood on the floor or consumers absorbing the cost. It seems preferable to search for ways in which the role of regulation can be confined and to search for ways to make that regulation more effective and less adversarial.
LOOKING FOR MINIMUM-REGULATORY ROLLOUT MODELS
In the author’s view, there is considerable merit in seeking to further explore non-regulated utility models for smart metering rollouts.
Models in which commercial decision-making plays a greater role than regulatory judgments have been applied in Sweden and are evident in the non-mandatory rollout that is occurring in New Zealand. Great Britain is also grappling with ways in which to maximise commercial incentives, and there is strong debate taking place on possible models.
The author considers that a “contestable franchise” model for rollout responsibility has considerable merit. Under such a model, which should not be confused with a distributor franchise, parties would bid for the right to roll out smart meters in a particular area. Requirements for such a franchise would be established in terms of the outcomes required for external parties: for example, performance requirements and standards such as for meter data collection timeframes; interoperability requirements; requirements for access to smart metering functionality by other parties such as for remote connection and disconnection, for outage information and supply quality information – all with associated service levels.
Under this model cost efficiencies and the value of benefits as perceived by the franchise bidding entity, the risks, the value uncertainty and the option value of potential future services and service enhancements can all be captured through the bidding process, following which the incentives and risks lie with that entity. In the author’s view, this model has the potential to minimise the extent to which regulators must make nearimpossible ex ante judgments; minimises the potential for difficult ex post assessments regarding variations between the ex post outcome and the ex ante assumptions; and maintains costand benefit-related incentives that are most likely to result in a maximised net benefit outcome. This also minimises the extent to which consumers effectively underwrite the rollout policy.
A rollout model such as this will also test the competitive advantages of a distributor over a supplier and will provide an opportunity for other parties, such as independent data managers, communications providers, other utilities or other entrepreneurial entities to enter the market either alone or as part of consortia. The corporate flexibility that this model allows may well unlock greater value than models in which any one electricity-sector entity is required to undertake the rollout and provide the smart metering service.
It may be suggested that the same outcomes can be achieved by distributors outsourcing the smart metering infrastructure deployment. However, this is likely to lead only to a reasonably cost-efficient rollout. We say “reasonably” because many aspects of the cost are locked in by design requirements and detailed specifications which are set by the outsourcing party and are therefore not themselves contestable. In the author’s experience, it is these factors that can significantly affect the rollout cost and the party that prescribes them will effectively limit the potential for innovation and set the cost/risk profile of the rollout.
IF WE MUST REGULATE…
To the extent that a rollout of smart metering needs to be undertaken using policy and regulatory instruments, what should such policies cover and what regulatory instruments are likely to prove most effective?
The author suggests the following critical success factors in designing such policies and regulatory instruments:
- Establish policy “requirements” to be imposed on the rollout entity only insofar as these affect other parties.
- This is likely to involve requirements related to market settlement and billing by other parties, and requirements for access to smart metering functionality such as remote connect and disconnect, supply capacity control and load control, and to non-metering data such as supply quality
- Standardisation of meter functionality and interoperability requirements may significantly reduce the cost incurred by other parties whose business processes and systems must each interact. This is also likely to increase the realisation of benefits by those parties. This applies particularly where the sector has been disaggregated and where retail competition applies.
- Standardisation within as wide a jurisdiction as possible will also lead to commoditisation of smart metering infrastructure, with resultant cost reductions and, importantly, improvements in the quality and reliability of smart metering deployments
- As the corollary to this, avoid policy prescription or regulation of aspects that are and should be within the domain of the entity responsible for the rollout.
- For example, if the distributor is to be responsible for the rollout, then it should not be necessary to prescribe if and how it should utilise functionality such as outage notification to improve its outage management performance; or even if it must use this functionality, and the information systems and costs of business process changes, c osts associated with this should be excluded from the smart metering regulatory scope.
- Similarly, in regard to the more sophisticated tariffs and billing possibilities that smart metering enables, and from which demand response and conservation benefits would be expected to flow, the author’s view is that the systems and change management requirements to introduce and manage such tariffs are best assessed by the utility; smart metering per se does not require such changes.
- To support policy decisions, use analytical techniques for decision-making under uncertainty wherever appropriate – eg least regrets and option theory
- Many aspects of smart metering policy require such techniques for sound decision-making, especially given the relatively high costs of the rollout of the meters themselves, and the certainty of advances in communications and data management technologies; commercial and policy decisions need to minimise the likelihood of a need to revisit or, worse, reinstall meters within the timeframe over which costs can reasonably be expected to have been amortised.
- Certain policy decisions made now may foreclose certain options for the future and a small but uncertain investment at the time of the meter rollout can have a significant potential benefit or may mitigate a significant future regret.
- These considerations should also drive decisions on the rollout timeframe. For example, if the net present value of a rollout is positive, then delay has an opportunity cost; on the other hand, decisions made with insufficient information may lead to a more costly rollout, a rollout in which a party is required to take unnecessary risk, or a rollout in which an option for significant future benefits is foreclosed.
- Consider using prototype or phased rollouts as part of the regulatory instrument.
- It is most unlikely that either the responsible party or the regulator will come even close to being able to make a valid upfront assessment of the efficient costs of a rollout or of the extent to which benefits can be realised. The risks for both parties in attempting this are considerable and unlikely to lead to an optimal outcome.
- Regulator involvement in prototype rollouts to test certain rollout processes and their associated costs, or phased rollouts in which the regulator moves progressively from “cost plus” to “incentive-based” as both parties become more knowledgeable, are likely to lead to better regulatory outcomes.
By confining regulatory scope, as indicated in the diagram below, and by improving knowledge and understanding, the regulatory challenge becomes more tractable. Decision theory can help to make the rollout more “future-proof”, thus increasing the potential for future benefits and reducing the risk of significant unanticipated costs.
Taken together, the author suggests that this approach will result in more effective regulation; that is, regulation in which those responsible for rolling out smart meters can be reasonably expected to be “made whole’ for their investment, to not incur risks in excess of normal business risks that can be reasonably managed, and for consumers and other parties to bear costs only to the extent that they can reasonably expect to reap offsetting benefits.
THE (OBVIOUS) CASE FOR EFFECTIVE POLICIES AND REGULATION OF SMART METERING ROLLOUTS
Whilst many analyses show a positive net societal benefit for smart metering, such business cases typically assume a reasonably cost-efficient rollout and the realisation of a wide range of benefits. These benefits typically accrue to a range of parties comprising metering service providers, networks, retailers, consumers and, in some cases, other utilities and potential providers of other low-bandwidth home services. It may be challenging, but it is nevertheless essential, to ensure that this range of parties can realise not only these initiallyassessed benefits but also can harvest additional benefits as the opportunities become apparent over the lifecycle of the smart metering infrastructure.
It is easier to envisage the ways in which a smart metering policy could prove to be an expensive folly than it is to envisage how to achieve an efficient and successful rollout. Any of a number of policy measures, or deficiencies, may lead costs to exceed efficient levels and benefits not to be realised to the extent that was anticipated.
Achieving a successful outcome requires careful consideration of the rollout and regulatory model. Rollout responsibility, ongoing metering service responsibility and the scope definitions for those services need to be defined by considering the regulatory and incentive implications. Standards and interoperability requirements also need to be defined to the extent that this is necessary to enable access by other parties to such services, at reasonable cost.
Above all, the author suggests that it is essential to invest significant effort into developing policies and regulatory mechanisms that will be effective. A rollout of smart metering infrastructure is a very significant investment but one which has many, many components both on the cost and the benefit sides of the equation. Rollout programmes should be given the greatest possible chance of success by ensuring that the policy and regulatory framework for them provides the ingredients for a positive societal outcome and value-positive outcomes – both for the different business entities involved and for consumers.