By Emmanuel Bouquillion and Louis Catala
A quarter of a century ago, the metering industry started to prospect new ways to interact with meters installed on their customers’ sites. This approach was triggered by the attractive perspectives of significant savings and potential markets.
For utility companies, whose activities are closely linked to the advanced metering infrastructure (AMI) business, savings could come from human costs (wages and retirements) and electricity production costs – production during peak hours being 50% more expensive than baseload production. For suppliers of appliances, home builders and industries gravitating around heating and air conditioning equipment, lighting, services, etc., the emergence of new communication standards to ease convergence towards a fully automated house meant new products and services to design, produce and market.
Consequently, in the 1980s, cross-industry partnerships developed to enable technological breakthrough, reach market consensus and promote smart homes in order to turn concepts into meaningful products. The Smart House Limited Partnership (SHPL) was created in 1987. Through its organisation and focus, it targeted new constructions and not existing houses, reducing significantly its potential market. Besides, despite strong support from a broad range of industries, the SHPL never achieved significant results and finally ended in the mid-90s. A few years before, in 1984, the Electric Industry Association (EIA) worked on the emergence of a new standard for home automation – the Consumer Electronic Bus (CEBus). It relied on power lines and in-home electric wiring. As a consequence, it could be used either for new or existing buildings. Nonetheless, the promises of energy management did not meet enough support from the market to make business sense and the consortium failed. Perhaps the market approach was more technology driven rather than customer driven and therefore the developed products never became real market successes. Perhaps also it was too early for the market (both on the supply and demand sides) to fully benefit from the opportunities that home automation offers, mainly because of cheap raw materials in general and energy in particular. Most probably, reality lies somewhere in between.
Recent changes brought back attention to energy savings and home automation
The market’s perception of energy management and home automation has changed recently in western countries. Indeed, the combined effects of climate change, Kyoto protocol enforcement (phase 1 started in 2005 and phase 2 in 2008) and the current oil crisis has entailed a drastic rise in energy prices (e.g. baseload contracts for the current year were quoted below 65€/MWh in January 2008 but are now quoted over 90€/MWh on Powernext – the French power exchange). And not only do the utilities have to pay more for electricity due to high prices of raw materials but now they also have to pay for the environmental impacts of the electricity production.
Normally, in a constraint-free energy market, the end user would pay for all this but given the specificity of the industry (free competition is highly theoretical) and the sensitivities of energy issues (e.g. Enron scandals, blackouts across the US and Europe), the regulators are eager to reshape the market in order to share responsibilities. Two major models are arising from two very different market structures. The first one is highly regulated, the other is more liberal. The former comes from California and the latter comes from France. Surprising? Not so much considering the histories of each industry.
Californian model – practical and efficient mechanisms to enhance energy savings
First, let’s focus on the Californian energy market. Due to high prices in the mid-90s (California was the most expensive state in the US – back then a kWh of electricity cost 11 c against an average of 8.5 c in the rest of the US), authorities decided to deregulate the market by the end of the decade. The Bill was passed in 1996 and the electricity market opened in 1998. In 2000, the electricity crisis burst as a result of poor implementation of deregulation, market manipulation (including the Enron scandal) and, mainly, structural weaknesses. Governor Davis declared the state of emergency in January 2001 and the California Public Utility Commission (CPUC) decided a partial move back to market regulation in September of the same year. The crisis lasted over a year, entailed bankruptcy of the two largest investor owned utilities (IOUs) and cost the state of California about $45 billion. The state of emergency was called off in 2002 and, since then, 39 publicly owned utilities (POUs) and 3 IOUs (San Diego Gas & Electricity – SDG&E, Southern California Edison – SCE, Pacific Gas & Electric – PG&E) serve a monopolistic end-user distribution market.
Obviously, since the utilities benefit from local monopolies, there is a need for market regulation and, as a consequence, the CPUC and the California Energy Commission (CEC) implemented a market decoupling mechanism – the Electricity Revenue Adjustment Mechanism (ERAM). Based on a collaborative approach with the IOUs, the purpose of that mechanism is to separate sales from revenues. At the beginning of the year, the Californian Commissions and IOUs agree on a fair rate of return for service provision and required investments. Then, at the end of the year, if revenues exceed initial agreement, the IOU will give the surplus to the CEC; otherwise, the CEC will pay the IOU so it can get its fair share. Therefore, there is no incentive for the IOUs to spur their sales as it will not spur their net profits.
Besides, in order to get shareholder support, another mechanism has also been implemented to enhance IOU profits: the Energy Efficiency Risk/Reward Mechanism (EERRM). As noted above if there is no incentive to increase sales, there is no incentive to increase energy savings either. The purpose of the EERRM is to correct that flaw from the ERAM by setting the IOUs’ objectives in terms of energy savings (in MWh) and offering them significant bonuses for achievement (and reasonable penalties for failure). The maximum bonus and the maximum penalty are $450 million per year (Figure 1). The intent of this programme is to create a virtuous cycle as total costs are evaluated at $2.6 billion while expected savings reached $5.4 billion for a net profit of $2.8 billion (exceeding total costs, which means a rate of return greater than 100%!). If significant results can be achieved through energy efficiencies requiring only “standard” technologies (isolation, lighting, heat and power combined cycle, etc.), the IOUs know that in the coming years not only is there room for AMI to foster energy savings through enhanced energy efficiency techniques (households and small/home office technical management) and local energy solutions (solar panels, small hydro, biomass power, geothermal power, etc. – see Figure 2) but also there are commercial opportunities to address if one considers that, through AMI, the IOUs will be able to access and interact with several million customer sites. Obviously, it means they will be able to provide a broad range of domotics services, collect meaningful data for market-based companies and broadcast selective commercials to targeted customers. Through enrichment of already huge customer databases, AMI will provide the IOUs with a tremendous opportunity to widen their business model.
Nonetheless, this new business is not the IOUs’ core business and, in a regulated market, they might prefer to focus on what they know best and not take any business risks to address a market that does not really exist in any country.
The French model - combination of complex regulation and free competition
At the other end, the French market is completely deregulated (expect the transmission and distribution system operators, which are natural monopolies) and energy service providers compete with each other for the same clients. However, while deregulation started in 2004 for all professional customers, enforcement of deregulation for individual customers was effective in July 2007. Therefore, there is no relevant insight available a year later about the impact of market opening on strategic marketing position.
Nonetheless, it is observed that energy service providers – both incumbent and new comers – are showing a lot of interest in home automation. Indeed, for new comers, providing new services is an efficient way to differentiate themselves from the others. It becomes possible to build a corporate image, set up an appropriate marketing approach and develop a customer portfolio (an issue that incumbents never had to deal with). Besides, and it is also true for incumbents, selling new services to your customers is not only a very cost-effective way to market them but also an interesting way to prevent your clients from going to a competitor and therefore increasing your customers’ lifetime value (CLV). From a business point of view, it is a key performance indicator (KPI), as normally new comers would need about 1.5 million individual customers to break even, but with appropriate actions to enhance the company’s CLV, the break-even point can be lowered to 1 to 1.2 million individual customers. Such practices have already proven efficient in the banking industry and the telecommunication industry and there are many hints that utilities see a bright future in home automation. In a deregulated market, the perspectives offered in terms of service provision in areas such as energy, water and security were good enough for the French incumbent to create a subsidiary (Edelia) in 2005 in order to commercialise an energy box. The subsidiary recently launched a new phase of expansion after more than three years spent gaining handson experience in that business. In parallel, a newcomer, Poweo, has launched its own energy box.
However, in the French market, there is no equivalent to the Californian EERRM and it is, or at least it should be, a real concern. Indeed, if the EERRM sets up objectives in terms of energy savings and uses significant penalties and rewards to make companies comply with its goals, the system designed in France to favour energy savings – the collection of energy savings certificates – does not plan any reward but rather penalties. Consequently, for the French incumbents (EDF and GDF), if the “incentive” to promote energy savings is mainly to avoid a huge fine delivered by the authorities, not only do they have no reason to exceed expectation but they also get no financial support to engage more deeply in energy efficiencies and renewable energy sources. Besides, collecting those certificates implies a much more complex organisation for French incumbents than simply monitoring the overall sales of energy like the IOUs do in California. Somehow, it seems that French systems can never be both efficient and practical.
Nonetheless, the energy saving certificates system can be a double-edge sword. On one hand, its complexity is a difficult barrier to overcome but, on the other, implanting that system (and it is mandatory) implies reshaping an industry made up of several thousands of tiny businesses: the construction industry and surrounding services (e.g. plumbing). Indeed, to be able to gather the required certificates, the incumbents will need to set up partnerships with reliable actors. This should help establish good practices and quality standards that are more visible. Consequently, individual customers would be able to segregate good and reliable construction companies from the others; resulting in more customers trust (i.e. more business) and higher industry skills. It is difficult to measure how home automation (and through it, AMI) would benefit from the remodeling of the construction industry but given the sensitiveness of the technologies and the significant amount of money individual customers need to invest to get heat pumps or solar panels installed, there is no doubt the impact should be significant. Looking back to California, it can be noticed that the mechanism implemented to monitor energy savings is “too” practical and does not require such effort to reshape the construction industry. Consequently, it will not happen there.
The French and the Californian models would be complementary … if they were not mutually exclusive
The two models discussed show both interesting features and potential pitfalls. If the Californian model provides utilities with financial stability through captive market shares (which is necessary to investment in a new market), the lack of competition is a constraint to move faster towards home automation as it would imply moving from a risk free market to a market that does not exist yet and that could be competitive, making it quite risky. Through competition, the French model provides “incentives” (penalties and scarce market shares) to explore new markets and provide new services but does not provide any financial support to help stakeholders open a path towards new markets (even if providing financial support to a company like EDF that has 30 millions customers could be questionable).
Nonetheless, in both cases, the potential benefits of home automation seem to exceed by far the implementation cost in the medium term (five to ten years). In addition, taking into account the need to replace old meters, the human cost (wages and retirements) of agents in charge of meters reading and the lowering price of AMI – in California, utilities expected smart meters to cost $150 per unit in 2004 for about 15 millions units and, in 2008, ERDF (the main French DSO) expects its smart meter to be as low as €50 per unit for almost 30 millions units – there are many very good reasons for utilities to start investing in home automation technologies.
Demand side: the X factor
But this industry picture would not be complete unless one adds customers to it. Indeed, individually, they will also have to invest to acquire technologies and purchase new services. But will they do it? In a situation where energy prices are skyrocketing, if energy bills are not already a major concern for households, they will be pretty soon. And people can do the math, especially when it comes to their money.
Thus, on both the demand side and supply side of the energy market there are strong signals and meaningful indicators supporting the idea that it is the right time to start deploying AMI to mass markets as a first step towards home automation. Obviously, it will bring in new challenges (communication standards compatibility, deployment cost, expected return on investments and rates of return, etc.) and it will require involvement from industry leaders, research institutes, syndicates, investors and regulators to solve them. However, utilities are facing an even greater challenge: provide cheap, reliable and sustainable energy to a growing number of households in a context of market crisis and climate change. And the evidences that home automation will be key for success are overwhelming.